Working Paper Australian superannuation the outsourcing landscape

Transcription

1 Working Paper Australian superannuation the outsourcing landscape Kevin Liu and Bruce R Arnold 12 July Australian Prudential Regulation Authority

2 Copyright Commonwealth of Australia This work is copyright. You may download, display, print and reproduce this material in unaltered form only (retaining this notice) for your personal, noncommercial use or use within your organisation. All other rights are reserved. Requests and inquiries concerning reproduction and rights should be addressed to: Commonwealth Copyright Administration Copyright Law Branch Attorney-General s Department Robert Garran Offices National Circuit Barton ACT 2600 Fax: (02) or submitted via the copyright request form on the website Disclaimer While APRA endeavours to ensure the quality of this Publication, APRA does not accept any responsibility for the accuracy, completeness or currency of the material included in this Publication, and will not be liable for any loss or damage arising out of any use of, or reliance on, this Publication. Inquiries For more information on the contents of this publication contact: Dr Bruce R Arnold Policy Research and Statistics Australian Prudential Regulation Authority GPO Box 9836 Sydney NSW 2001 Tel: bruce.arnold@apra.gov.au

3 Australian Superannuation: The Outsourcing Landscape by Kevin Liu University of Sydney Bruce R Arnold Australian Prudential Regulation Authority 12 July 2010 Abstract: Utilising a unique dataset compiled by the Australian Prudential Regulation Authority (APRA), this paper examines the outsourcing landscape of the Australian superannuation industry. We show that outsourcing is widespread: All of the 115 funds in our sample outsourced a large number of fund functions, including administration, asset allocation, and investment management. We also find that there are clear patterns of outsourcing for different fund types: Not-for-profit funds are generally more likely to outsource than their retail counterparts, and when retail funds outsource, they are more likely to use affiliated service providers. Acknowledgements: The authors thank their APRA colleagues, including Ross Jones, Charles Littrell, Katrina Ellis, and members of the Superannuation Industry Group, for many comments and suggestions. Kevin Liu gratefully acknowledges the financial support of the Australian Prudential Regulation Authority and the Capital Markets Cooperative Research Centre. Disclaimer: The views in this paper reflect the authors views and not necessarily the views of APRA. APRA does not accept any responsibility for the accuracy, completeness or currency of the material included in this publication, and will not be liable for any loss or damage arising out of any use of, or reliance on, this publication. The authors can be contacted at: kevin.liu@apra.gov.au, bruce.arnold@apra.gov.au.

4 2 Summary Australia s system of superannuation requires employers to make contributions on behalf of their employees to complying superannuation funds. Beneficiaries are entitled both to choose the fund which receives the contributions, and to transfer amounts in their individual accounts from one fund to another. The combination of compulsory contributions and portable balances has created a large superannuation industry a A$1.23 trillion laboratory experiment of global interest. 1 In 2006, APRA compiled a unique dataset relating to 115 large superannuation funds with assets in excess of $200 million. One segment of the data relates to certain outsourcing arrangements across a number of key functions, such as custody and actuarial services, and includes both the identity of the service providers and the fee arrangements. We enhanced the data by determining any affiliation between the service provider and the trustee of the superannuation fund. The dataset provides a rich setting in which to explore outsourcingrelated issues. This paper constitutes a survey of the extent and patterns of outsourcing, while a companion paper, Australian Superannuation Outsourcing: Fees, Related Parties and Concentrated Markets (Liu and Arnold 2010), investigates the fee arrangements for evidence of conflict of interest where superannuation fund trustees outsource to related parties, and of rent extraction where the market for the outsourced function is highly concentrated. 2 Figure 1 shows the level of outsourcing across eight functions, after classifying the funds as not-for-profit or retail. Nominal refers to any formal outsourcing arrangement, whether the service provider is related or independent; effective refers only to arrangements with independent service providers. While not-for-profit and retail funds both outsource, the tendency to outsource most or all of the functions is greater for not-for-profit funds. At the same time, when retail funds do outsource, they were more likely to outsource to related parties. In sum, 67 of 83 not-forprofit funds outsourced six or more functions, while 29 of 32 retail funds outsourced four or fewer to independent service providers. 1 2 As at 31 December 2009, superannuation assets totalled A$1.23 trillion (APRA 2009). Liu and Arnold (2010) also discuss the risks assumed by an outsourcing superannuation trustee, including the burden of monitoring service providers, and the risk that service providers compromise the trust s reputation or compliance obligations.

