Since 2012 the Australian Prudential Regulation Authority's (APRA) scale test has hung like the "Sword of Damocles" over the nation's underperforming superannuation funds but there has not been a lot of action.
Earlier this year APRA's Deputy Chairman, Helen Rowell suggested the regulator was about to finally "turn up the heat" on the industry laggards which could herald a wave of consolidation among the sector's smaller players.
This might sound drastic but considering most Australians' largest investment outside their family home is their superannuation savings, a few underperforming funds going under would have a catastrophic effect on many people's retirements. A small fund failing is far different from a small business going to the wall.
Yet despite the regulatory pressure just 16 per cent of funds who participated in Mercer's 2020 Super Fund Executive Report Change or be Changed nominate consolidation as a strategic priority for their fund – even though 68 per cent believe there will be consolidation of funds.
Now while APRA has indicated some funds might be forced to merge in a bid to lift their performance and to cut their costs to serve, there are better options out there for smaller funds.
According to the chief executive officer of the Association of Superannuation Funds of Australia (ASFA), Martin Fahy, merging to achieve scale does not necessarily generate economies of scale. He says it's the "learning effect" which can improve the sustainability and performance of a fund.
Moreover, he suggests Australia has many smaller funds with their own specific identities across a range of professions that would suffer from a merger with a larger fund.
Mercer Australia's CEO, Ben Walsh agrees. While acknowledging mergers of equals can be good, the difficulty for smaller funds is "how do they keep their identity and look after their members".
"Smaller funds can be subsumed by a larger fund and have their brand identity diluted. You have to remember smaller funds are passionate about their members and their services offering," Walsh says.
"The problem for many smaller funds is 56 per cent of those with billion dollars or less invested are in a net cash outflow position. They have been working their organic growth programs very hard but this is difficult without scale. The challenge is essentially grow or fold."
Yet rather than be forced into a merger, Walsh suggests funds could look for partnerships. He says multi-service outsourcing gives funds scale.
"Outsourcing is not a new thing but [in the past] funds have sometimes fragmented their options with multiple suppliers. This can make it difficult to maintain a fund's brand, so an alternative is to find one partner and outsource the non-core or non-brand and non-trustee aspects of the fund."
According to Mercer's analysis, mid-size funds can reduce their cost to serve by 20 and 50 per cent by working with one partner.
"This is dramatic, it is a step change. All it requires is for a super fund not to fragment their spend but to find a partner who understands their fund and essentially can be the intelligence inside the fund enabling them to achieve their strategic objectives," Walsh says.
"Brand identity is critical and trustee and governance structure is critical."
Walsh cites Mercer's partnership with Virgin Money which has seen the bundling and packaging services together enable them to reduce their end price to the average member from $553 to $333 a year – a 40 per cent reduction.
According to Greg Boyle, CEO, Virgin Money Australia, the partnership between Virgin Money and Mercer is a good example of being able to maintain the fund's individual brand identity while also reflecting the benefits of a traditional merger.
"It is a true partnership with all aspects jointly agreed and each organisation has clear areas of responsibility. Virgin Money takes the lead on brand, marketing and new customer origination whilst Mercer drives product and portfolio engagement and retention. Throughout all aspects, we work closely with Mercer to ensure that we are delivering a Virgin experience to our superannuation customers," Boyle says.
Walsh says it's a win-win for members and the fund.
"Hubbing that back end allows the infrastructure partner to be the catalyst for innovation. Pooling the resources allows smaller funds to be a little more agile and to reinvest more in their customers and in innovations such as their digital experience," Walsh says.
In the case of Virgin Money and Mercer's partnership, Boyle says it gives customers an enhanced product offering, Mercer's best-in-class superannuation capability (including leading online account management and member engagement) and market-leading product design and customer experience.
"We also offer customers free simple super advice."
Importantly, Walsh says, partnerships such as the Virgin Money and Mercer tie-up is an additional arrow in the quiver for executives focused on keeping their costs down and delivering the best returns to their members. "Identifying the right partners that can bring all the different capabilities together is where the magic can happen," he concludes.
This article orginally appeared in The Australian Financial Review.