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Economics Legislation Committee
30/05/2018
Estimates
TREASURY PORTFOLIO
Productivity Commission

Productivity Commission

[22:24]

CHAIR: Good evening. Thank you very much for the Productivity Commission for appearing and disappearing and then appearing again. We're sorry that we gave you such mixed messages, but I'm very pleased that you're here this evening. Have you got an opening statement for us?

Mr Harris : No opening statement, but thank you for the opportunity of getting on tonight. We appreciate it.

Senator KETTER: Mr Harris, your draft superannuation report is now out. When it is scheduled for the final report to be released?

Mr Harris : On the superannuation report, I'm going to turn to Ms Chester, our deputy, who's shepherded most of this through for quite a substantial period.

Ms Chester : At the moment, our website states that the final report timing is to be determined. That's largely because we're very conscious that there's another commission happening in parallel to us such that we can't be determinative about some of the consultation that we need to go through with the interested parties and stakeholders before we finalise our report.

Senator KETTER: Would that be the royal commission?

Ms Chester : Yes, that's correct. We're the not-so-royal commission, perhaps. We'll be aiming to give it to government by the end of this year—with best endeavours, perhaps November. But we can't be more definitive until we have greater clarity around the royal commission's time lines.

Senator KETTER: If you can't tell me the time frame, what are the next steps between now and the release of the final report?

Ms Chester : In 2½ weeks time we'll have public hearings. Wherever we need to go around Australia we will have public hearings, but at the moment we think they'll largely be in Sydney and Melbourne, given the interested parties that we've had to date. We will then take post-draft report submissions from interested stakeholders and parties. There are three further supplementary papers that we'll be issuing that we identified in our draft report, the first being around some econometric work that we're doing on economies of scale and whether or not they've been fully passed through. The second one is around the fiscal costs and fiscal implications of having insurance within superannuation, which was a request in our terms of reference. When we get some further data from the funds—we wrote to the funds yesterday seeking that further data—we'll be doing some further analysis, and we will also issue that in a third supplementary paper.

Senator KETTER: Your report confirms that there is a performance gap between the retail funds and the industry superannuation funds, which can't be explained by asset allocation. Can you tell us how big the gap is?

Ms Chester : By segment, and on averages, the not-for-profit segment over the period that we analysed over 10 years was on average 6.8 per cent and the retail segment was 4.9 per cent.

Senator KETTER: So just under two per cent?

Ms Chester : Yes.

Senator KETTER: What do you think explains the gap?

Ms Chester : That's going to be an area for further analysis. We did some further analysis, including some econometric analysis, about whether we could attribute it to disparity in fees and scale. With fees it was really around admin costs. There are other characteristics we'd like to look at, and that's why several of the questions in our funds survey were so important. For example, once we get net investment returns by asset class, fees and costs by asset class, and fees and costs for related-party transactions, we'll have a much better handle on understanding what are the drivers behind that systemic difference.

Senator KETTER: Of the top-10 performing funds, how many are industry funds or not-for-profit funds, and how many are retail funds?

Ms Chester : I take it, Senator, you mean top-10 funds in terms of the analysis we did in our overview based on net investment returns over the 10-year period.

Senator KETTER: Yes.

Ms Chester : I'd have to look at the colour of the bubbles. I think it's fair to say that most of them are green, which means they're industry funds. There is one public sector, one retail and, I think, two corporates, including one little unicorn corporate way up high who outperformed everybody. So you're right, Senator: the majority are industry funds, but there's a splattering of corporate, retail and government.

Senator KETTER: Of the worst 10 performing funds, how many were industry funds and how many were for-profit funds?

Ms Chester : From my quick arithmetic here, there are two or three industry funds and two corporates and the rest are retail.

Senator KETTER: In your report you mention that the Productivity Commission undertook a 'novel' approach; that's the word you've used—

Ms Chester : Did you want me to run through the other segment?

Senator KETTER: Which other segment?

Ms Chester : The default segment—we missed that one, with the bubble story.

Senator KETTER: Okay.

Ms Chester : Of the 26 underperforming products in the default segment over the 10-year period there were 26 underperforming products: 12 were retail, 10 were industry, three were corporate and one was public sector.

Senator KETTER: Just going back to my question in relation to the approach you took to asset allocation, you said that looking at this was a novel approach. Are you concerned that both APRA and Treasury have not done work on this matter already?