5 3 Figure 1 NOMINAL AND EFFECTIVE OUTSOURCING BY FUND TYPE ALL FUNCTIONS With specific reference to five functions actuarial services, administration, asset allocation, legal services, and sales and marketing not-for-profit funds show a significantly higher tendency to outsource, particularly when one looks through nominal outsourcing arrangements with affiliated service providers. Custodial services varied from this pattern, as public-offer not-for-profit funds showed a higher propensity to outsource than either their non-public offer counterparts or retail funds. The Australian Superannuation Industry The Superannuation Guarantee Charge Act 1992 (Cth) and Superannuation Guarantee (Administration) Act 1992 (Cth) (collectively, the Superannuation Guarantee ), soon followed by the Superannuation Industry (Supervision) Act 1993 (Cth) (the SIS Act ), gave birth to a comprehensive system of private retirement accounts, funded by compulsory wage- or salarybased contributions, tax-deductible to the employer and held in tax-effective superannuation funds.

6 4 Australian superannuation has a century-long history, and many funds predate the Superannuation Guarantee. Public-sector funds were established to provide pension benefits to certain groups of state and federal government employees; corporate funds, to the employees of a single company; and industry funds, to unionised workers in a single industry. Membership in these three types of funds was both closed and mutually exclusive, thus the funds properly did not consider themselves to be competitors. Retail funds sprang up to cater to individuals not eligible for public-sector, corporate, or industry funds, such as professionals and other self-employed individuals, and to employers not large enough to justify their own dedicated funds. Retail funds also began to gather lump sums rolling out of not-for-profit funds which did not themselves offer post-retirement pensions. The Superannuation Guarantee raised the stakes massively increasing the amount of money flowing into the superannuation system while the SIS Act transformed the competitive landscape. The SIS Act allowed public-sector, corporate, and industry funds to become public-offer funds (SIS Act 18). Not only would these funds continue to safeguard the interests of their established membership, but they could also offer membership to the general public, in direct competition with retail funds. Based on the most recent APRA statistical release, retail funds accounted for 28.1% of the total; industry funds, 17.8%; public-sector funds, 14.0%; and corporate funds, 4.9%. The balance, or 31.2%, was held in self-managed superannuation funds, which are not regulated by APRA. Overall, one-and-a-quarter trillion dollars have been accumulated in superannuation funds (APRA 2009), representing the highest per capita investment of this type in the world. 3 Trusts and Trustees An Australian superannuation fund is constituted in the form of a trust. 4 In most cases, the trustee is a special-purpose corporation, and in common parlance, the directors of the trustee corporation are considered to be the trustees. For the trustee of a corporate or industry fund, the board is composed of a predetermined number of employer-, union-, or member-affiliated representatives. A special-purpose trustee company of this type is run on 3 4 As at the end of June 2008, the AFG Global Funds Management Index calculated that Australians had on average A$62,632 invested in managed funds, the vast majority of which were held through superannuation vehicles. The United States, second in the world, had an average investment of A$39,947 as at the same date. The exception to this rule is public-sector schemes established under various state or commonwealth laws, and run under the authority of the respective government or its delegate under the enabling law. SIS Act 10.

