Background

The regulation by APRA of Approved Trustees and of funds registered under the Superannuation Industry (Supervision) Act 1993 (SIS Act) is the subject of this performance audit. In light of public attention on some recent superannuation fund failures, there has been an increasing focus on regulation of the superannuation industry. Recent reviews have concluded that the current prudential regime for superannuation, which has remained largely intact since the SIS Act was introduced, is generally sound and effective. In late 2002, the Government announced a package of reforms intended to improve fund governance and trustee competence, give the Australian Prudential Regulation Authority (APRA) powers that support more proactive and preventative action, and improve disclosure of information, particularly to fund members.

Superannuation funds are regulated primarily by the SIS Act. To become a regulated superannuation fund and qualify for concessional tax treatment, a superannuation fund has to elect to be regulated under section 19 of the SIS Act. The Australian Securities and Investments Commission (ASIC) is responsible for regulating disclosure, consumer protection and member complaint provisions under the SIS Act. Responsibility for supervising superannuation funds is shared by APRA¹ and the Australian Taxation Office (ATO), as follows:

• Since 1999, the ATO has supervised small, self-managed superannuation funds. There are approximately 231 000 such funds with assets of some $100 billion. They represent some 95 per cent of superannuation funds.
• APRA is responsible for the prudential supervision of 160 Approved Trustees and 12 429 funds registered under the SIS Act. At 30 June 2002, these funds held at least $328 billion in members' funds.

APRA has undergone considerable organisational change since its establishment in July 1998. Initially, it incorporated staff from the Insurance and Superannuation Commission (ISC), the Government Actuary's Office and banking supervisors from the Reserve Bank of Australia. In July 1999, APRA gained responsibility for supervising credit unions, building societies and friendly societies and staff of State regulatory bodies were bought into APRA. In August 1999, APRA restructured its supervisory functions into two divisions (Specialised Institutions Division or SID, and Diversified Institutions Division or DID).

SID and DID comprised 64 per cent of APRA's staff as at 30 June 2002. Each division is responsible for supervising financial entities in each of the deposit-taking, insurance and superannuation sectors. Under the new arrangements, these two frontline divisions are supported by specialist units from the Policy Research and Consulting Division, who conduct on-site visits to institutions in conjunction with SID and DID supervisors. Simultaneously, APRA consolidated its head office in Sydney, losing experienced staff in the process. In April 2000, APRA started transferring the records of some 180 000 self-managed superannuation funds to the supervision of the ATO, and the Government Actuary's Office moved to the Department of the Treasury (Treasury). More recently, there have been a number of changes in senior staff and, in the wake of the HIH Royal Commission, the replacement in July 2003 of the APRA Board and Chief Executive Officer with an executive of three APRA members appointed by the Treasurer.²

SID supervises institutions whose activities are mainly in one of the categories of deposit-taking, insurance or superannuation, and where those activities are predominantly within Australia. It is responsible for supervising 4 402 superannuation funds with $162 billion in assets and 96 Approved Trustees licensed under the SIS Act.

DID is responsible for the supervision of functionally diversified groups that operate in more than one APRA regulated sector (deposit-taking, insurance, superannuation), and those with international links. It is responsible for supervising 6 093 superannuation funds with $166 billion in assets and 64 Approved Trustees licensed under the SIS Act.³

In addition to the supervisory teams within DID and SID, the Consulting Services and Statistics units of Policy Research and Consulting Division have a direct role in supervision. As risk experts, Consulting Services' primary role is to conduct visits and assist the frontline in their supervision of institutions. The Statistics Unit processes financial and other returns and produces a series of reports that are used by supervisors to monitor their institutions.

APRA has in its portfolio 1 934 lost funds inherited from ISC supervision. These funds registered for supervision after the commencement of the SIS Act in 1994, but were not subsequently supervised by either the former ISC or APRA (since 1 July 1998). APRA is actively pursuing these funds in order to identify their status with the aim of securing compliance with SIS Act reporting requirements, transferring them to the supervision of the ATO or winding them up by the end of January 2004.

Key Findings

Regulatory Framework

The main provisions of the SIS Act impose duties and obligations on trustees, such as the requirement to lodge annual regulatory returns. The SIS Act also provides APRA with supervisory and regulatory powers. In November 2000, APRA commenced the Lost and Lazy Project to identify, and take necessary action against, 7 520 ‘lost' funds that had not lodged annual regulatory returns for a number of years. Consequently, by June 2002, the number of lost funds had been reduced by more than two thirds to 1 934. APRA advised ANAO that by the end of January 2004, they will have taken regulatory action to resolve the status of all lost funds. These actions, and the introduction of proposed reforms to the SIS Act, particularly universal licensing, will resolve the issue of lost funds. APRA also advised that the reforms are scheduled to commence in April 2004. A two year transition period for the proposed reforms does not commence until July 2004.

