Competitive & Efficient?
Systemic risks to superannuation and the retirement income system
The Productivity Commission has just commenced the second phase of its competition and efficiency in superannuation work, focusing on alternative default models. Competition and efficiency in the superannuation system is rightly a high priority. However important it is to pursue measures intended to increase competition on the demand side of the superannuation system, it may prove to be in vain if there isn’t adequate competition in the supply chain. As the privatisation of NSW state owned superannuation administrator Pillar progresses, caution is needed to ensure that systemic efficiency isn’t derailed by lack of competition in administration.
Superannuation administration is a material component in the superannuation system supply chain. It typically consists of a bundle of associated services including core registry systems, contribution and benefit processing, data and website management, customer services, insurance and claims management, reporting, and risk and compliance services. The past five years has seen a significant investment by superannuation administrators implementing a mandatory automation standard for rollover and contribution transactions. It is hoped that this investment will allow for improvements in operational efficiency and lower fees and costs to members.
The privatisation process of New South Wales State government owned superannuation administrator Pillar Administration is currently underway. Market leading superannuation administrator Link Administration Holdings (Link Group) has announced that they are considering a bid to purchase Pillar. The ACCC has concurrently announced a public informal merger review of the potential acquisition.
A concentrated market
The market structure and composition is important for the purposes of both prudential and competition regulation. Vertical integration is common in the superannuation system, with a slight majority of member accounts administered ‘in-house’ or by related service company within the same conglomerate group. The market for third party administration services is dominated by the Link Group, with Pillar and Mercer providing the only competitors with material market share.
The prospective acquisition of Pillar by the Link Group would result in further market concentration. Link would be likely to administer almost 80% of assets and 90% of member accounts in third party superannuation administration market. While such a picture is bound to raise eyebrows and suggestions that the competition regulator should intervene; the picture doesn’t seem so clear cut if we take a closer look.
The ACCC is required to intervene to block a prospective bid if it determines that the acquisition would have the likely effect of substantially lessening competition in the market. To answer this question, consideration must be given to defining the market, and then assessing the likelihood of substantially lessened competition in this market if Link were successful in their bid.
Defining the market
Market definition will be central to how the ACCC will form a view of the likely effect of the potential acquisition. Importantly, the Courts have emphasised the need for market definition to ‘reflect commercial reality, rather than be driven by economic theory’.
The first question concerns whether self-administering superannuation funds can properly be considered as part of the market? While it is theoretically possible that these funds may choose to enter the market, the commercial reality is that this has not occurred. There are significant barriers for new entrants to the market.
Prudential regulation means that there are important yet costly challenges for a new entrant into the market to demonstrate adequate financial, human and technical resources and business continuity arrangements. Add the costs and efforts in ensuring that any potential conflicts of interest are appropriately managed and the prospect of an in-house administrator entering the market looks even less likely.
Viewed another way, it might be possible to argue that the services which have been bundled together as superannuation administration could constitute a number of separate markets for services which can be unbundled and delivered in a stand-alone manner. In both instances, the challenge lies in sorting the commercial reality from theoretical arguments. It is reasonably clear that the commercial reality is one where services are predominantly bundled together in a single market, and that new entrants or in-house administrators have chosen not to enter the market.
Superannuation fund trustees are required to run a tender or other decision making process when renewing or entering into a contract with a material service provider such as a superannuation administrator. Inherent in the prudential supervision of the outsourcing activities of superannuation trustees is the assumption and expectation of a competitive market for the provision of administration services.
The significant financial costs and operational risks associated with changing administrator make it even more important that competitive forces are retained. However infrequently a change in superannuation administration service provider may occur, robust competitive processes ensure that the arrangements are efficient and competitive.
This is only possible where there is a real possibility of the trustee deciding to change administrator or bring the function in house. The current level of competition is low, however the role that it plays in ensuring that operating costs don’t substantially increase can’t be stressed enough.
Let’s get this right while we still can!
The significant investment in process automation technology by the superannuation industry may never have the chance to deliver operational efficiency if there isn’t adequate competition in the market. At a time where we should hope to see reductions in fees and costs to members, it would be detrimental to the superannuation system and retirement incomes of Australians if this wasn’t realised due to a lack of competition.