7 5 a not-for-profit basis, thus the only fees charged by the trustee are to cover actual operating costs. For this reason, previous APRA studies have grouped corporate, industry, and publicsector funds into a single not-for-profit category. (See, e.g., Ellis, Tobin and Tracey 2008.) The trustee of a retail fund, on the other hand, typically is a member of a financial-services group such as a bank or insurance holding company. The trust structure makes outsourcing natural. Not only do trustees contract for professional services, but they also use third-party service providers to run the day-to-day business of a superannuation operation. In this regard, though, not-for-profit and retail funds take very different approaches. For not-for-profit funds, this type of outsourcing is a function of minimising member expense. In some cases, third parties can provide services at a cost less than that were the trustees to perform the function themselves. In other cases, several not-for-profit funds join in collaborative ventures, thereby attaining economies of scale without paying third-party profits. Some of these ventures charge fees calculated to cover actual operating costs, while others charge competitive rates but rebate profits to the owner funds (Brown and Davis 2009). Regardless of the exact arrangement, though, outsourcing to a collaborative service provider is intended to decrease members net expense. A third category of outsourcing in the not-for-profit space relates to corporate funds established by financial services firms for their own employees. These funds often use the services of the employer, but the outsourcing arrangement is not intended to benefit the service provider at the expense of the members. This is patently not the case when the trustees of retail funds contract services to affiliates. As the companion paper (Liu and Arnold 2010) has been able to establish, outsourcing to affiliated service providers, particularly in respect of administrative services, can result in significantly higher costs for members. Thus outsourcing does not necessarily reflect whether the trustee has the appetite and/or capabilities to render the service, but for some retail funds might be viewed as part of the business model. Data and Testing Procedures In late 2006, APRA asked superannuation trustees to complete two surveys, one relating to historical investment performance and the other to a wide range of governance issues, including outsourcing. APRA received 187 responses to the two surveys. 115 funds provided data sufficient for analysing five-year fund-level investment performance (see Sy and Liu 2010). Those same 115 funds are examined here.

8 6 In respect of outsourcing, trustees were asked to identify all service providers to whom five per cent or more of any of certain specified functions were outsourced, and to disclose the level of compensation paid to the service provider. We then undertook to enhance the data, by examining the relationship between the service provider and the superannuation trustee. This required us to classify each service provider as an independent party or related to the trustee. Service providers were deemed related if they were owned by the trustee company, or if the service provider and trustee company were members of the same consolidated group. For not-for-profit funds (especially industry funds), related also includes collaborative ventures. We augmented the survey data with information from both an APRA-maintained directory of service providers and quarterly information returns. The net result is what we believe to be a unique dataset, with relevance not only to the superannuation landscape in Australia, but also to any investigation of outsourcing in its own right. Our focus in this paper is to examine the tendency of different superannuation fund types to outsource across eight functions: actuarial services, administration, asset allocation, auditing, custody, legal services, and sales and marketing. For each fund and for each function of interest, we consolidated individual outsourcing arrangements to determine an aggregate level of outsourcing. (For example, if one fund had outsourced fifty per cent of its demand for legal services to one firm, and forty per cent to another, our data shows the fund to have outsourced ninety per cent of the legal function.) Excluding investment management, some 95 per cent of the time the entire function had been either outsourced or retained. A substantial number of the remaining responses showed outsourcing of 90 per cent or more, but less than 100 per cent. This suggested one of two interpretations: In the first case, the trustee may have retained an oversight role to which it had attributed a percentage of the overall function. In the second case, the trustee may have outsourced the entire function, but to more than one service provider. Another set of responses noted that ten per cent or less of a function had been outsourced, which suggests that the trustee had retained almost complete control of the function, but perhaps used a service provider for one or more small tasks. Roughly two per cent of the responses were true intermediate values, most of which referred to the investment management function, where multiple investment managers is more the rule than the exception. We consider trustees to have outsourced all functions where ten per cent or more has been reported (except for investment management).

