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Executive summary |
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Desirable Characteristics of Military Superannuation in Australia today A New Military Superannuation Scheme The impact on the ADF and ADF members IntroductionThe Terms of Reference (TORs) identify two principles that provide the philosophical context for the Review. Firstly, the ‘unique nature of military service’ requires careful consideration of the design features in military superannuation schemes. Secondly, superannuation benefits are a key component of ADF conditions of service and have the potential to contribute to recruitment and retention in the ADF. In summary, the TORs require: · A review of the current schemes against the two principles and in light of the contemporary superannuation framework in Australia and best practice superannuation, as well as developments in the ADF and elsewhere relevant to military superannuation arrangements. · Analysis of a list of specific technical design issues concerning the current schemes of enduring interest to stakeholders. This list was supplemented by the Minister’s letter to the Review Team requesting a review of the payment of superannuation benefits to individuals remanded in custody. Occupational superannuation in Australia has changed enormously over the last 25 years. Following the superannuation reforms of the 1980s, the Defence Force Retirement and Death Benefits (DFRDB) Scheme was closed and the Military Superannuation and Benefits Scheme (MSBS) was introduced. In particular, this widened vesting so all ADF members would benefit, and preserved benefits to age 55 in line with the new community standard. Since the MSBS was introduced in 1991, the contemporary superannuation environment has further changed. Changes that most clearly present challenges for the MSBS include the increased emphasis on flexibility and portability, increasing individual responsibility, a greater emphasis on transparency and funding, and the new 2007 tax arrangements. Changing employment patterns in the Australian workforce generally, and recent low levels of unemployment, have been reflected in increasing challenges to recruit and retain ADF members. These add to the case for reviewing current military superannuation arrangements. The unique nature of military service involves the significant risk of death and disability, and the likelihood that career ADF members will retire earlier than is standard practice in the Australian workforce. These characteristics have been, and should continue to be, reflected in military superannuation through the provision of generous death and disability benefits and through access to retirement pensions from age 55. In conducting the Review, the Team consulted widely and systematically despite its tight time deadlines. The Review Team also approached the task on the basis of working within the broad envelope of the current costs of the existing schemes, while identifying options that might be supported if additional funding were available. It did not approach the task as an opportunity for financial savings (particularly given the stated principles relating to the unique nature of military service and the potential to support recruitment and retention), but it was also conscious of the need to be financially responsible as implied by the several references to costs in the TORs. Desirable Characteristics of Military Superannuation in Australia todayDrawing together the desirable characteristics of military superannuation from best practice contemporary superannuation, the potential impact on recruitment and retention and the unique nature of military service, the Review Team has applied the following Guiding Principles for any new arrangements for military superannuation: · Flexibility, to meet individual member preferences regarding both contribution arrangements and the form of benefits and to respond to future changes to the broader superannuation or ADF environments. · Simplicity, to enable ADF members to clearly understand and measure the value of their current employer contributions to superannuation and the potential future benefits. · Adequacy, for all members of the ADF, both short-term and long-term, with a level of benefit that facilitates the maintenance of living standards, both on and through retirement. · Tailored, to address the unique nature of military service by providing generous life-time support for dependants in the event of death or disability and rewarding long and arduous military service. · Visibly attractive, forming an integral part of the remuneration package, enhancing the ADF conditions of service package and, in particular, supporting retention at critical points for the ADF and attracting former ADF members to re-enlist. · Financially sustainable, with stable employer contributions over time and no increasing unfunded liability. Assessment of current schemesThe Review Team determined that, while the MSBS compares reasonably well with most overseas military schemes and with other Australian schemes for ‘uniformed bodies’, it still falls well short of best practice contemporary superannuation and does not contribute significantly towards recruitment and retention. The DFRDB is rated well below the MSBS. In conclusion, the Review Team believes that a new scheme should be introduced that fully satisfies the Guiding Principles. A New Military Superannuation SchemeTo meet the Guiding Principles, the new scheme should have a contemporary approach to providing for retirement income by being a taxed, funded, defined contribution scheme. Unlike many contemporary schemes, however, it should offer a range of retirement benefit options including indexed pensions. In view of the unique nature of military service, it must also retain generous defined benefits for death and disability. In broad terms, the proposed new scheme will comprise: · an accumulation retirement plan, with individual accumulation accounts built on generous employer contributions increasing with length of service (at 16, 23 and 28 per cent of superannuable salary) and voluntary personal contributions. Members will be able to access their accumulated benefits in the form of a lump sum or an account‑based pension on reaching preservation age. Members with 15 or more years of service will have the additional option of converting their lump sum into an indexed pension or an account-based pension from age 55. · death and disability benefits which complement the accumulation retirement plan. For members discharged on medical grounds, disability income benefits will be paid in the form of rehabilitation-focussed salary maintenance payments until age 60. In addition, Defence will continue to make employer contributions to the accumulation plan building funds for retirement at age 60. Death benefits will supplement the funds accumulated in the retirement plan taking into account the members’ prospective service to age 60. This total lump sum can be converted into an indexed spouse pension with additional payments for dependent children, similar to current pension arrangements.
