Chapter 1: Introduction
Terms of Reference
The Minister Assisting the Minister for Defence, The Hon. Bruce Billson MP, announced the Review of Military Superannuation on 27 February 2007.
The independent Review Team comprised:
· Andrew Podger AO, former Public Service Commissioner and senior public servant with experience both in Defence and in superannuation policy;
· Dr David Knox, former President of the Institute of Actuaries of Australia and Foundation Professor of Actuarial Studies at the University of Melbourne. Dr Knox is currently a consulting actuary with Mercer Human Resource Consulting; and
· Air Commodore Lee Roberts, former Director-General Personnel, Air Force, and a member of the MSBS Board.
The 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, and
· analysis of a list of specific technical design issues of enduring interest to stakeholders that mostly concern the current schemes. 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.
In making recommendations, the TORs require, inter alia, that they be consistent with the spirit and requirements of the regulatory environment for superannuation, and not be detrimental to former and current members of the ADF.
The full TORs are set out at the beginning of this report.
Background to the Review
Changes in the superannuation environment
Occupational superannuation in Australia has changed enormously over the last 25 years. The scale of the changes is illustrated by the following two graphs. Figure 1–1 shows how the coverage of occupational superannuation has extended beyond the traditional public sector workforce with limited private sector coverage, to over 95% of the total workforce. Figure 1–2 shows how funds to meet the costs of superannuation benefits have increased almost exponentially from $32bn in 1983 to $1,054bn in March 2007, and are still growing quickly. Superannuation assets have grown from less than 40% of GDP in 1996 to more than 100% of GDP in 2007.
Figure 1–1: Australian employees covered by superannuation 1974 to 2006
Source Garry Barrett & Yi-Ping Tseng, Retirement Saving in Australia, SEDAP Research Paper No. 177, Table 1
Figure 1–2: Assets of superannuation funds 1983 to 2007
Sources APRA, Annual Superannuation Bulletin
APRA, Superannuation Trends, September 2004
PLEASE NOTE: Figures 1-1 and 1-2
may appear illegible on some browsers. Both Figures may be viewed in
PDF version [14KB].
Much of this change is in response to a series of policy reforms aimed at improving the effectiveness and efficiency of superannuation arrangements by improving the adequacy of retirement benefits for Australians while reducing their reliance on age pensions.
In the 1980s this involved reducing the bias towards lump sum benefits, improving preservation requirements, introducing Award superannuation and widening the vesting of benefit entitlements. It also involved the issue of indexed bonds to facilitate the availability of indexed pensions beyond the public sector.
In the early 1990s, employer contributions for superannuation were mandated through the Superannuation Guarantee, set at progressively higher levels (reaching 9% of employee earnings in 2002). The so-called ‘three pillars’ policy for retirement incomes was established, comprising the safety net of means-tested age pensions, mandated occupational superannuation and voluntary personal savings. The occupational superannuation industry, growing much larger and with strong competition amongst funds, introduced innovations in the range of products available and, influenced by government regulation, offered wider options for investment strategies.
A subtle but important shift in community attitudes towards superannuation was also taking place within the policy framework of mandated employer contributions, with individuals taking increasing control of their superannuation investments and benefits, rather than accepting the paternalistic guidance of employers. This demand for more responsiveness to individual preferences also led to increasing pressure for portability. In addition, many schemes moved from defined benefit to defined contribution, thereby moving the risk from the sponsoring employer to the members. These trends generated an attitude of greater ownership by members which, in turn, required greater transparency and funding and led to increased regulation.
One of the key drivers of the policy changes has been concern about the ageing population, and the risk of more adequate retirement incomes imposing unfunded liabilities to be met by future generations. There has also been a shift within the public sector away from unfunded, defined benefits schemes. The majority of these schemes have now closed and new employees are required to join funded, defined contribution schemes. This has also allowed the unfunded liabilities to be capped, while transferring much of the risk of future benefits from the sponsors to the members. The MSBS is now the only major Commonwealth scheme with unfunded defined benefits that remains open to new members, and hence is generating uncapped and increasing unfunded liabilities. The Commonwealth Future Fund, established by the Future Fund Act 2006, has been designed to ensure the current generation of taxpayers sets aside funds to meet the liabilities created by the unfunded, defined benefit schemes for Commonwealth employees that would otherwise be met by a future generation of taxpayers.