9 7 Tests of Significance We divided our superannuation trustees into two groups: not-for-profit and retail. We further distinguished the not-for-profit sector by whether the fund featured a public offer ( PO NFP vs NFP, NoPO ). Having converted the superannuation trustees responses into categorical data, we sought significant outsourcing patterns, by function, across the different fund types. Our principal test was Fisher s exact test, 5 which tests the null hypothesis that the probability of a trustee s electing to outsource a given function is not conditional on the group to which the trustee belongs. We also used Pearson s chi-squared test 6 to perform additional diagnostics where indicated. Both Fisher s exact test and Pearson s chi-squared test return a p-value, which indicates the probability that any pattern in the data could have been produced by random variation, rather than a statistical difference in the comparison groups. Detailed Analysis Every single respondent outsourced at least one function, and nearly two-thirds of the funds outsourced six or more. Table 1 sets out the frequency of outsourcing by superannuation fund type: Table 1 NUMBER OF FUNCTIONS OUTSOURCED TYPE OF FUND Nominal (Effective) Not-for-Profit Retail Total Total (3) (8) (24) (29) (18) (1) (5) (6) (11) (7) (1) (2) (5) (6) (14) (15) (25) (31) (18) (1) 115 The analysis below looks at each function separately, and examines whether other factors, such as the number of members or funds under management, influence the pattern 5 6 Sir Ronald Fisher devised this test in the context of 2 2 contingency tables (Fisher 1922). The test has been generalised for larger tables in the form of the Fisher-Freeman-Halton exact test (Freeman and Halton 1951), which is still commonly referred to as the Fisher exact test. Pearson s chi-squared test predated Fisher s exact test by some 25 years (Pearson 1900). The premise of the test is that the differences between observed values and the standardised count (ie, the expected number under the null hypothesis) are approximately normally distributed. Probabilities given by the Pearson s chi-squared test are asymptotic to Fisher s exact test probabilities with sample size large, but are not dependable where any standardised count is less than 10 (or, in a 2 2 table, less than 5).

10 8 of outsourcing. We additionally analyse whether public-offer not-for-profit funds begin to look more like their retail competitors than their not-for-profit colleagues which don t feature a public offer. The nominal and effective outsourcing across all functions and all fund types is summarised in Table 2. Table 2 OUTSOURCING ALL FUNCTIONS, ALL FUNDS Not-for-Profit Nominal (Effective) No PO Public Offer All NFP Retail All Number of funds Actuarial Services 42 (42) 9 (8) 51 (50) 6 (3) 57 (53) Administrative Services 46 (33) 25 (15) 71 (48) 21 (6) 92 (54) Asset Allocation 52 (44) 27 (22) 79 (66) 12 (5) 91 (71) Auditing 55 (55) 28 (28) 83 (83) 32 (32) 115 (115) Custody 36 (32) 26 (26) 62 (58) 19 (17) 81 (75) Investment Management 46 (46) 27 (27) 73 (73) 17 (10) 90 (83) Legal Services 49 (49) 25 (21) 74 (70) 9 (6) 83 (76) Sales and Marketing 5 (2) 9 (7) 14 (9) 4 (0) 18 (9) Administrative Services Where fund trustees outsourced administrative services, there was a strong preference to use a single service provider, as shown in Table 3. The exception is when trustees outsourced to related-party service providers, especially in the not-for-profit sector. This is due to the tendency of collaborative ventures to be established along functional lines. Table 3 TYPE OF FUND ADMINISTRATIVE SERVICES NUMBER OF SERVICE PROVIDERS Nominal (Effective) Total Not-for-Profit 12 (35) 62 (45) 6 (1) 3 (2) 83 Retail 11 (26) 19 (6) 2 (0) 0 (0) 32 Total 23 (61) 81 (51) 8 (1) 3 (2) 115 Joint hypothesis Fisher s exact test p = 0.099* (0.001***). Pearson s Χ 2 (df = 3) = ( ), p = 0.075* (0.002***).