The death and disability benefits will also be better integrated with the Military Rehabilitation and Compensation Act 2004 (MRCA) arrangements. The proposed new scheme will allow membership beyond ADF members. Membership, without administrative fees, will be available to the spouse and dependent children of a serving ADF member. Membership will also be open to all Reservists, without administrative fees. Members from these groups will have their own individual accumulation accounts. Members who leave the ADF but retain funds in the scheme can also choose to have contributions from future employers directed into their accounts, though they will have to pay an administrative fee. The Review Team considers that it is important for retention purposes to offer all current ADF members the option of transferring to the new scheme from their current scheme (MSBS or DFRDB). The Review Team also considers that preserved MSBS members should be allowed to transfer to the new scheme. The impact on the ADF and ADF membersThe proposed new scheme will meet the Guiding Principles far more closely than the existing schemes, though members will bear more of the risks. Members separating with under 20 years of service are likely to gain, and longer serving members are likely to receive broadly comparable retirement benefits to those under the MSBS. Disability benefits for compensable injuries are generally unchanged, and benefits for non-compensable injuries are, if anything, improved particularly by more generous indexation arrangements. There is also the likelihood of improved benefits at age 60, with access to a substantial accumulated lump sum that can be converted into an indexed pension. Disability payments would be reduced, of course, if the individual is successfully rehabilitated into employment. Death benefits are also likely to be more generous than under the MSBS. The apparent inconsistency of many ‘winners’ and few ‘losers’ but with the same long term cost to Government is explained by the transfer of risks from Government to members. The Review Team considers that the new scheme will have a positive impact on retention, in particular, by making transparent the value of the employer contribution as a component of the remuneration package, demonstrating its generosity compared to the level of employer superannuation contributions elsewhere. In so doing, it should take pressure off demands for increases in ADF pay and hence give better value for money to Defence from its total remuneration package. While superannuation does not have a major impact on recruitment of young people, the increased transparency of the value of the employer-financed benefit under the new scheme, and its enhancement of the remuneration package, should have a positive effect. There is likely to be a significant advantage for attracting older and more experienced recruits. Effective marketing will enhance these positive effects. The Review Team does not recommend that Reservists, other than those on continuous full-time service, be eligible for employer-financed contributions to the new scheme. It believes more careful consideration of the role and nature of Reservists is required, and that this should flow through to consideration of the appropriate remuneration package including the applicability and level of superannuation. Governance arrangementsA new board would assume all responsibilities for management of the DFRDB, MSBS and the proposed new scheme. In line with the Uhrig Report ‘best practice principles’, the board should comprise seven trustees, one of whom would be an independent chairperson. Implementation and transitionGiven the lead times that will be necessary, the Review Team believes the proposed new scheme should commence in the first half of calendar year 2009, allowing the initial budgeting impact to be spread over two financial years (2008-09 and 2009-10). This timing assumes Government agreement to the major recommendations soon after the Review Team reports at the end of July 2007. A detailed implementation plan will need to be developed once the Government’s responses to the Review Team’s recommendations are known. The main issues to be addressed in such a plan are identified in the report. The Review Team has suggested the Government could agree to the early implementation of some recommendations. Education and awarenessThe proposed new scheme will require substantial effort to educate members not only during the transition but also on an ongoing basis. Some details of the components of the transition education and awareness campaign are set out in the report. The new scheme will require a very different approach by ADF members towards their superannuation. It will involve a shift from the paternalism of the past to much greater responsibility being shouldered by members for the management of their superannuation savings. It will also offer Defence the opportunity to ‘sell’ its employer contributions as a generous element of the remuneration package, and to enhance its other recruitment and retention strategies. In both respects, this will require ongoing education and awareness of superannuation. Additional technical issuesThe TORs require the Review Team to analyse a list of specific issues which have been highlighted by emerging and extant Government policy and member feedback. MSBS Maximum Benefit Limits. To address retention concerns, as well as fairness, the Review Team recommends that MSBS Maximum Benefit Limits be fully abolished for all currently serving MSBS members at the date of that change. Consideration could be given to abolishing the MSBS MBLs before the implementation date of the new scheme. Interdependent Relationships. The Review Team believes the proposed new scheme should reflect contemporary practice and recognise interdependent relationships. It does not consider that the unique nature of military service would justify an exception. In principle, there is a strong case also for recognising interdependent relationships in the existing schemes. The Review Team suggests, however, that any change to the MSBS and DFRDB be made in conjunction with any such changes to the other Commonwealth defined benefit schemes. Indexation arrangements. The Review Team considers that there is an in-principle case for changing the indexation arrangement for DFRDB pensions to an earnings basis, but recognises that this would be expensive. Given Government policy on preservation arrangements, the Review Team considers there is no case to increase the generosity of benefits payable prior to age 55, but there is a case for older DFRDB pensioners. Accordingly, it is recommended that, only