KiwiSaver at a time of major change

“KiwiSaver is a landmark in our social and economic history. It will help New Zealanders build up more financial assets more quickly. It will help more New Zealanders feel wealthier and more secure.”

“Greater saving, coupled with increasing investment in innovation and productivity, will help make the economy much more resilient so we can better deal with the long term game.”

So stated Sir Michael Cullen, credited as the architect of KiwiSaver, in June 2007.  Then Deputy Prime Minister and Minister of Finance, Sir Michael oversaw the passage of the KiwiSaver Act in 2006 and commencement of the scheme on 1 July 2007.  Sir Michael died in August 2021. It is fitting that his prescient words are quoted in the FMA’s eleventh KiwiSaver Annual Report published at the end of September, covering the period from 1 July 2020 to 30 June 2021 and including a summary of the mandatory statistical returns lodged by KiwiSaver schemes as at 31 March 2021.  Of note is that Sir Michael emphasised both social and economic aspects of KiwiSaver in his statement, which points the way towards how the regulator regards its responsibilities and undertakings with respect to the scheme.

KiwiSaver has changed the financial landscape of New Zealand immensely over the course of the past 14 years.  The scheme was introduced as an universal workplace savings mechanism to help top up New Zealand Superannuation entitlements for over 65s, although there would inevitably be an extensive time lag time applying before hitting the magic age for many individuals to save up enough to enjoy true financial independence.  A secondary goal was to assist with first home deposit savings.  Both objectives – retirement saving and home ownership – are aided by the tailwind of a modest employer subsidy for those in paid jobs.  A distinguishing part of the scheme that attracted international attention to its design was the shrewd application of opt-out psychology to automatic enrolment of paid employees, which essentially relies on the widespread human tendency to inertia to keep many people on board.

KiwiSaver appears to be a rip-roaring success to date, if big numbers are anything to go by, with the latest Report reeling off the headline statistics*:

Table 1: Report’s facts at a glance

*All figures at 31 March 2021 and year-on-year, ** First home, mortgage diversion, end payment, death, serious illness, life-shortening conditions, emigration, Australian transfers, other enactments, † Management fees, administration fees; Source FMA, September 2021.

Looking more closely at the summary numbers, total membership growth at just 2% indicates the end of rapid take up of the scheme by new members, with more incremental, organic increase to be expected from here on.  Competing KiwiSaver providers will need to rely more heavily on luring existing members by way of transfer from other schemes than finding completely fresh recruits   Average balance at just $26,000 is nowhere near enough to live off in retirement or secure a first home with, suggesting substantial lopsidedness beneath that statistic between those individuals fortunate enough to have grown nest eggs sufficient to open up meaningful financial options in their lives and those who have so far hoarded only peanuts.

At $13 billion, investment returns constitute 16% of total funds under management at $82 billion.  If added back onto total funds under management, member withdrawals at $3 billion represent an outflux of 3.6%, while combined fee revenue at $650 million ($569.5 million in management fees and $80.8 million in administration fees) comes to a KiwiSaver provider income return of 0.8%.  However, it is the fee revenue that has attracted considerable attention from the FMA, as demonstrated in its publication of a Guidance entitled Managed fund fees and value for money in April 2021.

In its appendices the Report notes that there were thirty six KiwiSaver schemes operating as at 31 March 2021, broken down into nine default schemes, thirty one retail (active choice) schemes, and five restricted schemes, of which seventeen in total had assets under management exceeding $1 billion (Report p. 24).  By comparison, in its immediately previous KiwiSaver Annual Report, the FMA noted that there were thirty three KiwiSaver schemes operating as at 31 March 2020, categorized into nine default schemes, twenty eight retail (active choice) schemes, and five restricted schemes, of which fourteen in total exceeded $1 billion in assets under management (2020 Report p. 23). Impending changes to the number of default providers are further examined below.

Ensuring reasonableness of fees and value for money

The Report has a section dedicated to the April 2021 Guidance and provides a concise restatement of the principles driving reasonable fees and value for money as follows:

Our guidance said [MIS] managers are expected to annually review their fees with their supervisors, and to take concrete steps if they find their fees are unreasonable and don’t represent value for money – by increasing their services, reducing fees, or both.

Managers were told they must prove such reviews are happening, and our message that failure to do so could trigger a regulatory response was conveyed widely by significant media coverage.

(Report, p. 8). 

The Report goes on to single out KiwiSaver scheme membership fees, advice-related fees, and non-advice fees (for example, charges for a “robust investment process”) as requiring special attention from their managers to justify.

It should be noted that reasonableness of fees and value for money may not necessarily be evaluated by the same means.  New Zealand law already explicitly prohibits fees charged on all KiwiSaver schemes from being unreasonable.  The test for reasonableness of KiwiSaver scheme fees – the “fees assessment” - is set out in regulations 10, 11 and 12 of the KiwiSaver Regulations 2006 (there is no comparable explicit set of fees assessment rules for non-KiwiSaver retail MIS).  Specifically, it is stated at regulation 12(a) that the primary test relies upon “whether the relevant fee or fees in relation to the scheme are significantly higher [our emphasis] than the fees charged in relation to other schemes or classes of schemes (whether or not KiwiSaver schemes) that the FMA or the court considers comparable”.

