Financial condition reports a must post Cooper

By Darren Wickham, Mercer retirement, risk and finance business principal
Thu 29 Jul 2010

Superannuation funds should introduce financial condition reports to manage the myriad risks that will need to be addressed post Cooper, says Mercer's Darren Wickham.

It's been over a year in the making, but finally the much anticipated final report of the Cooper review has been handed down.

Although the review is now complete, further change is afoot as Cooper's recommendations are implemented and as industry consolidation continues.

What's more, the risk environment for super funds has altered dramatically in the past few years, with the global financial crisis (GFC) bringing to light a number of dormant risk areas for superannuation funds.

The risk profile will continue to change, particularly as the population ages and the industry approaches a new era of drawdown, where more members will be drawing down from their savings rather than accumulating.

Rapid change in the industry and growth in funds under management mean superannuation funds have become more complex and vulnerable to risk.

Today, the assets and revenue of many industry funds are approaching (and sometimes exceeding) those of mid-sized insurance companies.

Furthermore, the scope of funds is expanding: most large funds offer intra-fund advice, they are developing and managing reserves, developing post-retirement products and in-sourcing more of their operations.

In the post-Cooper era it will be vital funds have all the tools at hand to govern well, both in terms of risk management and strategy.

In light of this, Mercer is calling for superannuation funds to introduce financial condition reports - similar to those required for insurance companies - to manage increased risks and ensure they are positioned to thrive in a post-Cooper environment. But neither funds nor the regulator need to reinvent the wheel to design more robust risk management tools for superannuation funds.

Financial condition reports, which are required for other financial services providers, have already been proven to help general, health and life insurance providers and friendly societies gain a deeper insight into their business and they can do the same for superannuation funds.

A key recommendation of the Cooper review is for operational risk reserves and capital with levels to be determined on a risk-assessed basis. Just like in other sectors of financial services, Mercer believes financial condition reports provide the ideal link between assessing risk and determining appropriate levels of reserves. 

However, unlike other areas of the financial services industry, the Australian Prudential Regulation Authority (APRA) does not require superannuation funds to prepare a financial condition report, with currently only a handful of superannuation funds using them.

This represents a real gap in risk management, especially when you consider the $1.3 trillion of savings tied up in super that belongs to regular Australians. It's time for a rethink on what makes for best practice in superannuation risk management.

Risk management is only part of the benefit of a financial condition report, which can also be used to guide the development of a superannuation fund's business strategy and contribute to good governance.

They give the fund's trustee and executives insights and clarity that may help them identify opportunities and plan for the future. The industry is changing in many ways, so funds must ask themselves: are they up to it? Do they have all the tools to govern well, both in terms of risk management and strategy?

Financial condition reports will provide fund trustees and executives with an objective assessment of a fund's financial condition, today and in the future, by taking into account fund reserves, business strategies and projections of member contributions and behaviour, as well as assess the material risks and issues that could affect the fund in the future.

An analysis of member balances and member behaviour, for example, is particularly important in a post-Cooper review environment as it can assess questions such as what could be the impact of automatic consolidation of small accounts or how important is the retention of funds after retirement? Such data can raise important questions that affect the fund's future planning.

Myriad risk factors facing funds were brought into the wider public domain during the GFC, including liquidity risk, unit pricing errors and investment risk. All types of risks have the potential to impact on the performance and in turn the confidence of members.

Introducing a financial condition report for superannuation funds would act as a measure to ensure all funds are operating with a depth of insight into their current and future financial conditions, and have an appropriate risk management framework in place.

It can also help to ensure funds are operating in best practice to manage certain risks, such as having projections in place to help prepare for liquidity risk.

From APRA's perspective, introducing the requirement for financial condition reports offers several benefits: it provides a sound methodology for testing the adequacy of the trustee's risk management framework and assessing the adequacy of a fund's reserves for various purposes as part of the risk management framework.

The financial condition report also pulls together an assessment of the various APRA prudential practice guidelines into one document, reviewed by an independent, external expert, in effect streamlining the process of assessing the identification and management of risks facing funds.

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