Annual returns are APRA's main source of information on the financial status of registered superannuation funds. The SIS Act requires trustees of superannuation funds to prepare annual statements of financial position, operations and cash flows. To date, APRA has not sought detailed annual financial information as part of superannuation fund annual returns from trustees. APRA advised ANAO that SID compensates for that by requesting and reviewing audited annual accounts.

In June 2003, APRA announced new superannuation annual returns to apply for financial years ending on and after 30 June 2004, and quarterly returns for funds with assets of $50 million or more to apply from the second half of 2004. APRA advised ANAO that it anticipates the new returns will increase the availability of information within its statistical database, the consequent options for electronic analysis of trends and exceptions, and achieve greater efficiencies in APRA. ANAO considers a more comprehensive suite of returns from superannuation funds is likely to improve the quantity, quality and timeliness of financial information available to APRA for supervisory purposes.

APRA recognises that late lodgement of superannuation fund annual returns compromises its ability to perform its prudential function of detecting fund weaknesses and protecting the interests of fund members. APRA initially experienced a disappointing record of timely lodgement of annual returns from superannuation funds. Only 17 per cent of expected returns were lodged on time in 1999–2000, rising to 77 per cent in 2000–01 and, with active follow-up, 97 per cent of expected 2001–02 returns were received by July 2003.

Until 2001, APRA's pursuit of superannuation funds that had not lodged an annual return was limited to a single reminder notice mailed out to trustees of non-lodging entities almost 12 months after the end of the financial year for which the annual return had been due. APRA has advised ANAO that since the failure to lodge a return has become a strict liability offence (from 18 January 2001), it has actively pursued non-lodgements. More recent action has involved a combination of reminder letters and more effective sanctions that have improved the lodgement of superannuation fund annual returns.

Risk based supervision

Since August 1998, APRA has been seeking to adopt an explicit risk-based supervisory approach. Subsequently, a number of different risk-based methodologies have been developed.⁴ Most recently, in October 2002, APRA introduced an upgraded risk-rating system (the Probability and Impact Rating System/Supervisory Oversight And Response System or PAIRS/SOARS) that, for the first time, seeks to formally integrate the probability of a regulated entity's failure with the potential impact of that failure into a single combined supervisory measure.

APRA expects the implementation of this new system to place it in a stronger position to gauge the scale of its overall supervisory task, identify priority areas within the regulated population and allocate resources according to the degree of risk. The new system is also designed to encourage more vigorous intervention and narrow the scope of judgement for any individual APRA supervisor. APRA anticipates it will allow for more consistent authorisation, peer review and quality assurance processes. In May 2003, APRA advised ANAO that all large APRA regulated entities, accounting for approximately two thirds of Australia's prudentially regulated assets, had been rated under PAIRS. However, APRA will not individually rate the 7 821 small APRA funds (SAFs) under the management of an Approved Trustee, relying instead on its assessment of the Approved Trustee.⁵

APRA has recognised that forming an accurate assessment of the risk profile and risk management systems for all the superannuation funds it regulates is an essential part of ensuring the protection of fund members. However, as of June 2002, some 68 per cent of regulated superannuation funds had not been risk-rated, the majority of which were small funds managed by an Approved Trustee. Some registered superannuation funds managed by certain Approved Trustees have been individually risk-rated: most, however, have not.

ANAO sampling of superannuation funds and institutions where an on-site review was conducted in 2001–02 showed that APRA allocated risk-ratings in 93 per cent of cases and developed supervisory action plans in 90 per cent of cases. ANAO found that a risk-based approach to the supervision of superannuation funds has yet to be consistently and promptly applied within APRA. While SID showed evidence of the inspection and risk rating of subsidiary superannuation funds under the Approved Trustee, this was not evident in any of the DID reviews. Furthermore, while 71 per cent of SID risk ratings and supervisory action plans were complete within two months of the on-site visit, only 35 per cent of DID's risk ratings and 12 per cent of supervisory action plans were complete within that time.

