APRA ensures that financial promises from regulated entities will be honoured in all reasonable circumstances. In any given year over 99.9 per cent of our supervised entities meet their promises. The great majority would have done so with or without APRA, but we are confident that our oversight makes a substantial difference at the margin. Since APRA's founding in 1998, we have helped several hundred regulated entities merge, transfer business, or otherwise exit the industry. Most exits were voluntary but a substantial minority required APRA encouragement and in some cases insistence. Furthermore, our rehabilitation and enforcement teams have overseen many entities who experienced financial difficulties, but have now returned to a reasonable position.
Against several hundred exits and turnarounds without loss, we have experienced eight payment failures: three general insurance groups and five superannuation groups.
Because the superannuation failures to date have involved relatively small funds, a myth has sprung up that superannuation risk is concentrated in small funds. This is regrettably not the case. APRA has discovered and dealt with many prudential problems involving large funds. Just in the past few weeks, for example, we have asked an approved trustee to hand in its licence, and we may make the same request to another approved trustee shortly. We also reached the point of litigation with a corporate fund, before the fund sponsor sensibly decided to address APRA's concerns. The funds involved in these cases were not trivial, amounting to well over one billion dollars.
We have also uncovered at various points operational and other risks, including fraud, in multi-billion dollar funds. So far we have managed to deal with these issues without losses to members or adverse publicity, but there is no guarantee that this will always be the case. It would not be unusual for APRA to have at any one time about 20 funds with more than $10 million in assets rated high or extreme risk. Some of these funds would hold several hundred million dollars in assets, in some cases into the billions. Super funds over all are safe; over 90 per cent are not in the high or extreme risk category, and so far we are remediating perhaps 98 per cent of the funds that are in this category. Big super funds, however, are not exempt from risk, any more than big insurance companies or big deposit takers are exempt from risk.
APRA is mainly concerned with the risks associated with incompetence and inattention, mostly associated with poor investment decisions and poor operational risk management. We also address the blessedly rare cases of criminality.
When APRA was formed we regulated our four industries based on previous practice. Deposit takers were relatively closely and directly supervised, based on regulatory experience from the early 1990s. For insurance companies and superannuation entities APRA relied heavily on auditors and actuaries, as well as on our own efforts.
It has not escaped our notice that APRA has not yet had a failure among deposit takers. In some cases, particularly for smaller super funds, we have had useful assistance from auditors and actuaries, but many failures and near misses have not been accompanied by any useful warning from these external sources. Accordingly, our loss experience is teaching us that APRA must be proactive in both physical and electronic oversight in all our regulated industries.
This was particularly the case in 2002 as APRA, supported by the general insurance reform act, completely relicensed the general insurance industry. We are gearing up to undertake a similar effort in the superannuation industry from 2003. In the interim the Government is considering many suggested reforms to the Superannuation Industry Supervision Act, and APRA will incorporate any reforms into its ongoing work.
There are four major themes in our oversight of superannuation: risk management policies, investment management policies, outsourcing, and ensuring that unfit and improper people are excluded from responsible positions.
The risk management plan needs to focus on operational risks, ranging from fraud through business continuity planning, and including procedures to ensure proper fund accounting and reporting, as well as protection of assets.
The investment management plan should require trustees to make explicit and informed decisions on member time horizons and risk preferences, and matching these in an asset and liability model. The model in turn should define asset allocations and rebalancing and review policies. Fund manager selection criteria, hopefully including considerations surrounding active vs. passive management, should feature in the investment management plan. APRA is considering the pros and cons surrounding a requirement to include a shareholder activism policy; this is of limited value to any one fund but collectively could generate better long term outcomes for fund members.
The risk and investment management plans together need to consider liquidity issues. Liquidity management is likely to become increasingly important to super funds over the next several years.
Heavy reliance on outsourcing is a feature of the superannuation industry. APRA intends to supervise outsourcing more closely than has been the case in the past, and is likely to take an approach similar to the recent standards issued for authorised deposit takers.
Finally our supervisory oversight includes fitness and propriety considerations for the trustees and other critical individuals associated with superannuation funds. As we identify the hopefully rare individuals who should not have access to other people’s retirement savings, we will do our best to remove them from the industry.
To support more intensive supervision APRA has substantially lifted its on-site visit program to approximately 1,000 funds per year. We are also making great strides in improving our statistical returns, and these help us better target our supervisory efforts. When APRA was formed the superannuation industry was evidently under the impression that timely and accurate statistical returns were optional. We are now achieving over 90 per cent compliance on returns, up from well under 50 per cent a few years ago.
It is likely that the total risks to superannuation will be greater in the next twenty years than was the case in recent years. The great bull market is over, so we can no longer rely on excess returns to bail out mediocre investment choices. Complexity is increasing, both in investment decisions and in operational issues such as electronic access. Complexity gives opportunity but also risk.
To offset greater underlying risk, we will have to become better at risk management. For APRA's part we have several initiatives in place to become better superannuation regulators, and I expect you all have plans in place to become better superannuation managers. The most important improvement on the APRA agenda is a cultural change towards more proactive regulation of large entities. It may be a valid criticism of APRA's past that we were good at dealing with small troubled entities, but tardy in responding to trouble signals generated by larger entities. Suffice it to say that we are becoming more inclined to intervene earlier and more forcefully with larger entities, as two approved trustees and a corporate fund have discovered in recent weeks.
In addition to worrying about investment and operational risk, APRA is increasingly concerned with agency risk. We observe the rapid growth of investments generated by so-called independent agents, who in theory work for investors but who in practice are paid by fund managers. At the individual level this is an ASIC issue. At the institutional level, however, entities relying on third party origination tend to three risky behaviours:
- they lose the risk filter provided by truly independent advisers;
- they can grow rapidly, with all the risks that entails; and
- to justify high origination costs, they tend to engage in higher return (hence riskier) asset allocations and more complicated investment strategies.
APRA cannot guarantee that every single super fund is safe. We can state that the industry overall is safe, with well over 99 per cent confidence. We also guarantee that APRA will make every effort to keep increasing industry safety, and we look forward to your cooperation with our efforts.