Concern about the ageing population has also led to the impending increase in the preservation age to age 60, and the introduction of incentives for continued employment after age 60 through ‘transition to retirement’ provisions allowing access to benefits while still working.
The most recent policy reform took effect from 1 July 2007, simplifying tax arrangements for superannuation and removing all tax from benefits paid from taxed schemes to people aged 60 or more. While also reducing tax from benefits paid from untaxed schemes, the new arrangements reflect a policy preference for taxed schemes over untaxed schemes, as well as reinforcing the policy shift to increase the preservation age to age 60 and to promote funded superannuation.
The history of military superannuation and its contemporary challenges correspond closely to this changing policy framework. The DFRDB scheme was introduced in 1972 when superannuation was not common in the wider community. It addressed the unique nature of military service by ensuring generous disability and death benefits, and it provided pensions for those with 20 years or more service but without any age limit. Following the superannuation reforms of the 1980s, Sir William Cole reviewed military superannuation and recommended the closure of the DFRDB and introduction of the MSBS. The MSBS continued DFRDB’s generous disability and death benefits, but reflected the new environment by vesting retirement benefits for those with less than 20 years service, and requiring all retirement benefits to be preserved until age 55. Like the DFRDB (and the public service scheme introduced around the same time), the MSBS is a largely unfunded, defined benefit scheme.
Since the MSBS was introduced in 1991, the contemporary superannuation environment has further changed as outlined above. 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.
Changes in Defence employment
The ADF has always comprised a majority who serve for less than ten years and a minority who choose a substantial career with the military, staying for up to 20 years or more. 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. Figure 1–3 illustrates patterns of mobility in the ADF in recent years.
Figure 1–3: Separations by years of service
PLEASE NOTE: Figure 1-3 may appear
illegible on some browsers. This Figure may be viewed in PDF version [11KB]
Some of the shifts in separation rates at earlier years of service reflect changes in Service policies on enlistment and initial minimum periods of service. The sharp fall in separations after 20 years reflects the phasing out of the DFRDB. Overall separation rates have increased for those who have completed initial training but with less than ten years of service.
Recruitment patterns have also changed over the years, partly reflecting changing community attitudes but also reflecting changing ADF requirements and the competition for labour. In particular the ADF is now recruiting more mature age workers.
Even in 1991, the new MSBS was designed to address concerns about recruitment and retention. Vesting benefits for short-term members improved the overall remuneration package for recruits, and the increases in employer contributions after seven years of service and again after 20 years provided incentives to remain in the ADF (the latter offsetting the reduced incentive flowing from the cessation of DFRDB’s 20 year pensions). The introduction of vesting and preservation was an important improvement but the long term Consumer Price Index indexation of preserved benefits now appears out of date.
Changes in provisions addressing the unique nature of military service
As detailed at the end of the TORs, the unique nature of military service involves in particular 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 reflected in military superannuation through the provision of generous death and disability benefits and through access to retirement pensions from age 55 (or earlier).
In earlier times, repatriation arrangements provided a mix of means-tested pensions that were more easily accessed than civilian social security benefits (eg from an earlier age) and non-means tested death and disability payments providing flat rates of compensation for war-related events. As military superannuation was introduced (initially after the First World War as part of the civilian scheme, and then specifically for the military after the Second World War), superannuation benefits were paid in addition to any repatriation entitlement, adding an earnings-related component to death and disability benefits.
