Question and Answers on the Financial Impacts of Alternative Indexation Arrangements for Commonwealth Superannuation Pensions (updated 17 May 2013)
- What are the indexation arrangements for Commonwealth superannuation pensions?
- What are the differences between the two alternative indexation arrangements?
- Are Commonwealth civilian and military pensions the same as the Age Pension and the Service Pension?
- What is the Consumer Price Index?
- Who has calculated the estimated financial impacts?
- What are unfunded superannuation liabilities and why do changes in them matter?
- How are the unfunded superannuation liabilities calculated?
- Why have the actuaries assumed a CPI rate of 2.5 per cent when CPI is currently higher?
- What (discount) rate is used to calculate the Commonwealth’s unfunded superannuation liabilities?
- Is the same (discount) rate always used to calculate the Commonwealth’s unfunded superannuation liabilities?
- Are the Commonwealth’s unfunded superannuation liabilities audited?
- Why are the unfunded superannuation liabilities different from the Future Fund Target Asset Level?
- Do the Commonwealth’s unfunded superannuation liabilities take into account scheme assets?
- Do the Commonwealth’s unfunded superannuation liabilities take into account assets held in the Future Fund?
- Does the Future Fund have excess earnings or assets?
- What do the additional cash payments for higher indexation represent?
- Did the actuaries assume that enhanced indexation would change the proportion of benefits taken as a pension?
- Why is there a negative impact on additional cash payments for 2011-12?
- Do actuarial assumptions affect the level of benefits paid to scheme members?
- What is included in superannuation expenses?
- What does the impact on notional employer contribution rates represent?
- Why are the notional employer contribution rates for the military superannuation schemes higher than those for the civilian superannuation schemes?
- Are notional employer contribution rates calculated net of member contributions?
- Why have financial impacts changed since the Matthews Report?
- What pensioner data did the actuaries use in calculating the updated financial impacts?
- Would there be clawback from enhanced indexation arrangements?
- Why are the costs of increased indexation not reduced by clawbacks?
Indexed pensions for the Australian Government defined benefit civilian and military superannuation schemes are payable under the:
- Superannuation Act 1922;
- Papua New Guinea (Staffing Assistance) (Superannuation) Regulations 1973;
- Commonwealth Superannuation Scheme (CSS);
- Public Sector Superannuation Scheme (PSS);
- Defence Forces Retirement Benefits Scheme (DFRB);
- Defence Force Retirement and Death Benefits Scheme (DFRDB); and
- Military Superannuation and Benefits Scheme (MSBS).
Pensions are adjusted in January and July of each year for increases in the Consumer Price Index (CPI) measured across Australia’s eight State and Territory capitals during the preceding six month period to September and March respectively.
The two alternative indexation arrangements examined are:
- indexation at the same rate as that for the base rate of the Age Pension; and
- indexation at the higher of the CPI, the Pensioner and Beneficiary Living Cost Index (PBLCI) and the increase in Male Total Average Weekly Earnings (MTAWE).
In general, the maximum single base rate of Age Pension is increased in line with the higher of the growth in the CPI or PBLCI and then subject to a ‘floor’ minimum amount of 27.7 per cent of MTAWE. That is, indexation is effectively done by calculating the pension that would result if it was increased by the higher of CPI or PBLCI and then comparing that amount to 27.7 per cent of MTAWE. If it is less than 27.7 per cent of MTAWE, then the maximum single rate of pension is increased so that it is equal to 27.7 per cent of MTAWE. That is, the single base rate of Age Pension cannot be lower than 27.7 per cent of MTAWE after indexation has been applied.
It should be noted that the Age Pension can increase by less than the increase in MTAWE. This occurs after a period where MTAWE increases have been lower than the higher of CPI and PBLCI which has taken the Age Pension above the MTAWE floor. Subsequent Age Pension increases would be at the higher of CPI and PBLCI until the MTAWE floor catches up.
This is different from indexation by the higher of CPI, PBLCI and the increase in MTAWE. That is, the growth in superannuation pensions would compound on the higher of each index over time. Consequently, under this methodology, superannuation pensions would be indexed at a greater rate than the Age Pension over time as pension increases cannot be less than the increase in MTAWE.
The actuaries’ advice sets out further information on the difference between the two alternative indexation arrangements.
3. Are Commonwealth civilian and military pensions the same as the Age Pension and the Service Pension?
Civilian and military pensions are not comparable to the Age or Service Pensions. They are different benefits provided for different purposes.
