Uplifting superannuation trustee capital using risk-based capital management

Developments in the super landscape

The superannuation industry has continued to evolve in the eight years since APRA introduced its key risk-based reserving requirements through Superannuation Prudential Standard 114: Operational Risk Financial Requirement. Industry consolidation, coupled with the continued growth in superannuation assets, has led to larger APRA regulated funds. At the same time, there has been an increased regulatory focus on enhancing long-term member outcomes, in addition to the long-standing Superannuation Industry Supervision (SIS) Act requirement of acting in members’ best financial interests.

A key governance-related regulatory change to the SIS Act following the 2018 Royal Commission into Misconduct in the Banking, Superannuation and Financial Services prohibits superannuation trustees from being indemnified out of superannuation fund assets in the case of penalties and fines. This change will lead to trustee entities (as opposed to the fund for which they are trustee) needing to have trustee capital or access to non-fund related capital or insurance.

With the growing sophistication of superannuation entities and the governance of the superannuation funds for which they are trustee, there is an opportunity for the superannuation industry to better integrate the requirements of current risk management and reserving standards into an overarching RBC Management (RBCM) framework that can help drive long-term member outcomes.

Uplifting trustee RBCM through a single integrated framework

A working group commissioned by the Actuaries Institute’s Superannuation and Investment Practice Committee (SIPC) has explored the interplay between superannuation trustee risks and capital requirements. The Working Group noted that the RBC policy structure of many trustees is typically fragmented and lacks a framework to link together risk and capital management. An RBCM framework pulls together into a unified structure the processes and systems that can ensure a tight link between trustee entity capital and risk management.  Such a framework brings together the current incumbent regulations and legislation, the trustees Risk Management Framework, and key reserving and capital management related policies to be applied in a much more cohesive way.

The working group discussed the extent to which undertaking a trustee’s SPS 114 responsibilities might be enhanced by managing through a more integrated RBCM framework. Currently, SPS 114 defines the superannuation trustee reserve for operational risks. This standard requires trustees to hold a reserve equal to an Operational Risk Financial Requirement (ORFR) target. The target is set out by the trustee and expected to be calculated using a straightforward approach whilst being equivalent to at least 0.25% of funds under management. The working group noted situations where trustees have set the ORFR target at 0.25% of funds under management, treating the annual review process as little more than a compliance exercise and missing the opportunity to use the annual ORFR review to facilitate a rich discussion around the impact of operational risk management on member outcomes.

ADI/Insurer ICAAP and relevance to superannuation trustee

The working group considered the internal capital adequacy assessment process (ICAAP) currently applied by other APRA regulated industries to ensure risk and capital management is appropriately linked and used it as a reference point to explore what might be the components of an uplifted superannuation RBCM framework. Whilst the working group noted the fundamental differences in the financial risks, a bank or insurer needs to manage compared to a superannuation trustee, it also noted there are similarities with respect to operational and conduct risk exposure for example. It concluded that the ICAAP components are generally relevant to a superannuation trustee, and when adopted by a superannuation trustee as part of an integrated RBCM framework would assist to strengthen the application of existing superannuation regulatory requirements. The working group did not necessarily see it as important that ICAAP be introduced as a new superannuation industry regulatory requirement.  

Taking the first step – other practical RBCM examples

In addition to the earlier mentioned step of developing an overarching integrated RBCM framework, the working group also discussed how integrating key elements of an overarching RBCM strategy and framework into the annual strategic business and member outcomes assessment (SPS 515) might be an easy way to lift the profile of RBCM within a super trustee. Other practical examples were considered in relation to introducing greater RBCM style analysis into the annual review of the ORFR target required under SPS 114, and the use of scenarios to test the adequacy of both financial and contingent sources of trustee capital.

Conclusion

In conclusion, a successful uplift to trustee RBCM would see SPS 114 form part of a broader strategy, allowing easier compliance with any future changes to regulatory requirements. Further, such a framework would provide a more structured approach to help resolve capital management challenges as and when they arise, such as the current issue of trustee indemnity from superannuation fund assets if a material fine were received. More generally, an RBCM framework will help provide greater decision-making clarity and governance in relation to the use of a capital reserve under different circumstances. The working group invites participants from the super industry to join the conversation on how a superannuation trustee entity might use a more integrated RBCM framework to enhance long-term member outcomes.

We encourage readers to reach out to Peter Cominos for a copy of the working groups draft paper, that further explores the topic of superannuation trustee capital and which we intend to present at the upcoming 2022 All-Actuaries Summit.

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