Allen Truslove - Submission to the Super System Review

Allen L Truslove
Actuary & Statistician
ABN 74 080 890 311
19 February 2010
Super System Review
GPO Box 9827
Melbourne VIC 3001
GPO Box 4504
Melbourne, Victoria 3001
Level 31, 570 Bourke St
Melbourne, Victoria 3000
Freecall 1800 198 940
Tel 03 9670 2450
Fax 03 9670 2718
Reception@truslove.com.au
Cooper Review Phase 3 - SMSF Issues
Context
The increase in the number of Self Managed Superannuation Funds (SMSF’s) since the Wallis review should
be seen in the general social context of the continuing development of greater individualism and choice as
opposed to community activities and responsibilities. The extensive application of the “user-pays” approach is
one indicator of the trend. The development of SMSF’s is consistent with and indicative of this change in
community attitudes.
SMSF Administrative and Audit Issues
Most SMSF’s provide for the retirement needs of a husband and wife. Such SMSF’s generally have a simple
accumulation account structure during the members’ working years and provide a simple account based
income stream during retirement. The complications and complexities of the Superannuation Industry
(Supervision) Act and Regulations are largely avoided. The consequence is that administrative requirements,
accounts and audit are generally straightforward. The accounting and audit needs for such simple funds
appear to be adequately and inexpensively met by the average accountant even if they provide such services
for only a few funds. If there are some technical breaches of the SIS Regulations that are undetected then the
problem would be better addressed in the interests of retirees by simplifying the Regulations than by imposing
expensive licensing requirements on accountants and auditors.
Administrative simplicity and low cost is crucial. For an average 8% p.a. return a 1% p.a. cost is equivalent to
tax at an average rate of 12.5% on income and capital gains. For members with a taxable income under
$80,000 p.a. the low tax rate concession is absorbed by fees and the tax advantage of superannuation is lost.
Regulatory Framework
The Australian Taxation Office (ATO) is the regulator of SMSF’s for reasons set out in the Wallis report. The
ATO’s primary function is collection of tax from millions of companies and individuals whose tax affairs range
from the very simple for some individuals to the complex and multinational for some companies. The ATO
has a pragmatic approach that enables it to deal with its diversity of clients without any need, for example, to
advocate that small businesses or their accountants and administrative advisors should be amalgamated to
create economies of scale and ease of taxation administration. This approach appears similarly to be
effective in fulfilling its taxation collection and regulatory responsibilities for hundreds of thousands of SMSF’s.
No change is needed.
The large number and diversity of SMSF’s means that the problems of concentration arising in other regulated
industries are avoided. In the insurance industry for example amalgamation and concentration of industry
participants means that the supervisory workload is reduced. However when a problem arises such as the
collapse of HIH then the effect is significant, noticeable and problematic for government. The diversity of
SMSF’s and the service providers means that such problems are of much less significance.
The responsibilities of SMSF trustees managing their own money differs from the responsibilities of trustees
managing other person’s money. This distinction, identified in the Wallis review that presaged SMSF's, is still
valid. Hence SMSF trustees’ duties are properly less onerous.
Investment Performance
The SMSF structure provides a number of investment advantages:
• Generally investments rise in value over time during a bull market but fall in value quickly when a bear
market occurs. An SMSF can sell quickly in such circumstances. In contrast an APRA regulated fund
must give lengthy notice to members before making significant asset allocation changes.
• The common direct investment approach of SMSF’s avoids the disadvantage of buying tax liabilities
in respect of accrued capital gains within managed investments.
• The common direct investment approach frequently avoids investment management costs.
Cooper Review Phase 3 - SMSF Issues
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• SMSF trustees may invest in higher yielding illiquid investments to the extent assets are not needed
for cash payments. SMSF trustees as members control benefit payment time and size and so have
real control over liquidity needs. This contrasts with APRA regulated funds where members may roll
out their benefits at any time so that liquidity needs are greater.
The observed outcome is that SMSF investment performance is as good as or better than that of other
superannuation industry sector participants.
Given the Cooper report finding that SMSF investment returns are generally higher than competitors the
suggestion that SMSF trustees have low financial literacy is anomalous. The optimum outcome is higher
investment returns, so that “improvements” to change this are unwelcome.
Given the superior investment performance of SMSF’s there is no obvious justification for imposing
investment restrictions, training requirements, or other impediments to continuation of existing superior
performance. Similarly imposition of a custodian requirement would inevitably impose delay in investment
and assets changes that would adversely affect investment performance.
Better SMSF performance in investment return and lower administrative cost belies the supposed benefits of
economies of scale. SMSFs generally provide simple accumulation and account based benefits that do not
involve the complexities that public offer superannuation funds must contend with. This reduces costs.
Competition Issues
SMSF's generally provide their members with control, higher investment returns and lower administrative
expense. SMSF’s also provide competition to industry and public offer superannuation funds in both
investment performance and administrative cost. Imposition of new requirements and limitations on SMSF’s
would lessen these competitive pressures so that expense levels would be likely to rise over the whole
superannuation industry.
SMSF’s are superior to Small APRA Funds (SAF’s) because of greater control, lower cost and the absence of
delay in implementation of investment changes. These advantages warrant preservation.
Self-Insurance and Insurance
At the 99.75% capital adequacy probability of sufficiency required by APRA of life insurance companies, a
death only insurance risk portfolio of about 100,000 lives needs to hold between 150% and 200% of expected
claims cost. (The higher percentage applies to female lives with lower death rates and expected claims cost.)
This reserve would be generated over about 3 to 4 years from premium savings given the claims are 44% of
premiums as stated by Cooper. It would be reasonable to allow large funds to obtain such savings from self
insurance. However, for SMSF’s self-insurance is not feasible because the number of members is too small,
unless there are reserves to cover the risk.
The existence of contribution limits, together with the generally older ages of SMSF members and the high
cost of insurance at those ages, means that imposition of a death cover requirement would reduce assets
accumulated for age retirement. At younger ages SMSF members have been known to hold a nominal
balance in an industry fund to access the relatively cheap insurance cover offered by those funds. There is no
apparent pressing need for compulsory insurance cover in SMSF’s.
Benefit Form - Annuitisation
Baby-boomers comprise the majority of SMSF members. These members are reminded by their parents that
as a precursor to superannuation their parents paid an additional tax during the 1950’s and early 1960’s to a
national pension fund to provide a pension in old age. However that fund was expropriated by the
government in the mid 1960’s and with some sophistry their corresponding age pension entitlement
rescinded. That moral hazard issue was addressed when superannuation guarantee entitlements were
introduced by holding the assets in trusts entirely separate from government. In the absence of any
significant market for annuities in Australia the proposals that government provide age retirement annuities
raises real concerns about the moral hazard involved.
Annuities are not an attractive proposition. For persons around 60 the annuity when expressed as a % of the
purchase price is virtually the yield obtainable on an investment grade bond portfolio without recourse to
capital. SMSF members understandably see no merit in giving up their capital to obtain an income no greater
than that obtainable by direct investment. At much older ages an annuity is more attractive because of the
relatively higher longevity risk. As well, credit risk in an insurance company annuity may be significant and
reduce that attractiveness of an annuity, as the disabled persons with income replacement annuity
entitlements with HIH found circa 2000.
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