In 2004, the Military Rehabilitation and Compensation Act (MRCA) was introduced, effectively replacing the repatriation death and disability payments (that had evolved into what was known as ‘veterans entitlements’) with earnings-related compensation for disability and lump sums for work-related death and impairment, more in keeping with community workers’ compensation and rehabilitation arrangements though at more generous levels. The disability payments topped up any superannuation payment to largely replace the earnings previously paid, while the death benefit supplemented superannuation death benefits. Notwithstanding the improvements flowing from the MRCA, the interaction with superannuation remains very complex, with separate systems for assessing disability, different approaches to rehabilitation and different coverage (one based on service-related events, the other on any event leading to death or disability).
As mentioned, the MSBS replaced the DFRDB’s 20 year pension arrangement with retirement benefits preserved to age 55, in line with the then community requirement. While the preservation age is gradually being increased to 60 for the rest of the community, and the compulsory retirement age in the ADF has also recently increased to 60, the MSBS continues to allow indexed pensions from age 55. Figure 1–4 demonstrates the continuing practice in the ADF of retirements by age 55, and illustrates the increasing likelihood under the MSBS of retirements peaking at or near age 55 in the future.
Figure1–4: Separations by age for those over 50.
PLEASE NOTE: Figure 1-4 may appear illegible on some browsers. This Figure may be viewed in PDF version [10KB]
Conduct of the Review
The Review Team has been supported by a secretariat from the Department of Defence comprising civilian and military staff with experience in Defence personnel and superannuation matters. These staff are listed at Appendix A. The secretariat engaged actuarial services from the Australian Government Actuary and, in particular, Mr Michael Burt, who has provided ongoing advice to the Review Team on the financial implications of the options under consideration.
The Military Superannuation Reference Group, comprising senior officers from Defence and the three central agencies (the Departments of Prime Minister and Cabinet, Finance and Administration and the Treasury), provided guidance to the Review Team on Government superannuation and related policies and offered comments on options being developed. The Review Team also consulted ComSuper, the Department of Veterans’ Affairs, the MSBS Board of Trustees and the DFRDB Authority as it developed its proposals.
The Review Team was ably assisted by these arrangements. It has nonetheless retained its independence, and the Review Team accepts full responsibility for its recommendations which may or may not be agreed by the agencies with which it has worked.
The Review Team consulted widely and systematically despite its tight time deadlines.
- Submissions were invited by newspaper advertisements and by written approaches to key stakeholders, both within the ADF and externally.
- Internal ADF submissions were also facilitated by on-line arrangements using a website set up for the Review and a simple submission form allowing long or very short submissions to be made by a member of the ADF. 381 submissions were received.
- Members of the Review Team visited ADF establishments in all States and territories except Tasmania, holding information sessions and seeking views on the current schemes and on contemporary arrangements outside the public sector.
- The Review Team met with the CDF and Service Chiefs, and the Chiefs of Staff Committee, during the Review.
- Other key stakeholders were invited to meet the Review Team to discuss their submissions, and some were consulted confidentially on the options being considered by the Review Team.
- When the Team’s proposals were substantially developed, focus group discussions were held in Canberra, Sydney and Wagga Wagga with small groups of ADF members in three separate demographic categories (those with less than eight years of service, those with eight to 20 years of service and those with more than 20 years of service).
Appendix B sets out lists of people and organisations consulted, and from whom submissions were received. A table identifying the key issues raised in the submissions received is at Appendix C.
The Review Team also commissioned a telephone survey of ADF members to strengthen the evidence available of the actual and potential links between military superannuation and ADF recruitment and retention rates.
The Review Team was asked by the Minister to provide its recommendations by the end of June 2007. It did so under cover of an interim report explaining briefly the basis of its recommendations. The recommendations in this final report are essentially unchanged from those in the interim report.
In developing its recommendations, the Review Team divided the task into two main parts, corresponding closely to its first two TORs. The first involved a review of the current arrangements against contemporary best practice and current policy settings for superannuation (as well as the unique nature of military service and the potential to support recruitment and retention), and the development of preferred arrangements. The second involved an analysis of a list of technical issues that have been the subject of criticisms about the current schemes. This Report is broadly structured around these two parts.
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 for Government consideration 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. A discussion of the financial implications is set out in the final chapter of this report.