if the Government is willing to go beyond the envelope of current costs, it should consider indexing DFRDB pensions on a similar basis to that applying to age pensions. Any such improvement should be limited to pensions paid from age 55 or, at a lower cost, from age 65. The MSBS has very generous arrangements for converting lump sums into indexed pensions, and it would be difficult to justify an even higher subsidy for pensions by indexing them on the basis of earnings rather than prices. Accordingly, the Review Team does not recommend a change in indexation arrangements for MSBS pensions. Life Expectancy Factors. The Review Team acknowledges the significant improvement in life expectancy since the 1960s, but is not persuaded by the claim for a more generous treatment of commutation arrangements under the DFRDB which still applies those life expectancy factors. The fact is that the conversion factor based on a 1960s life expectancy is substantially more generous than a cost-neutral conversion factor that takes into account opportunities to earn interest on the commuted lump sum. A conversion factor based solely on current life expectancy figures would be even more excessively generous. Calculation of Final Salary. While there are valid reasons for using Final Average Salary (FAS) as the basis for setting retirement benefits in the MSBS, these do not apply in the case of death and disability since the benefit is based on prospective service rather than past, and the member cannot choose the date of death, injury or separation. Accordingly, death and disability entitlements under the proposed new military superannuation accumulation scheme are more aligned towards the MRCA benefit regime and will be based on final salary (not FAS). The Review Team considers a similar approach should be adopted for MSBS death and invalidity benefit calculations; this could be implemented quickly. Individuals remanded in custody. During the course of the Review, the Minister Assisting the Minister for Defence raised with the Review Team the applicability to military superannuation of provisions elsewhere to suspend pensions for individuals remanded in custody by Federal or State Authorities. Current arrangements are complex and not particularly coherent, with some Government payments suspended and others not suspended. Apart from the existing provisions for corruption, the Review Team is inclined to an approach along the following lines: · Safety net payments such as service pensions should be suspended while Government covers living expenses directly while the person is imprisoned. · Compensation payments for loss of earnings and impairment should not be suspended. · Superannuation payments either from accumulated funds or via defined benefit disability payments should not be suspended. · In the last two cases State authorities could, should they choose to, pursue recovery of costs to offset accommodation and living expenses associated with imprisonment, or to contribute to victim compensation. Financial ImplicationsThe financial implications of the Review Team’s recommendations fall under several headings: · The employer contribution rates. These are the critical indicators of the underlying costs of current and proposed arrangements. · The cash requirements and impact on unfunded liabilities. The shift from unfunded defined benefit schemes to a funded defined contribution accumulation plan will replace the build up of unfunded liabilities to be met in the future with real funding set aside now. The cash required for this current funding is not, in any way, a measure of the costs of the new scheme. · The transitional impact on accrued liabilities. This is a real cost (or saving), but is one-off and is not a measure of the underlying or continuing cost. The employer contribution rate under the proposed new arrangements (i.e. the combined rate for ADF members across the DFRDB and MSBS as well as the new scheme) is projected to be broadly similar under the current and proposed arrangements though with a small increase over the first few years. The cost of the new scheme itself, in terms of the employer contribution rate for new scheme members only, is no higher than the cost of current arrangements. The transitional arrangements proposed will bring forward previously unfunded liabilities accrued under the MSBS and DFRDB. This will require an immediate funding on introduction of the proposed scheme of about $7-8bn (based on a 2009 commencement). In addition, the Defence contribution for members in the proposed scheme will fund benefits directly rather than notionally. The Review Team notes that the Future Fund is the most obvious source of the cash required, it having been established precisely for the purpose of meeting the unfunded liability. In basic economic and financial terms, these cash requirements will not have any real impact if met from the Future Fund: they will merely bring forward future liabilities and they will transfer funds from the Future Fund’s investments to the new superannuation fund’s investments. There will be a commensurate reduction in the unfunded liability that would otherwise continue to grow with the continued operation of the existing schemes. Indeed, the Actuary’s estimates show that the total unfunded liability will drop instead of growing substantially and continuously. The transitional arrangements will have a ‘one off’ impact on accrued liabilities as members of DFRDB and MSBS choose whether to transfer into the proposed scheme. The Actuary suggests this impact might be a saving on accrued liabilities of around $150-200m, comprising savings as a result of current contributors transferring offset by the costs of MSBS preservers transferring. Aside from the option to change DFRDB indexation arrangements, the costs of the recommendations on the additional technical issues, both in terms of ongoing employer contribution rates and in terms of accrued liabilities, can be met within the current broad cost envelopes along with the new scheme and the recommended transitional arrangements. As changes to DFRDB indexation could not be met within these envelopes, the Review Team’s recommendation in this regard has been accorded a lower priority than the other recommendations. The Review Team also recognises there would be flow-on pressure for such a change to also apply to the Commonwealth Superannuation Scheme for public servants. The large one-off increase on the unfunded liability would, however, be paid out over many years with only a modest budgetary impact in the first few years. |
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Last updated: 24 December 2007 |