Appendix E. History and description of current schemes

The DFRDB

The DFRDB Scheme was implemented with effect from 1 October 1972 following the Joint Select Committee Review of Defence Forces Retirement Benefits Legislation, chaired by Mr J D Jess MP. This Committee was established in view of the concerns of private members and Senators with the operation of the Defence Forces Retirement Benefits Act 1948, particularly the very high contribution rates required of certain pre-1959 entrants to the scheme, delays in completing statutory actuarial reviews and the ever growing complexity of the legislation.

The DFRDB arrangements replaced the DFRB Scheme for all serving members and existing DFRB contributors were transferred to the DFRDB Scheme under no detriment provisions.

The key features of the DFRDB Scheme (as introduced from October 1972 under the legislation passed in 1973) are:

• a flat contribution rate of 5.5% of military salary, with member contributions being paid into and all benefits paid from the Consolidated Revenue Fund;
• retirement pay (i.e. pension) eligibility after 20 years of contributory service (35% of retiring salary, rising to a maximum of 76.5% after 40 years service);
• notional retiring age penalties for officers who voluntarily resigned below specified ages for their rank;
• indexation of pension amounts by a wage based index although this was replaced in 1974 by annual movements in the Consumer Price Index (CPI);
• an option to commute up to four times the annual retirement pay benefit to a lump sum payment, with an associated reduction in the retirement pension amount;
• a simple refund of member contributions (with no indexation or interest) for those who took voluntary separation before becoming eligible for a pension at 20 years; and
• a three-tiered system of invalidity benefits based on the maximum retirement pay rate and a member’s incapacity for relevant civilian employment.

The scheme effectively replaced the funded arrangement under the DFRB. The Jess Committee had recommended the move to pay benefits from Consolidated Revenue but, in first announcing the Government’s decision to introduce the new scheme, the then Prime Minister, Mr W McMahon MP, stated that the fund would continue. The legislation passed under the Whitlam Government, however, reflected the original Jess Committee recommendation.

The maximum commutation factor was progressively increased from four to five times annual retirement pay over 1982 to 2002 to offset the impact of the 1983 concessional tax increases on lump sum eligible termination payments. The original intent of the commutation feature (in the DFRB Scheme) was to allow retiring ADF members to buy a home and the proposed use of the commutation funds had to be approved by the (DFRB) Authority. However, over time this requirement was dropped.

While those discharging with less than 20 years of service were ineligible for pensions and only received a refund of their contributions, they could also receive a small lump sum gratuity based on length of service.

The 1991 Cole Review, which led to the introduction of the MSBS, also led to a number of enhancements to the DFRDB scheme. These involved:

• formalisation of arrangements for accrual of the three 3% Productivity Benefit introduced from January 1988;
• annual CPI indexation for the lump sum component of orphans’ and children's benefits;
• the introduction of a commutation option for dependent spouses on the death of a contributing member;
• changes to the calculation of benefits for re-entered DFRDB pensioners and a choice between resuming DFRDB membership or joining MSBS; and
• the cessation of DFRDB contributions on completion of 40 years service.

The DFRDB is a totally unfunded scheme. The compulsory member contribution of 5.5% of military salary is paid to Consolidated Revenue. The final defined benefit is paid out of Consolidated Revenue with the notional member contribution and the notional 3% Productivity benefit considered tax-paid for superannuation purposes. However, the majority of the benefit is considered untaxed and precludes members from receiving all the benefits of the new Better Super arrangements such as tax-free benefits after age 60.

The DFRDB scheme is closed to new members but currently has some 5500 contributors in service.

The MSBS

In May 1989, the then Minister for Defence Science and Personnel (Mr David Simmons) announced a review of the DFRDB Scheme. As part of the announcement, the Minister gave an ‘ironclad guarantee’ to serving members that existing DFRDB benefits would continue to be available to be taken up when they left the Services. A Review of the DFRDB Scheme was subsequently undertaken by a small team led by Sir William Cole and their report of 25 June 1990 (which became known as the Cole Report) concluded that the DFRDB Scheme was no longer appropriate for the majority of ADF members, particularly younger personnel, and did not adequately meet the ADF’s personnel management objectives.

