Australian DC pensions: post-consolidation

The UK defined contribution (DC) pension market is well behind its Australian counterpart in many aspects. In a new series of blogs, we highlight the advancements the Australian DC pension market has made, and what this could mean for the UK in the future. In this first part, we focus on consolidation.

When we talk about DC pension fund consolidation in the UK, Australia’s superannuation system is often held up as an example to follow. The UK market is clearly tracking the Australian market and bilateral conversations between senior leaders in the two countries occur regularly.  

Recent developments in the market’s consolidation and its regulator’s push for innovation in the at-retirement market can be useful in helping to better inform the UK market.

Why does this matter for the UK?

Our focus on Australia ties in with our collaborative global study with the OECD. We have also taken research trips to the US and European countries and garnered insights from the various organisations we are working with globally, including in South America. 

It is clear that each country is looking at all others for the answer to the DC pension problem; no country has found the Holy Grail of a perfect system. We are all engaged in an iterative process, whereby a country implements an idea, the next country builds on that idea, and in-turn the next country further develops that idea. 

But our big focus on Australia was proven to be well placed when, earlier this year, we visited the country for the third time since 2014 to pick up clues as to how the UK DC pension market will evolve. While we travelled just a few hours to get to the other side of the world, it felt as if we are looking 10 years into the future of UK pensions.

We spoke with regulators and pension providers as they approach the industry’s next key moment. It will be something of a turning point – expanding its focus to the retirement income phase. 

While it’s clear we’re following the same path as Australia – in terms of the flow from single trust-based to master trust-based arrangements as well as the consolidation of providers – there are distinct and important differences between the two systems. 

State of the superannuation market

Australian DC reached significant scale some time ago, which has brought some advantages. 

Total superannuation industry assets reached $3.3 trillion on 30 June 2022, according to the Australian Prudential Regulation Authority (APRA). At least three funds boasted more than $150 billion in assets; one of them had more than $250 billion. 

At least thirteen mergers were completed in the year to 30 June 2022, with a further five also in the works. The regulator typically considers funds with less than $30 billion to be small and potentially unfeasible and is putting pressure on them to merge with others — particularly those that are not performing well.

A key nuance in the Australian market is that individuals choose their pension fund, rather than the decision being made by the employer as in the UK. This fixates providers on investment performance league tables, as these are a key element that drives individuals to enrol or switch into their funds, or out of them. 

Additionally, the regulator has put in place benchmarks, or ‘measures’, to protect members. 

If a fund underperforms a measure in a single year, the provider must write to its members to inform them and note they could consider moving their assets to a better performing fund. If the fund underperforms for a second year, it is essentially forced to merge with another provider.

Consolidation – size matters 

Due to the mass consolidation of Australian superfunds, many are now of a size and capacity to make significant allocations to illiquid investments, including in infrastructure. 

For example, AustralianSuper, the country’s largest superfund, receives $10 billion of contributions each year, so liquidity is unlikely to be an issue. 

There will also be further opportunities for the consolidation of Australian superfunds over the next few years. Another mega-superfund is expected at some point, which could be the result of a merger of two large funds or several smaller funds. 

As highlighted by the Chancellor’s last Mansion House speech, the UK Government is keen for UK DC pension funds to replicate Australian superfunds’ allocations to infrastructure. However, certain aspects of the UK market would need to be reformed for this to be successful.

The main arguments against UK DC schemes investing in infrastructure relate to illiquidity, due to their relatively small size and potential for bulk transfers.

Unlike the UK, the bulk transfer of assets is quite uncommon in Australia because, as noted above, it is the individual, rather than the employer or trustees, who controls into which fund the contributions and assets are placed. 

At-retirement challenges

While Australia’s efforts to drive consolidation in the accumulation phase have been a success, the at-retirement phase still requires reform. The largest issue is that people are not drawing enough from their pension pots for an adequate retirement income.

The size of this challenge also needs to be more widely recognised. Almost a quarter (22.3%) of Australian superfund assets are in the at-retirement phase, according to the Connexus Institute’s State of Super 2023 report, which equates to about $0.5 trillion. 

APRA is growing increasingly concerned and is now redoubling its efforts. The regulator introduced the Retirement Income Covenant (RIC) in July 2022, requiring superfunds to have a strategy to assist their members in retirement.

We hope this will lead to much-needed innovation in retirement products by Australia’s superfunds – but there is still a long way to go. We will explore the impact of the RIC in a separate article.