11 9 Two-thirds of the trustees of retail funds (21 of 32) nominally outsourced administration, compared to the 86 per cent of trustees of not-for-profit funds (71 of 83). As Table 4 shows, this difference in proportions is statistically significant, with a p-value of 3.5%. On an effective basis, the difference is even greater: Only 19% of retail trustee outsourced, compared to 59% of not-for-profit trustees p < Within the not-for-profit sector, there is no significant difference in the outsourcing tendencies, either nominal or effective, between funds which feature a public-offer and those which do not. Table 4 COMPARISON GROUPS ADMINISTRATIVE SERVICES COMPARATIVE DIAGNOSTICS Fisher s Exact p-value Nominal (Effective) Outsourced Nominal Effective Retail 21 (6) / 32 Not-for-Profit 71 (48) / ** <0.001*** NFP, NoPO 46 (33) / 55 PO NFP 25 (15) / There are no significant differences in outsourcing administration nominal or effective based on the number of members in a fund, nor are there significant differences in nominal outsourcing based on fund assets. (The regression diagnostics are set out in Appendix 1.) However, in the not-for-profit sector, the larger funds (by both members and assets) show a tendency to use collaborative ventures. As a result, when effective outsourcing is regressed on the size variables, the coefficients are negative (indicating that smaller funds outsource more) and marginally significant. While statistically significant, there is little explanatory value of the finding other than to capture the relative size of the funds in the collaborative ventures. Asset Allocation In a pattern similar to that for Administration, the vast majority of trustees electing to outsource this function did so to a single service provider, as shown in Table 5.

12 10 Table 5 TYPE OF FUND ASSET ALLOCATION NUMBER OF SERVICE PROVIDERS Nominal (Effective) Total Not-for-Profit 4 (17) 72 (60) 5 (4) 2 (2) 83 Retail 20 (27) 11 (5) 1 (0) 32 Total 24 (44) 83 (65) 6 (4) 2 (2) 115 Joint hypothesis Fisher s exact test p = <0.001 (<0.001). Pearson s Χ 2 (df = 3) = ( ), p = <0.001 (<0.001). More than 95 per cent of the trustees of not-for-profit funds outsourced the asset allocation function; roughly one in six of those took advantage of collaborative ventures. (There is no perceptible difference in behaviour between not-for-profit funds based on whether they feature a public offer.) By comparison, only one in three retail fund trustees outsourced asset allocation, and more than half of those did so to related parties. The overall effect, as shown in Table 6, is that retail funds strongly tend to maintain control of this function compared to not-for-profit funds. Table 6 COMPARISON GROUPS ASSET ALLOCATION COMPARATIVE DIAGNOSTICS Fisher s Exact p-value Nominal (Effective) Outsourced Nominal Effective Retail 12 (5) / 32 Not-for-Profit 79 (66) / 83 <0.001*** <0.001*** NFP, NoPO 52 (44) / 55 PO NFP 27 (22) / In the retail sector, the decision to outsource asset allocation is not related to either the number of members in the fund or fund assets. In the not-for-profit sector, the tendency to outsource appears to have a significant inverse relationship with both members and size, i.e., smaller funds outsource more. Given that 95 per cent of all not-for-profit funds outsource in the first instance, though, this finding means simply that the handful of not-forprofit funds which chose not to outsource were larger than their peers. (See Appendix 1.)

13 11 Legal Services Superannuation fund trustees which outsourced legal services did so most often to a single service provider, but with a substantial portion of those roughly one-third used two or more providers. Table 7 TYPE OF FUND LEGAL SERVICES NUMBER OF SERVICE PROVIDERS Nominal (Effective) Total Not-for-Profit 9 (13) 52 (51) 15 (15) 6 (3) 1 (1) 83 Retail 23 (26) 6 (3) 1 (3) 2 (0) 32 Total 32 (39) 58 (54) 16 (18) 8 (3) 1 (1) 115 Joint hypothesis Fisher s exact test p = <0.001 (<0.001). Pearson s Χ 2 (df = 4) = ( ), p = <0.001 (<0.001). The outsourcing of legal services follows the same pattern as both Administrative Services and Asset Allocation. Comparatively fewer retail fund trustees outsourced the function, while an overwhelming majority of not-for-profit trustees did so. Interestingly, the extent to which retail trustees retained effective control is virtually the same across all three functions: In two cases, 9 of 32 retail funds outsourced to independent parties, and in the third case, only 8 funds did so. However, with Administrative Services there was a pronounced tendency to enter into formal arrangements with affiliated service providers. This is consistent with the observation that formal outsourcing by a retail trustee to a related party is motivated more by the business model than by the trustee s willingness or ability to perform the function. As the absolute level of fees for the Asset Allocation and Legal Services functions are significantly less than for Administrative Services, retail trustees have less incentive to enter into formal outsourcing arrangements, as shown in Table 8. Table 8 COMPARISON GROUPS LEGAL SERVICES COMPARATIVE DIAGNOSTICS Fisher s Exact p-value Nominal (Effective) Outsourced Nominal Effective Retail 9 (6) / 32 Not-for-Profit 74 (70) / 83 <0.001*** <0.001*** NFP, NoPO 49 (49) / 55 PO NFP 25 (21) / As with the other services, the decision to outsource generally does not seem to be influenced by the number of members or fund assets (see Appendix 1). The one result of