Ms Chester : It was a novel approach to do it across a system. It's not such a novel approach from an industry perspective. If a super fund trustee board is doing regular performance attribution analysis, they would typically construct such a benchmark portfolio to assess what they bring to the table in terms of overperformance, underperformance or meeting the market. So it's not novel to that extent. It is very novel, and it's a lot of sweat and endeavour from my team over the last six to 12 months, to do it across a system when the data is so poor. That's the novel part of it—doing it across a system. So we're in a situation of being able to compare apples and zebras—funds and products with very different asset allocation.

Senator KETTER: So it's really not that difficult to conduct that type of analysis across the system?

Ms Chester : It's not difficult to do it for a single fund or a single product when you have all the data. It is incredibly difficult to do it across the number of products and funds that we were dealing with over that time horizon when the data is very poor. For example, for the default segment, the regulators only started collecting data by product for MySuper 3½ years ago. If you want to understand the members' experience you need to collect product-level data, and that's what was important to us in our analysis. What we've had to do is take the 3½ years of data that the regulator collects and then purchase data from a ratings agency and literally go through them one by one and match them up and staple them together so we get something a little more longitudinal in terms of long-term performance. Indeed, that's something you and I have discussed several times over past Senate estimates hearings, making sure we could do that long-term analysis to better understand the distribution and composition of the tale, so we've now done that. To that extent it is novel and new. We're not aware of it being done anywhere else globally or in Australia previously.

Senator KETTER: My question is really: why didn't Treasury or APRA do this previously?

Ms Chester : I think that's a question for Treasury and APRA.

Senator KETTER: APRA in particular has responsibility in this area.

Ms Chester : So that would be a question to ask APRA. I think it's clear in our report that we're underwhelmed and a little disappointed with the data that the regulators have retained, and indeed we've said the data the regulators have collected from the industry had two problems. Firstly, they weren't really collected from the members' perspective; they were collected from the funds' perspective. Secondly, some of the data the regulators have received over time are nonsensical and there have been no repercussions of funds providing nonsensical data—for example, zero investment management expenses for listed equities, which doesn't make sense.

Senator KETTER: What types of recommendations and policy options do you think warrant further investigation arising from that?

Ms Chester : We've been quite explicit with what we would like the regulators—we've taken a very forward-looking lens with respect to the regulators, based on our findings. So first cab off the rank is go forth and work out what is the best data to collect. Certainly what we've collected and analysed here, we would expect the regulators to use and do going forward. Indeed, I'm sure we'd be happy, post report, to share the datasets that we've established with them so they can hit the ground running. There's also a policy lens here in terms of what data government going forward would need to inform good public policy. Thus we recommended a task force with Treasury, APRA, ASIC and ATO to lift the tide on data collected by the regulators with input from Treasury through a public policy lens, and also for the regulators to have another look at what data capabilities they have to make sure they have the ability to do that work going forward.

Senator KETTER: Can you elaborate on your criticism of there being too many choices in the choice fund space.

Ms Chester : I think we used the term 'product proliferation' and members being 'lost in the weeds'. There are two angles here. One is that 40,000 options, or 40,000 products, in accumulation does seem to be a form of proliferation such that it would be difficult for any member to do any form of comparable assessment. Even a retired actuary, I think, would struggle to be able to assess products across that range. Indeed, we've heard from financial advisers and financial planners that also struggle. That's one perspective. The other perspective, apart from making meaningful member engagement and meaningful decision-making by members easy, is the cost. We did do some further econometric analysis around the cost impost that that has on members, having so many products with so few members in them.

Senator KETTER: What would you say about the level of competition in this area?

Ms Chester : In the choice segment?

Senator KETTER: Yes.

Ms Chester : 'Unhealthy' is the adjective we used in the report.

Senator KETTER: I'm going to move to a different area—

CHAIR: Senator Ketter, I'm conscious of the fact you've had more than 12 minutes and two other senators have questions for the Productivity Commission. I just wonder whether we should come back to you rather than move on. I'll move on and come back to you.

Senator STOKER: Thank you, Chair. The draft report on super makes a pretty big deal of the importance of avoiding balance corrosion through fees and charges. Can you please outline the findings on the potential impacts of members' retirement savings of fees, duplicate accounts and other charges, including insurance premiums.