The “significantly higher” fees assessment threshold may not be breached by a KiwiSaver scheme (or a non-KiwiSaver MIS), and so its fees might not be captured as unreasonable on that peer comparison criterion.  Yet that same scheme might still run afoul of value for money assessment as set out in the Guidance, particularly in relation to the types of fees specified in the Report.  The topic of MIS reasonableness of fees and value for money was covered in more depth in The Supervisor article of June 2021.

Truth-to-label with integrated financial products

Increasingly influential in the KiwiSaver marketplace are “integrated financial products”, which the Report states are intended to reflect “New Zealand’s transition to an ‘integrated financial system’, which takes into account non-financial factors such as natural, social and human impacts, not just financial returns” (Report, p. 9).  The Report reminds the reader of the FMA’s Guidance of December 2020 entitled Disclosure framework for integrated financial products, which it states to be principally concerned with “‘responsible’ or ‘ethical’ KiwiSaver funds, and ‘green’ bonds” (ibid.).  Key problems identified by the Report concern “[m]isleading marketing, poor product design and other types of ‘green-washing’” (ibid.). 

The logic of the FMA’s concerns about integrated financial products dovetails in with matters the Report raises about reasonableness of fees and value for money, in that members of KiwiSaver schemes, not to mention other retail investors in New Zealand, are to be protected from putting their money at risk where they might not be receiving all that they believe they are paying for.   Potentially investors might be shelling out too much for financial products and/or deceived about where the returns are really coming from.  In either case, the FMA’s core objective is to preserve investor confidence in New Zealand’s financial markets, expressed in the Report principally but not exclusively in relation to KiwiSaver schemes.

Twin focus areas

The Report considers two KiwiSaver-specific “focus areas”: fund switching and default providers. 

KiwiSaver fund switching gained prominent topicality when there was a rash of it during the Covid-19 initial panic of early 2020, as fearful investors hastily exited shrinking investments in higher risk funds to attempt capital preservation in lower risk funds.  The Report notes that although switching dropped in volume in the year to 31 March 2021 versus 2020, it is still elevated relative to the last pre-Covid-19 year of 2019.  Evidence points to investors switching from lower risk funds to higher risk funds, although according to a PWC analysis commissioned by the FMA, some 90% of investors who switched from higher risk to lower risk during the panic had not switched back again by August 2020.  Younger investors and members of bank-run KiwiSaver schemes tended to switch around more often than others.

In respect of switching behaviour, the Report summarizes:

Future considerations for providers included improvements to customer communications, such as highlighting the risks of switching, and prompts to have members pause before completing a switch.

(Report p. 12)

With respect to KiwiSaver default providers, the Report succinctly describes the history of default funds and the transformation presently under way requiring that such financial products are low-fee balanced funds that all scheme members can access equally.  In May 2021, a new mix of six KiwiSaver default providers was announced by the Government, down from nine appointed in 2014, with a start date for their collective services set at 1 December 2021. 

Table 2: Default provider changes

Source MBIE, 2014 and 2021

According to the Report, the FMA will be focusing on “whether any moves by default members out of their allotted default funds is [sic] in those members’ interests” and “reviewing how many active members join the default funds, attracted by the lower fees and balanced risk setting” (Report p. 14).  Once again, reasonableness of fees and value for money come to the fore as chief regulator considerations.

Conclusion

“The FMA’s KiwiSaver Annual Report is always an important document for the financial services sector, including licensed Supervisors, to analyse carefully each year,” said Matthew Band, General Manager of Corporate Trustee Services at Trustees Executors.

“The current Report is a case in point, because not only is it of significance to KiwiSaver providers and their Supervisors, but it is also highly relevant to other licensed MIS managers and investors.”

“With the 2021 Report, the FMA has taken the opportunity to signal its concerns that go beyond the ambit of just KiwiSaver when reasonableness of fees, value for money, and integrated financial products are discussed.”

“The issues raised on these topics are not going away in a hurry, and the regulator makes plain that they will continue to remain a core part of its future focus.”

“That means for MIS managers and their Supervisors that they too will need to keep focused on these same issues in years to come.”

“The Report makes clear that in addition to such generic considerations for the financial services sector, there are topics peculiar to the KiwiSaver subpart that the regulator has under the spotlight, such as how KiwiSaver scheme members are treated by their providers over fund switching and default funds.”

“As a Supervisor, we look forward to constructive engagement with all our clients – KiwiSaver providers and others - who are affected by the issues covered in the Report and the ramifications for successful compliance."

“We are also open to engaging with new KiwiSaver providers who need the high standard of supervisory services that will help them meet the FMA’s rightly demanding expectations of what they will provide both now and in the future to the lasting benefit of their scheme members.”

For comment or more information, or to be added to the free email subscriber list of “The Supervisor”, please contact Matt at [email protected]