14 12 marginal significance, that the more populous PO NFP funds tend to outsource less on an effective basis, should be discounted in light of the high propensity of these funds to outsource in the first instance. Custody With the exception of three not-for-profit funds, all superannuation funds utilising third-party custody nominated a single custodian, as shown in Table 9. Table 9 TYPE OF FUND CUSTODY NUMBER OF SERVICE PROVIDERS Nominal (Effective) Total Not-for-Profit 21 (25) 59 (56) 3 (2) 83 Retail 13 (15) 19 (17) 32 Total 34 (40) 78 (73) 3 (2) 115 Joint hypothesis Fisher s exact test p = (0.192). Pearson s Χ 2 (df = 2) = (3.3837), p = (0.184). Unlike Asset Allocation and Legal Services, PO NFP and NFP, NoPO funds did not exhibit the same pattern of outsourcing: Over 90 per cent of the public-offer funds outsourced their custody requirements, while less than two-thirds of the non-public offers funds outsourced. As the following table shows, the non-public offer funds were very similar in their outsourcing as retail funds. When considering the result shown in Table 10, one must also consider that different fund investments entail different custodial needs. Many funds invest in, or give their members the choice of, investment products where custody of the underlying assets remains with the product sponsor. Indeed, of the 17 funds which reported having outsourced their entire investment management function, 12 did not use custodians. Otherwise, however, the regression analysis (see Appendix 1) finds few outsourcing patterns: In the not-for-profit sector, smaller non-public offer funds (especially measured by assets) were more likely to forego third-party custodians, while retail funds with fewer members were also less inclined to use custodians. There was no correlation, however, between the level of direct investing and the use of third-party custodians.

15 13 Table 10 CUSTODY COMPARATIVE DIAGNOSTICS COMPARISON GROUPS Nominal (Effective) Outsourced PO NFP 26 (26) / 28 NFP, NoPO 36 (32) / 55 Retail 19 (17) / 32 NFP, NoPO 36 (32) / 55 Retail 19 (17) / 32 PO NFP 26 (26) / 28 Retail 19 (17) / 32 All Not-for-Profit 62 (58) / 83 Fisher s Exact p-value Nominal Effective 0.007*** 0.001*** *** 0.001*** Sales and Marketing A preliminary examination of the data relating to Sales and Marketing confirms the expectation that non-public offer funds, because of the closed nature of their memberships, would have had little need to market their services. Indeed, of the 55 non-public offer (notfor-profit) funds, only two funds used independent sales and marketing service providers. The relevant comparison, then, is between retail funds and public-offer not-for-profit funds. Table 11 TYPE OF FUND SALES AND MARKETING NUMBER OF SERVICE PROVIDERS Nominal (Effective) Total Public Offer Not-for-Profit 19 (21) 7 (5) 1 (1) 1 (1) 28 Retail 28 (32) 4 (0) 32 Total 47 (53) 11 (5) 1 (1) 1 (1) 60 Joint hypothesis Fisher s exact test p = (0.003). Pearson s Χ 2 (3) = (9.0566), p = (0.029). Overall, there was relatively little outsourcing of sales and marketing, by either type of fund. The striking figure, though, relates to effective outsourcing: Four retail funds reported a formal outsourcing arrangement, and all four were with related parties. As a result, exactly none of the 32 retail funds had effectively outsourced the sales and marketing function. By comparison, one third of the not-for-profit funds nominally outsourced sales and marketing, with two of the 28 funds using related parties.