The Age or Service Pension is based on need. It is a safety net that guarantees qualifying Australians a minimum income level if they do not have adequate superannuation or other forms of income or savings to support, or fully support, themselves in retirement.
Civilian and military superannuation pensions are retirement income related to employment. Those receiving civilian or military superannuation pensions, or both, are able to supplement their retirement income with the Age or Service Pension (whichever is applicable) if they meet the relevant qualifying and eligibility tests.
In his review of pension indexation arrangements, Mr Matthews drew a distinction between the obligation of the State to provide an income support safety net to its more disadvantaged citizens and the obligation of the State (as an employer) to provide superannuation to its employees and former employees.
The Australian Bureau of Statistics (ABS) is responsible for producing the CPI. The Australian CPI measures price changes facing households and is compiled according to international standards. It is based on robust data collection and compilation methodologies. More information can be found on the ABS website.
The ABS prepared a paper on the Australian CPI for the Matthews Review [ 41 KB], discussing a range of matters in relation to the CPI, including that:
- it is the best available broad measure of changes in the cost of living faced by Australian households; and
- the inclusion of social welfare beneficiary and superannuation households in the reference population since the September quarter 1998 better aligned the CPI for use in indexation of social security benefits and indexation of superannuation pensions respectively.
The financial impact of changes to the schemes is calculated by actuaries. The estimated costs of alternative indexation arrangements have been calculated by Mercer (Australia) Pty Limited (Mercer) for the civilian superannuation schemes and the Australian Government Actuary (AGA) for the military superannuation schemes.
Mercer and AGA comply with the Institute of Actuaries of Australia’s Professional Standards in providing actuarial advice. Both undertake internal peer review of their advice. Notwithstanding this, Finance engaged Cumpston Sarjeant, an actuarial firm independent of the scheme actuaries, to undertake a third party peer review of the actuarial advice provided by Mercer and AGA.
The unfunded superannuation liabilities represent:
- the present value of expected superannuation benefit payments from Consolidated Revenue for superannuation entitlements accrued to that time;
- the accumulation of member and productivity contributions (where relevant).
The Table below shows the Budget estimates of Commonwealth unfunded superannuation liabilities over the forward estimates.
Table- Estimate of superannuation liabilities as in Budget Papers 2013-14
30 June 2013
30 June 2014
30 June 2015
30 June 2016
30 June 2017
* Includes the civilian defined benefit superannuation schemes, Judges’ Pensions Scheme, Parliamentary Contributory Superannuation Scheme, Governors-General Scheme and Federal Magistrates Statutory Death and Invalidity Benefits Scheme
Unfunded superannuation liabilities are a financial liability on the Government’s balance sheet. Changes in these liabilities affect the Government’s net financial worth, and thus fiscal strategy targets linked to net financial worth.
The long term costs of the main civilian and military superannuation schemes are assessed in detail every three years by Mercer and AGA, the scheme actuaries. Their findings are reported in Long Term Cost Reports, the most recent being the 2011 Report for the CSS and PSS, and the 2011 Report for the DFRB, DFRDB and MSBS . Mercer and AGA update these estimates annually, in between Long Term Cost Reports.
Assumptions underpinning the calculation of the unfunded superannuation liabilities are detailed in the Long Term Cost Reports. In the 2008 Reports the key economic assumptions for both civilian and military schemes were:
- CPI of 2.5 per cent per annum;
- investment returns of 3.5 per cent per annum above CPI; and
- general salary increases of 1.5 per cent per annum above CPI.
These assumptions did not change between the 2008 and 2011 Long Term Cost Reports.
The key demographic assumptions relate to promotional salary increases and, where relevant, rates of death and invalidity, age retirement, resignation, retrenchment, take up of pensions, mortality, new entrants, member contributions, and proportions of members married or partnered at the time of death.
Estimating the Commonwealth’s unfunded superannuation liabilities requires a long-term CPI rate, consistent with the long-term nature of the liability.
The assumed CPI rate of 2.5 per cent is consistent with the most recent actuarial Long Term Cost Reports for the CSS, PSS, MSBS and DFRDB, whose purpose is in part to assess appropriate long term assumptions. It is also consistent with the 2010 Intergenerational Report and is the midpoint of the Reserve Bank’s Inflation Target range of 2 to 3 per cent.