Overall conclusions

APRA's review of superannuation funds and Approved Trustees has been impacted by re-organisation, relocation, and changes to case selection and auditing methodologies. A risk-based supervisory approach has yet to be consistently and comprehensively applied in relation to all superannuation funds regulated by APRA. Some two-thirds of the superannuation funds supervised by APRA were not allocated a risk rating.

ANAO found that supervisory action within APRA varies significantly depending upon which of APRA's supervisory divisions is responsible for a particular fund or Approved Trustee. The supervisory approach, adopted by SID in recent years to balance efficiency with risk, was found to be generally effective in identifying exposures and underlying prudential risks and applying enforcement options. SID consistently applies a documented methodology for supervising superannuation funds, whereas DID does not have a documented separate methodology for reviewing superannuation entities within financial conglomerates. Also, SID has formalised a more systematic approach to escalating supervision and undertaking enforcement actions compared to DID's informal consultative approach.

ANAO considers that there are a series of administrative improvements that APRA can initiate to enhance its prudential supervision of Approved Trustees and superannuation funds. With respect to its regulatory functions, improvements could be made to: APRA's reporting of superannuation funds' lodgement of annual returns; and risk identification and review. As to operational processes, ANAO considers that improvements can be made to: the timely documentation of APRA's supervisory reviews of superannuation funds; and the development of a standardised supervisory approach to Approved Trustees and superannuation funds.

Agency responses

A proposed report was issued to APRA, Treasury and the ATO. ATO provided a number of factual comments. Treasury had no comments on the Section 19 draft report. APRA agreed with all five audit recommendations. APRA advised ANAO of its response to the audit as follows:

APRA accepts the overall conclusions of the report and recognises the need for administrative improvements to enhance its prudential supervision of Authorised Trustees and superannuation funds.

In APRA's view, the complexity, size and diversity among the superannuation entities it supervises, requires it to tailor its supervision stance in terms of strategy, approach and resourcing. However, in response to this report, APRA will refine its risk-based supervision approach and methodology to ensure the consistency of supervisory action plans and documentation.

The ANAO audit focussed on APRA's supervision of superannuation entities during 2001–02. There have been significant changes since then, as summarised below:

• The PAIRS/SOARS risk-based methodology that has been developed with reference to international best practice has been further rolled out across the APRA supervisory divisions.
• A Quality Assurance and Consistency Unit has been established which will focus on ensuring there is a consistent application of supervisory methodologies and timely and comprehensive documentation of supervisory activity.
• Risk Assessment and Internal Audit has increased its activities in the monitoring of APRA's supervision strategies and action plans.

APRA will report on its attention to the findings and recommendations of this ANAO audit in its 2003–04 Annual Report.

Footnotes

1 APRA's role includes certifying funds' eligibility for tax concessions, licensing certain funds' Approved Trustees, monitoring fund management and the delivery of benefits and, where necessary, intervening if it considers a fund's capacity to meet its financial promises to its members may be compromised. In addition to its superannuation fund regulatory responsibilities, APRA is the prudential regulator of banks and other authorised deposit-taking institutions (ADIs), general insurance and reinsurance companies, friendly societies and life insurance companies.

2 The appointments were announced by the Treasurer on 27 June 2003, putting into effect the Australian Prudential Regulation Authority Amendment Act 2003.

3 Superannuation funds supervised by DID include some 6 027 small funds with balances up to $20 million, through to several large public offer funds with up to $19 billion in assets. Similarly, SID supervises 2 606 small funds, some significant public offer funds and 4 402 corporate funds, of which the largest have over $10 billion in assets.

3 Superannuation funds supervised by DID include some 6 027 small funds with balances up to $20 million, through to several large public offer funds with up to $19 billion in assets. Similarly, SID supervises 2 606 small funds, some significant public offer funds and 4 402 corporate funds, of which the largest have over $10 billion in assets.

4 Initially, APRA applied the methodology used by its predecessor, the Insurance and Superannuation Commission (ISC). In August 1998, APRA started implementing the Controls, Risks, Investments, Management and Planning (or CRIMP) methodology, that had been under development in the ISC. CRIMP was replaced in July 2000 by EMAS (Risk Exposure, Risk Management, Risk Assessment and Supervision). In October 2002 EMAS was replaced by the Probability and Impact Rating System/Supervisory Oversight And Response System (PAIRS/SOARS).

5 Senate Economics Legislation Committee, answers to Questions on Notice, Treasury Portfolio Additional Estimates 12–14 February 2003, Question Add 23, p. 2.