Ms Chester : Yes. Wherever we found a problem in our analysis, we try to translate to the member experience through our cameos. Typically our cameos were of a 21-year-old new job entrant—a typical worker with average weekly earnings throughout their lifetime. In terms of fees and costs, to show the downside of compound interest when it's not working well for you through your working life, if you have fees and costs that are 0.5 percentage points greater, or 50 basis points greater, during your working life in an accumulation fund, you would be $100,000 worse off in retirement. In terms of unintended multiple accounts, we did analysis through our fund member survey and using ATO and APRA data to establish that one in three, or 10 million of the 30 million member accounts, are unintended duplicates. That means that those members are paying admin costs and insurance premiums that they don't need. The annual cost of that is about $2.6 billion across the system. When you look at it as a cameo analysis for an individual fund member, that would see them worse off by $50,000 when they retire. In terms of the performance side of the equation, taking a fund member from a bottom performing quartile fund and popping them in a top performing quartile fund throughout their work life, a new job entrant today would be $365,000 worse off when they retire in 2064.

CHAIR: Sorry, if you take them from the worst quartile to the best quartile they would be better off, not worse off?

Ms Chester : Sorry, yes. I was getting ahead of myself in terms of policy changes, doing the flipside of the story in terms of the gains they would make. They'd be $365,000 worse off.

CHAIR: Better off? If they go from the worst performing quartile to the best performing quartile they'd be $365,000 better off?

Ms Chester : Let me say what the cameo is, because I flipped it around at the beginning. Someone who was in the bottom quartile, instead of being in the top quartile, would be $375,000 worse off. The cameo flipside is if you take somebody who has defaulted twice into a bottom performance fund and default them once in a top performing fund, they would be over $400,000 better off in their retirement. I've just got to make sure I don't confuse my cameos. Sorry; it's been a long week.

Senator STOKER: That's understandable. The government announced in the budget a packet of reforms aimed at protecting members' superannuation savings from erosion and reducing duplicate accounts by proactively reuniting them with members where possible. What impact do you expect those changes to have?

Ms Chester : We hadn't done any analysis around those options, because our report was finalised and with government just prior to the budget. That said, I think it's fair to say that there's quite a bit of overlap between those measures and our measures in terms of getting rid of inactive accounts and unintended multiples. So we are all heading in the same direction. The only cameo analysis that we've done is really around the unintended multiple accounts, and that's to do with defaulting only once. The government's package in the budget was more about—I guess the best way of describing it is that the government's measures were about mopping up the mess after it's occurred, and we've got recommendations that closely align with those. In addition to those, and where we did most of our quantitative analysis, it was about preventing the duplication from occurring.

Senator STOKER: Some of the industry have criticised the government's proposals in respect of insurance—in particular, the proposal to make new members under 25 opt in to insurance rather than opt out. I notice the report came to a similar recommendation. Can you explain why the Productivity Commission regarded the opt-in approach as preferable?

Ms Chester : We'd consulted on that quite extensively following on some good work that had been done previously by Rice Warner. Our terms of reference asked us to make sure that members were getting insurance that was value for money. When you look at the needs of the under 25s, it's hard to contemplate a world where having a life insurance policy would be value for money. You are then looking at income protection and whether or not that's something that would be better done on an opt-in basis. It was purely through that lens that we formed that view, prior to the budget, and it was also in the budget.

Senator STOKER: Some of the industry have also criticised the government's proposal to switch off insurance after 13 months of inactivity. Again, your report came to a similar recommendation. Can you talk us through how the Productivity Commission reach those conclusions?

Ms Chester : Again, largely based on consultation. If I recall correctly, that was in the original draft of the insurance code of conduct, which was widely disputed amongst industry funds, such that that was taken out. That's an area where we might refine our thinking. We've had feedback from other interested parties—in particular, Choice—that 13 months may still be too long a period of inactivity. The reason that we arrived at 13 months was informed by consultation around the incidence of people departing the workforce for paternity leave, and that seemed to us to be sensible. But, again, it's a draft report, so I'm sure we'll get some feedback and comments on that recommendation as well.

Senator STOKER: Do you think the government's reforms will lead to better outcomes for members and do you think the government's reforms will materially improve members' overall retirement savings?

Ms Chester : In terms of the budget measures?