16 14 Table 12 COMPARISON SALES AND MARKETING COMPARATIVE DIAGNOSTICS Fisher s Exact p-value Nominal (Effective) Outsourced Nominal Effective Public Offer Not-for-Profit 19 (21) / *** Retail 28 (32) / 32 There were no noteworthy patterns to the outsourcing of Sales and Marketing based on the size of the fund. Actuarial Services The passage of the Superannuation Guarantee gave an enormous impetus to definedcontribution schemes, whereas prior to that time most superannuation funds provided defined benefits to their members. Table 13 sets out the distribution of superannuation funds based on their type and the nature of their benefit scheme, and their outsourcing of actuarial services. ( Hybrid refers to those funds incorporating both defined-benefit and definedcontribution schemes.) While some defined-contribution funds employed actuaries (usually in the case where the fund self-insured death or disability benefits), actuarial outsourcing was prevalent where defined-benefit schemes were involved. In all cases where outsourcing occurred, a single actuarial firm provided the service. Table 13 ACTUARIAL SERVICES OUTSOURCING BY BENEFIT SCHEME TYPE OF FUND Defined Benefit Hybrid Defined Contribution Total No Public Offer NFP 3 (3) / 5 32 (32) / 33 7 (7) / Public-Offer NFP 1 (1) / 1 3 (3) / 3 5 (4) / Retail 4 (2) / 7 2 (1) / Total 4 (4) / 6 39 (37) / (12) / Looking only at funds managing defined-benefit schemes, nearly all not-for-profit funds outsourced actuarial services. Although the sample size is relatively small, this preference was not shared by retail funds.

17 15 Table 14 COMPARISON ACTUARIAL SERVICES COMPARATIVE DIAGNOSTICS Fisher s Exact p-value Nominal (Effective) Outsourced Nominal Effective Retail 4 (2) / *** 0.001*** Not-for-Profit 39 (39) / 42 There is no evidence of correlation between fund size (members or assets) and the decision to outsource Actuarial Services. Investment Management Survey respondents were asked to identify all service providers to whom five per cent or more of any of certain specified functions were outsourced; Investment Management is the category which seems to be most affected by the five-per cent threshold. Twenty-five of the 115 funds reported that they had no outsourcing arrangements in respect of investment management. However, APRA s regularly collected data shows that all 115 funds reported that they had outsourced some or all of the investment activities, and only 27 funds reported that they self-managed more than ten per cent of their assets. One possible explanation is that the 25 funds reporting no outsourcing of Investment Management used multiple managers, but none for more than five per cent of the respective fund s assets. For the purpose of this study, we used the regularly collected data for the level of nominal outsourcing, and subtracted all reported related-party arrangements to determine the level of effective outsourcing. Table 15 INVESTMENT MANAGEMENT NUMBER OF SERVICE PROVIDERS TYPE OF FUND Nominal (Effective) Did Not Report Total NFP, NoPO 3 (3) 8 (9) 14 (13) 21 (21) 9 (9) 55 PO NFP 3 (4) 4 (3) 9 (9) 11 (11) 1 (1) 28 Retail 9 (3) 2 (1) 5 (5) 1 (1) 15 (22) 32 Total 15 (10) 14 (13) 28 (27) 33 (33) 25 (32) 115 Based on APRA s regularly collected data, the average level of direct investing was approximately five per cent for the retail funds and eight per cent for the non-public offer not-for-profit funds a statistically insignificant difference. On average, the public-offer

