Australia
Melbourne, 9 August 2010

An increasing number of superannuation funds are already establishing and accessing operational risk reserves even though they are not yet required to by law, according to Mercer’s second survey on the use of operational risk reserves in the superannuation sector.

Mercer’s latest study, with results from 28 industry, public sector and corporate superannuation funds found the use of operational risk reserves has increased over the past two years with 75 per cent of funds surveyed saying they had a reserve in place, a substantial increase from 56 per cent in 2008. Of the 21 funds with an operational risk reserve, one third (7) had actually used their reserve during 2009.

Although Australian Prudential Regulation Authority (APRA) regulated superannuation funds are not yet required to hold an operational risk reserve, it is highly likely they will have to if the Government adopts the Cooper Report’s recommendation.

Mercer’s survey, which is the only study to examine the attitudes and approaches to operational risk reserves amongst fund executives, was completed in July 2010, as a follow up to an initial study conducted in 2008.

Dr David Knox, Senior Partner in Mercer’s Retirement, Risk and Finance business said the widespread uptake of operational risk reserves highlighted the advantage of the practice and bode well for seeing Cooper’s recommendation passed as legislation.

“If the recommendation on operational risk reserve is adopted, the good news is it won’t be a quantum leap for many super funds, instead it is a continuation of good practice within the industry.

“However, it is important to stress that there is no ‘one size fits all’ approach as to how big a reserve should be or how it is built. While it makes sense to have a minimum and maximum range for reserve levels, the fund should be given flexibility according to its size, insurance arrangements and actual operations. This will ensure reserves are established in a way that makes sense for the fund and its members.”

Dr Knox noted a third of the surveyed funds with reserves had accessed their reserve in the past year and in most cases they were being used for genuine operational risk events.

“The fact that one third of funds accessed their reserve in a single year highlights the advantage of the practice. Operational risk events do occur but with a reserve in place the fund is able to continue to operate after the event and members aren’t penalised.

“It is important that reserve funds are being used for the right reasons; these being to cover the financial consequences of unexpected events caused by errors, fraud or failures.”

Dr Knox said if Cooper’s recommendations surrounding capital requirements and risk reserves are adopted it will be important to iron out any confusion that exists around capital requirements and the reserve.

“Capital and risk reserves serve different purposes. Minimum capital requirements exist to ensure the organisation remains solvent. Unlike operational risk reserves, capital cannot and should not be relied upon for a ‘rainy day’ - that’s what operational risk reserves are for, to ensure there are immediate funds available to compensate members if required,” Dr Knox concluded.

 Download the report - Operational Risk Reserves: Current market practices and attitudes.