Senator STOKER: Yes.

Ms Chester : Given they align with the direction that we're going in our report, and under our act we should be doing all of those things, yes, we do agree.

Senator WHISH-WILSON: Why did you so emphatically rule out—although it was only a very small couple of paragraphs where you talked about it—government ownership of the default super sector?

Ms Chester : A single, government-owned monopoly provider for the default segment?

Senator WHISH-WILSON: Yes. Peter Costello came out and called for this late last year.

Ms Chester : I think it's fair to say that that wasn't a model we would have typically contemplated ourselves, given we were looking at injecting a competitive dynamic into the system.

Senator WHISH-WILSON: I see Peter's laughing!

Mr Harris : No, no.

Ms Chester : That said, others did suggest it to us in the context of our enquiry, separate to suggestions that have been made within the Australian media—professors Barr and Diamond, two very highly respected pension plan academics who have informed Sweden, Norway and other places. So we did contemplate it but we didn't find it was warranted or without problems, and I think we articulated that over several pages, not a few paras.

Senator WHISH-WILSON: I only found a couple of small paragraphs to be honest. Maybe I missed the other pages. I'll go back and have a look. But there was a question about infrastructure—

Mr Harris : There was a clear-cut finding on it. If you turn the pages to 'Findings', you'll find there's quite a specific conclusion on that and the potential implications that might come from it.

Senator WHISH-WILSON: Okay. Could you very quickly say what they were? There was a comment about infrastructure and not trusting them to make the right decisions around infrastructure.

Ms Chester : No, I think our main concern was two-fold. There were three things. Firstly, it gives up on any contemplation of member engagement, even if you made things simpler and safer, and thus you also remove any competitive dynamic. There would without doubt be some form of political or implicit government guarantee on the performance of such a fund.

Senator WHISH-WILSON: Yes. Is that such a bad thing though?

Ms Chester : I think we point out in our report that one of the desirable qualities of the Australian superannuation system when it came about 27 years ago was that there wasn't such a government underwrite of the performance of the system. Indeed, that's the trend that other countries internationally are now following. So we would be having a bit of a groundhog day if we were to go back and do so. The other issue is, if it does bring with it an implicit government guarantee, any government would then want to make sure that single monopoly fund had a very conservative investment strategy such that it didn't underperform in any one year, and that would be at great cost to members, similar to the findings we made about life-cycle products, which take way too much growth off the table. So you would be—it would be similar to taking out—

Senator WHISH-WILSON: Would you say the same for the Future Fund? Don't they just all use IFAs anyway? They outsource their financial advice, as do some industry superfunds, for example.

Ms Chester : The Future Fund has an explicit investment strategy to meet an unfunded liability that the government has given it. So, to some extent, if we were to go down the route of having a government owned monopoly provider, thus with an implicit guarantee that would need to be funded, you would actually be expanding the scope of the Future Fund's need to further fund an unfunded liability.

Mr Harris : The other difference come from, if you were to do a default fund to this purpose, eventually it would have to manage paying out, which would meet a different investment strategy from the Future Fund, which may not have to pay out to individual members in pension phase. So there's quite a different investment strategy that would go with it. The presumption that the Future Fund's quite substantially effective rates of return are driven by exactly the same investment strategy you would use if you were saving for default members is an inaccurate assumption. It would be different. They would run a different investment strategy.

Senator WHISH-WILSON: I understand they would be different. I'd like to get into more detail about that, but I don't have time. But I would like to ask you, Mr Harris: how much longer have you got left with the Productivity Commission?

Ms Chester : That's a good longevity question.

Mr Harris : It is a good longevity question, yes. I'm coming into pension phase. I think I finish 10 September, if I get the whole way through.

Senator WHISH-WILSON: So we won't see you again at estimates?

Mr Harris : Unless there are some really remarkable events, that's probably right.

Senator WHISH-WILSON: Here's a chance to reflect on what your legacies are. Can you tell me what are some areas that you think are unfinished business?

Mr Harris : I'm not generally one for running too many statements of regret, Senator. I did a speech the other night—it's on the public record—about my background in infrastructure, which predates my time at the Productivity Commission. I have a view that we tried in infrastructure and have improved asset allocation and pricing strategies for almost every form of infrastructure, except for roads. That speech is on the public record. It indicates that inevitably we're going to have to go down the path of pricing road access. So I spend my time on that. That's not particularly related to the Productivity Commission; although, we have had a go at it twice in my time.

