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Financial condition reports to manage super fund risk
Superannuation funds should introduce financial condition reports like those required for insurance companies to manage increased risks in a changing regulatory environment and the entering of more members into drawdown phase, according to Mercer.
Superannuation funds have become more complex and vulnerable to risk following rapid growth in the industry and incorporation of advice services, said Darren Wickham, a principal in Mercer’s retirement, risk and finance business.
“The financial crisis brought to light a number of dormant risk areas for superannuation funds. As well, the risk profile will continue to change particularly as the population ages and the industry approaches a new era of draw-down, where more members will be drawing down from their savings rather than accumulating,” Wickham said.
Some funds, which had already prepared financial condition reports, had found that the benefits being paid out were increasing relative to inflows, he said.
“[Funds] need to increase their retention of people’s retirement benefits to keep their cash flow positive, they need a more sophisticated approach to retaining those pension assets,” he said.
There is a gap in risk management in super funds, which now rival insurance companies in size and complexity, and unlike other parts of the financial services industry are not required by the Australian Prudential Regulation Authority (APRA) to prepare financial condition reports.
Only about one fifth of super funds currently use the reports, which would provide funds with an assessment of financial strength, modelling of the fund’s sustainability, a thorough risk review and deep dive stress tests on key areas of risk, Wickham said.
The reports could also be used to guide the development of a superannuation fund’s business strategy and contribute to good governance, he said.
“Financial condition reports provide more than just a risk profile. They give the fund’s trustee and executives insights and clarity that may help them identify opportunities and plan for the future,” Wickham said.
A financial condition report will provide an objective assessment of a fund’s financial condition by taking into account fund reserves, business strategies and projections of member contributions and behaviour, as well as assessing the material risks and issues that could affect the fund in the future, according to Mercer.
AUTHOR
Mike Taylor
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