18 16 not-for-profit funds directly invested almost twenty per cent of their assets, which proves to be significantly different from the other fund types. 7 Table 16 shows a breakdown of funds by type and level of direct investment. Table 16 TYPE OF FUND LEVEL OF DIRECT INVESTMENT (INCLUDING AFFILIATED INVESTMENT MANAGERS) Number of Funds <1% 1 10% 10 20% 20 65% 65 99% 100% No Public Offer NFP Public-Offer NFP Retail Auditing APRA requires superannuation funds to retain independent auditors; all 115 respondents reported that they had complied with this requirement. The only pattern of note is that retail funds almost invariably used a single auditor, while more than a quarter of not-forprofit funds used multiple auditors a proportion that is unaffected by whether the fund features a public offer. Table 17 NUMBER OF SERVICE PROVIDERS AUDITING TYPE OF FUND Nominal = Effective Total Not-for-Profit, No Public Offer Public Offer Not-for-Profit Retail Total Joint hypothesis Fisher s exact test p = Pearson s Χ 2 (df = 4) = , p = Conclusion Among our universe of 115 large superannuation funds, outsourcing is widespread, so much so that selecting, monitoring, and managing service providers in many cases has become the trustees main function, and the remuneration of service providers has become the fund s largest cost. In respect of the investment management function, superannuation 7 This is consistent with APRA (2007) which shows direct investment by retail funds of 3.5% and by not-forprofit funds of 18.7% (all funds >$100 million).

19 17 funds are essentially funds of funds, where the large majority of the managers of the underlying funds seek commercial profits. In respect of of the other functions, there are clear patterns of outsourcing for different fund types, as shown in the Table 18: Retail funds are considerably less likely to outsource a tendency more pronounced when one looks through outsourcing arrangements with affiliated service providers. The findings of the companion paper to this survey, Liu and Arnold (2010), support the hypothesis that outsourcing by not-for-profit funds is driven by functionality and/or cost-efficiency, while outsourcing by retail funds is integral to the revenue model. Table 18 FISHER S EXACT TEST PROBABILITIES NOMINAL (EFFECTIVE) FUNCTION Comparison Group Actuarial (funds with defined-benefit component only) Administrative Services Asset Allocation Custody Legal Services Sales and Marketing (publicoffer funds only) Not-for-Profit vs Retail 0.031*** (0.001***) PO NFP vs NFP, No PO 0.035** (<0.001***) (0.642) <0.001*** (<0.001***) (1.000) PO NFP vs Retail NFP, No PO vs Retail *** *** (0.126) (0.001***) (0.661) (0.001***) <0.001*** (<0.001***) (0.116) (0.003***) As Appendix 1 shows, the decision to outsource generally was not related to fund size, except that smaller not-for-profit funds tended to outsource Asset Allocation more frequently.

20 18 References Australian Prudential Regulation Authority, Celebrating 10 Years of Superannuation Data Collection , APRA Insight Issue Ellis, Katrina, Alan Tobin, and Belinda Tracey, 2008, Investment Performance, Asset Allocation and Expenses of Large Superannuation Funds, Working Paper, Australian Prudential Regulation Authority. Fisher, RA, 1922, On the interpretation of Χ 2 from contingency tables, and the calculation of P. Journal of the Royal Statistical Society 85, pp Freeman, GH and JH Halton, 1951, Note on exact treatment of contingency, goodness of fit and other problems of significance, Biometrika 38, pp Liu, Kevin and Bruce R Arnold, 2010, Australian Superannuation Outsourcing: Fees, Related Parties, and Concentrated Markets, Working Paper, Australian Prudential Regulation Authority, [date]. Available at [website]. Pearson, Karl, 1900, On the criterion that a given system of deviations from the probable in the case of a correlated system of variables is such that it can be reasonably supposed to have arisen from random sampling, Philosophical Magazine 50, pp Sy, Wilson and Kevin Liu, 2010, Investment Performance Ranking of Superannuation Firms, Working Paper, Australian Prudential Regulation Authority.

21 Appendix 1 Table A1 OUTSOURCING REGRESSED ON NUMBER OF FUND MEMBERS, FUND ASSETS T-stat Probability of > t Pearson s R 2 Administrative Services Asset Allocation Custody Legal Services Sales and Marketing Actuarial Services Not-for-Profit, No Public-Offer Public-Offer Not-for-Profit Retail Members Fund Size Members Fund Size Members Fund Size Nom Eff Nom Eff Nom Eff Nom Eff Nom Eff Nom Eff * ** *** *** <0.001*** 0.025** 0.022** 0.029** ** 0.009*** 0.007*** * 0.100* * **

22 Telephone Website Mail GPO Box 9836 in all capital cities (except Hobart and Darwin) SA_WP_ASOL_072010_ex