The Productivity Commission: for the rest of it, I guess, the job is a tremendously important job in my view, and it is important that we have access to pretty good staff who try quite hard. The first best approach to public policy can be difficult for politicians to implement, but, nevertheless, the story should be told from that perspective and then the political overlay can be applied to it. If you absent that kind of first best analysis you really don't have a pole star to aim at. I think that's the job, both at the chairman level and then down through the organisation.

I aspired to do this job because I had previously, in some of my other approaches to microeconomic reform going back 25 and 30 years, actually used the then Industry Commission for exactly that same purpose. When the opportunity came up and Gary Banks was retiring, I thought, 'This is a fantastically important job,' and I'm just pretty much grateful for the chance to have done it for 5½ years. It is the longest period, I might say, that I have ever spent in a job. It was all worth doing, Senator: thank you for the chance.

Senator WHISH-WILSON: Can I ask for your reflections on something? To be honest, when I read it, I didn't think I would ever see this, but this is the APRA report into the Commonwealth Bank of Australia—the Report on the prudential inquiry into the Commonwealth Bank of Australia. In the executive summary, they basically talk about all the problems with the CommBank's culture. They said that there is no simple answer to what has caused this. But they said:

However, a common refrain has emerged from the Panel’s intensive analysis and enquiries over the past six months: CBA’s continued financial success dulled the senses of the institution.

Have you got any comments you'd like to say about—

CHAIR: I'm wondering whether this is a relevant question for the Productivity Commission?

Senator WHISH-WILSON: Yes it is. They do all sorts of—just because you have your own agendas.

CHAIR: Others have other questions.

Senator WHISH-WILSON: I have my 10 minutes and you've got yours.

Mr Harris : Chair, I think I have a reasonable answer to that. We are actually taking that into account in our current inquiry into competition in the financial system.

Senator WHISH-WILSON: That's right.

Mr Harris : Perhaps I could just say that when that report is completed, which has to be before 1 July—that's our drop-dead date for that one—the government will then publish it at its discretion. But that particular report will be taken into account in one of the particular chapters, and will feature, potentially, a recommendation.

Senator WHISH-WILSON: Yes. And I'd like to say on record that I've probably got five or six questions specifically on that report, especially around where the IRB accreditation process can be improved. Some of these questions I've been asking all night, but I understand that we don't have you for very long so we can't really get into any detailed questions. Hence, some of my—

Mr Harris : There will more in the final of that report on the IRB process.

Senator WHISH-WILSON: Can you just tell me when you think that is due to be—

Mr Harris : It has to finish by 1 July. The government then chooses when to publish it, but the government will have it by 1 July.

Senator WHISH-WILSON: Okay, great. I'll give back to Labor; they have a few extra minutes.

CHAIR: Thank you, Senator Whish-Wilson.

Senator KETTER: I had some other questions in relation to the appointment of a Productivity Commissioner focused on Indigenous issues, but in the interests of time I'll ask that they be taken on notice.

Mr Harris : Thank you, Senator.

CHAIR: Thank you to the officers of the Productivity Commission. We'll let you go for the evening. Thank you for staying so—no?

Senator WHISH-WILSON: I did have one question about the Defence Export Facility that has been set up—the $4 billion Defence Export Facility. You've made fairly scathing comment about the lack of success and failures of that kind of approach in the past. Will you be doing any work on this particular area? Or more generally in defence procurement?

Mr Harris : I don't think we have anything programmed to do on that. The comments that we made were in the context of this analysis we do every year on levels of assistance to industry—the TAR report, as it is. But no, I don't think we have anything programmed on that one.

CHAIR: Thank you to the officers of the Productivity Commission. We will let you go and in the last five minutes we will call the Commonwealth Grants Commission.

Senator WHISH-WILSON: Do you want to—

CHAIR: Sorry, Mr Harris, I didn't realise this was your last estimates! Thank you very much for your services, it's been a pleasure.

Senator WHISH-WILSON: Have we got time to thank him?

CHAIR: We'll sing 'For He's a Jolly Good Fellow'! Thank you, you've been absolutely terrific!

Mr Harris : I can't always say it, but, generally, it's been a pleasure!

CHAIR: Good on you!