9. What (discount) rate is used to calculate the Commonwealth’s unfunded superannuation liabilities?
The value of unfunded superannuation liabilities at a particular date represents the:
- present value of expected superannuation benefit payments from Consolidated Revenue from superannuation entitlements accrued to that time;
- accumulation of member and productivity contributions (where relevant).
The present value is calculated by applying a discount rate, to convert the future nominal dollars to dollars at the valuation date.
This rate was 6 per cent per annum (nominal) in the most recent Long Term Cost Reports. This rate is the actuaries’ best estimate of the expected return on government bonds over the long term.
The actuaries have also used the 6 per cent discount rate to estimate the increase in unfunded superannuation liabilities that would occur under the two alternative indexation arrangements.
A 6 per cent discount rate was also used for preparing the estimates contained in the Matthews Review.
10. Is the same (discount) rate always used to calculate the Commonwealth’s unfunded superannuation liabilities?
For the purposes of budget reporting, the Australian Government uses the 6 per cent rate applied by the actuaries in preparing the Long Term Cost Reports for the relevant schemes. This is used to estimate the present value of future unfunded superannuation benefits.
For annual (actual) reporting purposes, that is, for the Consolidated Financial Statements and the Final Budget Outcome, Australian Accounting Standards require the discount rate for valuing the unfunded superannuation liabilities to be determined by reference to market yields on long term government bonds as at the reporting date. This rate is commonly referred to as the spot rate. It typically varies from year to year and is usually different from the long term rate of 6 per cent per annum used for budget reporting purposes.
All other things being equal, the lower the discount rate used, the higher the value of the unfunded superannuation liabilities, and vice versa. Over recent years, the discount rates used for the purposes of the Final Budget Outcome have been both lower and higher than 6 per cent per annum. Accordingly, Final Budget Outcomes have been higher or lower than the Budget estimates. However, the differences are due to spot rate movements, not changes in the underlying nature or quantum of the Australian Government’s superannuation obligations.
The use of the Long Term Cost rate for budget reporting purposes avoids introducing volatility due to spot rate movements into future calculations of the unfunded superannuation liabilities.
The Australian National Audit Office audits the financial statements of the Department and the Department of Defence each financial year. In undertaking the audits, the ANAO engages its own consulting actuary to review the actuarial assessments and assumptions underlying the calculation of the unfunded superannuation liabilities.
12. Why are the unfunded superannuation liabilities different from the Future Fund Target Asset Level?
The Future Fund Target Asset Level (TAL) is related to the unfunded superannuation liabilities, but is not an alternative valuation of these liabilities. It is calculated by a Designated Actuary (currently the AGA) and represents the assets of the Future Fund that would be required to offset the unfunded superannuation liabilities at the same point in time.
The TAL is lower than the unfunded superannuation liabilities because the Designated Actuary assumes that the Future Fund will achieve a return of 7.2 per cent per annum, consistent with the Fund’s Investment Mandate. This return is higher than the 6 per cent used to derive the present value of the unfunded superannuation liabilities.
For example, for 30 June 2013, the estimated unfunded superannuation liabilities are $143.5 billion (based on the 2013-14 Budget estimates), whereas the TAL for 2012-13 is $110.3 billion.
Yes. Unfunded liabilities are calculated net of scheme assets, including member contributions.
14. Do the Commonwealth’s unfunded superannuation liabilities take into account assets held in the Future Fund?
The Commonwealth’s unfunded superannuation liabilities do not take into account assets held in the Future Fund. These assets are not held by the Commonwealth’s superannuation schemes. They are financial assets disclosed separately in the Government’s accounts.
The Future Fund does not have sufficient assets to finance the extra costs of increased indexation.
The Future Fund’s assets at 30 June 2013 are estimated to be $87 billion. The estimated Australian Government unfunded liability as at 30 June 2013 is $143 billion (2013-14 Budget).
Commonwealth superannuation pensions are paid from Consolidated Revenue. The additional cash payments from adopting the alternative indexation arrangements reflect the change in pension payments from Consolidated Revenue.
17. Did the actuaries assume that enhanced indexation would change the proportion of benefits taken as a pension?
Yes. Mercer and AGA have assumed that enhanced indexation arrangements would result in more PSS and MSBS benefits being taken as a pension because the pension would become relatively more valuable.
Mercer has assumed under both alternative indexation arrangements that an additional 10 percentage points of PSS benefits would be taken as a pension rather than a lump sum compared to the relevant assumption in the 2008 CSS and PSS Long Term Cost Report.
