Australian superannuation funds holding operational risk reserves

An Australian study by Mercer says 75% of super funds hold op risk reserves

The majority of Australian superannuation funds are holding operational risk reserves to protect against potentially fatal operational risk shocks.

Op risk loss reserves are being held by 21 of the 28 industry, corporate and public sector retirement funds surveyed by Mercer, a financial consultancy, in Australia.

Furthermore, seven of the pension funds said they had drawn on their op risk reserves during 2009.

"It is commonly for pricing errors," says David Knox, the senior partner at Mercer responsible for the report. "We've had a number of mistakes in the industry where people have got it wrong, and they've had to go back to compensate people for that."

The reserves provide a crucial op risk buffer against the cost of a sudden unexpected loss.

"They might recoup most of the costs through insurance, but that can take time and compensation needs to be paid out quickly," he says. "If the event is significant enough, the future of the fund could be at risk, with members deciding to move money elsewhere."

It is the second time Mercer has conducted a survey of the funds in two years, with 56% of funds having op risk reserves in place in 2008. According to this year's report, the amounts set aside for op risk events typically represented 0.3% to 0.8% of assets or liabilities.

This year's Mercer study report follows the submission of the Final Report of the Super System Review (the Cooper Review) which recommended improvements in corporate governance standards and the implementation of op risk reserves at the funds.

The recommendations of the Cooper Report were submitted to the Australian government on June 30 to pave the way for legislation over the country's superannuation funds.

"That is the expectation, but we are in the midst of an election campaign, with the country going to the polls on August 21," says Knox. "The expectation of the incumbent government is that most of Cooper will be implemented into law within a number of years."

The Australian Prudential Regulatory Authority (Apra), the country's financial regulator, could be responsible for setting minimum operational risk requirements for the superannuation funds.

"The regulator has not indicated the level of the reserves, over how long they would be built up, or any of the details," says Knox. "The reserve is quite different from capital, as it can be used if needed, rather than seen as capital that must be maintained as a minimum level against insolvency and regulatory intervention."

Superannuation funds do not have a single corporate or government sponsor behind them, but instead tend to be industry-specific funds (for example, retail or construction) and rely on the pensions contributions from multiple employers based on percentages of their employees' salaries.

"If something goes wrong for a fund and they need money to compensate members, there is no sponsoring employer stood behind them," says Knox. "The funds themselves can be almost shells with third-party providers. Operational risk is the major risk faced by these funds. Most of the insurance and investment would be outsourced, with even administration often outsourced."