The Cole Report noted that the DFRDB Scheme was designed in a superannuation environment markedly different to that existing in 1990. Since 1983, major changes had been made to the regulatory system governing superannuation and taxation to encourage people to fund their own retirement and ease future demands on the social security system. These changes sought to establish the prime purpose of superannuation as providing for genuine retirement income. Additionally, DFRDB arrangements failed to meet the requirements of the Occupational Superannuation Standards (OSS) Act 1987 in several key areas such as returns on member contributions, the payment of commutable retirement pensions before age 55 and the structure of the DFRDB Authority.

The Cole Report’s rationale for a totally new ADF superannuation and benefits scheme was based on the following deficiencies in the DFRDB Scheme with respect to OSS compliance:

• members who served for less than 20 years received no employer-financed benefit (unless they had reached retiring age for rank with at least 15 years service);
• the lack of any investment return on member contributions;
• payment of an employer benefit (pension) well before the age of 55 (in some cases retirement pay could commence at age 36 for former trade apprentices); and
• the substantial cost (and scheme design changes) required to overcome these compliance issues unless the Minister’s ‘ironclad guarantee’ regarding the continuation of the extant DFRDB benefit structure were abrogated.

Cole also identified a problem with separation rates linked to the DFRDB Scheme design in that the retirement pension provision tended to cause very low separation rates in the 12-20 year service bracket, but created a dramatic peak after the 20 year point. This resulted in many experienced members leaving after 20 years service to access the lump sum available through commutation.

All DFRDB contributors had a one year window from 1 October 1991 to elect to transfer to the MSBS after the new scheme’s introduction. On transfer, they received an (unfunded) member‑financed benefit based on their contributions and notional interest at the long term bond rate. A notional employer-financed benefit was also determined based on their average salary and length of service.

95% of DFRDB members serving at the time made an election and 38,355 personnel (or 59% of electees) chose to transfer to the MSBS. This transfer figure represented 81% of (former DFRDB) members with less than ten years service, 41% in the 10-15 year bracket, 23% with 15-20 years service and 17% of members with more than 20 years.

MSBS became the compulsory superannuation scheme for all members joining the ADF from
1 October 1991. The scheme remains in force and is essentially a hybrid accumulation/defined benefit arrangement with the following key features:

• Compulsory member contributions (a minimum of 5% and maximum 10% of after tax salary) are invested in the MSBS accumulation fund with regular contributions and investment earnings added to the member balance via a unitised account system. Members may choose from a range of investment options.
• The member-financed benefit is payable only as a lump sum and all contributions and earnings from 1 July 1999 are subject to superannuation preservation requirements.
• The employer-financed benefit is a totally separate (largely unfunded) defined benefit which is calculated on a member’s discharge according to length of service (based on multiples of 18% for the first seven years, 23% from 8-19 years and 28% for more than 20 years) and final average salary.
• The MSBS employer-financed benefit is subject to the preservation rules and can be taken either as a pension (indexed at CPI), a lump sum or a combination of both from the age of 55. The pension option is favourably priced.
• The death benefit for a contributory member is an immediate lump sum of the member component and an employer-financed lump sum based on prospective service to age 55. This lump sum can be converted on generous terms to an indexed pension to a surviving spouse with additional benefits for dependent children.
• The MSBS features a three-tiered invalidity benefit structure which is similar to the DFRDB arrangements.

The MSBS member contribution and consequent earnings are fully funded and taxed and may be withdrawn after preservation age and will now be tax-free after age 60. The employer component of the scheme is unfunded and untaxed except for the notional value of the 3% Productivity element. This increases at the MSBS default investment choice earning rate. The employer-financed defined benefit is paid out of Consolidated Revenue with the 3% Productivity benefit element considered to be a taxed benefit. However, the majority of the benefit is considered untaxed and precludes members from receiving all the benefits of the new Better Super arrangements such as tax-free benefits after age 60.