AGA has assumed, under both alternative indexation arrangements, that:
- an officer would take 90 per cent of their MSBS employer component as a pension; and
- other ranks would take 80 per cent of their employer component as a pension.
If the actuaries had not made these assumptions:
- additional cash payments would be higher than shown in the updated financial impacts with 2011-12 being positive rather than negative; and
- superannuation expenses and the unfunded superannuation liabilities would be lower than shown in the updated financial impacts.
Mercer and AGA have assumed that enhanced indexation arrangements would result in more PSS and MSBS benefits being taken as a pension. This is because pensions would become relatively more valuable (and attractive) than lump sum benefits. This assumption means that some lump sum payments that would otherwise be taken immediately would be replaced by a series of pension payments over time.
In the first year, the decrease in lump sum payments is estimated to be greater than the increase in pension payments for that year of the alternative indexation arrangements. Therefore, the total cash payments from Consolidated Revenue would be lower than the current budget estimate.
However, for the second year and thereafter, the increase in pension payments from alternative indexation arrangements becomes greater than the decrease in lump sum payments. That is, cash payments from Consolidated Revenue would be higher for the alternative indexation arrangements than currently forecast.
No. Benefits payable are determined by legislation (not actuarial assumptions). Key factors include a member’s:
- length of service or employment;
- salary at or near retirement;
- age upon leaving; and
- in some cases (for example the PSS), the amount of member contributions.
The actuarial assumptions are required to value the costs of the schemes for the Commonwealth’s accounts.
Annual superannuation expenses are the sum of:
- superannuation entitlements accrued from further service or employment in that year (service cost);
- the nominal interest cost on the unfunded superannuation liabilities. The interest cost is the increase in the present value of the superannuation liability because the benefits are one year closer to payment;
- return on assets expected to be derived from investments.
The impact on superannuation expenses of changed indexation reflects the additional balance sheet cost for the year. This is different from the impact on cash payments. The impact on cash payments only reflects the cost of the increase in pension payments paid to pensioners in a particular year.
The Commonwealth defined benefit superannuation schemes are largely unfunded. That is, employer contributions are not paid until the person’s benefit is paid.
The notional employer contribution rates are the employer contribution rates that would be necessary to fully fund employer financed benefits if the schemes were funded. They are analogous to employer contributions in an accumulation scheme. For example, the notional employer contribution rate for the PSS of 18.8 per cent (including productivity contributions) is analogous to the employer contribution rate for the Public Sector Superannuation Accumulation Plan of 15.4 per cent.
22. Why are the notional employer contribution rates for the military superannuation schemes higher than those for the civilian superannuation schemes?
The notional employer contribution rates reflect the benefits provided under each scheme. The higher notional employer contribution rates for the military schemes reflect that, all other things being equal, benefits payable under those schemes are more costly than benefits payable under the civilian schemes.
A major difference affecting the costs of benefits is in relation to invalidity benefits. There is a higher prevalence of invalidity benefits in the military schemes.
Yes. The notional employer contribution rates are calculated net of scheme assets, including member contributions.
The change in the financial impacts is attributable to the upward trend in the Commonwealth’s unfunded superannuation liabilities from successive Long Term Cost Reports. Changes have arisen, for example, from mortality improvement and increased take-up of pensions.
Mercer and AGA used pensioner data as at 30 June 2009, as summarised in the table below.
Table – Pensioner data used for updating the financial impacts
|Number of pensioners||
Mercer and AGA perform a range of data validation checks. In addition, they have used the latest available data set of pensioners. This can mean that the pensioner data may not be the same as disclosed in the scheme annual reports. Differences arise from late notifications of deaths and processing delays in commencing new pensions.
There would be reductions in other Commonwealth expenditure (such as the Age Pension) and increases in Commonwealth taxation revenue as a result of adopting alternative indexation arrangements.
The Department of the Treasury has undertaken analysis, based on the Treasury tax microsimulation model, of the potential tax and Age Pension clawback associated with changes in the indexation arrangements for Commonwealth superannuation pensions. This shows that the overall clawback (combined for civilian and military schemes) is in the order of 30 per cent. The level of clawback will vary between individual scheme members. The clawback estimate is sensitive to the assumptions used and should therefore be treated with some caution.
The costs of increased indexation are not calculated net of ‘clawback’ effects. In accordance with Budget rules, the estimated costs of increased indexation take into account the direct impacts of the proposal. Clawback impacts are considered secondary impacts.
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