Chapter 10: Financial implications
Cash requirements and impact on unfunded liabilities
Transitional impact – accrued liabilities
The Review Team used the services of the Australian Government Actuary (the Actuary) to provide estimates of the costs associated with the introduction of the proposed new scheme, which are set out below. These estimates do not take into account tax or social security impacts: the Actuary considers that the tax and social security effects should roughly even out in the long term between the current unfunded arrangements and proposed funded arrangements. The estimates are based on membership data as at 30 June 2006 and, for the most part, the new scheme starting from that date. The Actuary has advised that the main features disclosed by the costings would still be present if the implementation date were in 2009. A more detailed report by the Actuary is at Appendix H.
The financial implications fall under several headings:
The employer contribution rates. These are the critical indicators of the underlying costs of current and proposed arrangements. The rates for the current schemes are mostly ‘notional’8 in that they do not relate to funds actually being set aside, but are the Actuary’s assessment of the funds that would have to be set aside to meet the accumulating liability of the schemes (that will eventually be met by future budget allocations and/or Future Fund disbursements). Despite being ‘notional’ they are nonetheless paid out of the Defence budget back into Consolidated Revenue. Under the new scheme, the employer contribution rate is mostly real money transferred into the superannuation fund (the provision for death and disability benefits will remain a ‘notional’ insurance premium as benefits will be funded on a pay-as-you-go basis).
The cash requirements and impact on unfunded liabilities. The shift from mainly 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 extent of this ‘bring forward’ will depend upon the extent to which current ADF members and MSBS preservers choose to transfer to the new scheme. The cash required for this current funding is not, in any way, a measure of the costs of the new scheme. After all, there will be a corresponding reduction in future unfunded liabilities as a result of paying for them now.
The transitional impact on accrued liabilities. This is a real cost (or saving) on transition, but is one-off and is not a measure of the underlying or continuing cost. It arises from such things as the choice made by ADF members to transfer to the new scheme, and changes made to the DFRDB or MSBS affecting accumulated entitlements. The one-off cost (or saving) affects the unfunded liability which may not be met until sometime in the future.
The following sections focus firstly on these three financial implications of the proposed new scheme and then on the implications of the recommendations relating to the existing schemes. Estimates of the departmental expenses affecting transitional and ongoing costs are also set out below.
As mentioned in Chapter 1, the Review Team has taken the general approach that its central recommendations should cost about the same as the current arrangements. By this it means that the employer contribution rates should be in line with the current employer contribution rates. As well, if possible, there should be no significant one-off increase in accrued liabilities. Within these cost ‘envelopes’, the Review Team has developed its central package. The one option (DFRDB indexation – Recommendation 14) that could not be met within these envelopes has been explicitly accorded a lower priority. Because the costs of all the other recommendations do come within these broad envelopes, they are all considered high priority by the Review Team and form a coherent and affordable package.
These cost envelopes do not include consideration of any immediate cash requirements as these requirements do not affect either the underlying long-term costs or any one-off transitional costs arising from the recommendations.
Employer contribution rates
Figure 10-1 and Table 10-1 compare the employer contribution rate for the current schemes if they continue unchanged and the proposed scheme, as projected by the Actuary.
As demonstrated by Figure 10-1, this measure of the underlying employer cost is projected to be broadly similar under the current and proposed arrangements though with a small increase over the first few years. The employer contribution rates are, however, based on no change to the costs of death and disability benefits. The Actuary has advised that estimating the impact of the proposed changes to these benefits is difficult. The Actuary considers it more likely that the costs in the new scheme will be lower rather than higher than under the current schemes due, in part, to the increased rehabilitation focus. The Department of Veterans' Affairs experience would support this view.
In addition, the existing costs for the current defined benefit schemes are less certain than the costs arising from the proposed defined contribution scheme.
Figure 10–1: Employer contribution rates under current and proposed schemes (including death and disability costs)
PLEASE NOTE: Figure 10-1 may
appear illegible on some browsers. This Figure may be viewed in PDF version [12KB].
Table 10–1: Employer contribution rates under current and proposed schemes (including death and disability costs)
|
Financial Year |
Current arrangements |
Proposed arrangements |
|
|
Combined % |
New Scheme % |
Combined % |
|
|
2006/07 |
25.6 |
24.7 |
26.6 |
|
2007/08 |
25.8 |
24.7 |
26.5 |
|
2008/09 |
25.7 |
24.6 |
26.3 |
|
2009/10 |
25.7 |
24.6 |
26.1 |
|
2010/11 |
25.4 |
24.5 |
25.8 |
|
2011/12 |
25.3 |
24.5 |
25.6 |
|
2012/13 |
25.3 |
24.5 |
25.4 |
|
2013/14 |
25.2 |
24.5 |
25.3 |
Cash requirements and impact on unfunded liabilities
The proposed transitional arrangements 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). This funding requirement is likely to be spread over two financial years due to the proposed 12 months window for active and preserved members to choose.
In addition, the Defence contribution for members in the proposed scheme will fund benefits directly rather than notionally. This will have no impact on Defence for which the current ‘notional’ contribution is an identified expense in its budget, even though the contribution is returned to Consolidated Revenue but it will require additional cash of around $0.4bn per year for a number of years from the Government’s overall budget. This additional cash requirement will rise to around $0.7bn (in nominal terms) before falling, and will eventually become negative.
The Review Team notes that the Future Fund is the most obvious source of the initial 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 taken 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, as highlighted by Figure 10–2 by 2045 the Actuary’s estimates suggest the total unfunded liability will drop from the current $33bn to $19bn instead of growing to $134bn (in nominal dollars).
Figure 10–2: Unfunded liabilities for military superannuation schemes (nominal prices)
PLEASE NOTE: Figure 10-2 may appear
illegible on some browsers. This Figure may be viewed in PDF version [11KB].
Figure 10–3 shows the impact of the proposed new scheme on the Government’s projected total defined benefit superannuation liabilities, including both civilian and military schemes, assuming the recommendations contained in this report (excluding DFRDB pension indexation) are adopted.
It is apparent, again, that the introduction of the new scheme and the proposal for current and preserved members to transfer to the proposed new scheme will not only cap the Government’s projected liabilities but also reduce them. Nonetheless, there remains a substantial role for the Future Fund over many years to meet the defined benefit liabilities.
Figure 10–3: Impact of proposed new scheme on unfunded liabilities
Figure 10–4 shows the effect if the MSBS were closed to new entrants but without offering portability to current and preserved members. A similar effect to that of the Review Team’s recommended approach is shown, but the capping is at a higher level and the maximum in respect of the military superannuation liabilities is reached more than ten years later. In effect, a decision not to allow the portability options to the current and preserved members would increase these liabilities each year resulting in an increase of more than $20bn for each year in the projection period after 2023-24. Of course, this reflects the failure under this option to meet these liabilities earlier.
Figure 10–4: Unfunded liabilities where new scheme open only to new members
In other words, the Review Team’s firm recommendations to allow current ADF members and MSBS preservers the choice to transfer to the new scheme will reduce the unfunded liabilities somewhat further than if the new scheme were available only to new ADF members, but will only modestly reduce the continuing role of the Future Fund.
Access to the Future Fund is constrained by its legislation, but in 2007 it already holds $51bn and this will increase further from its investment income and when the proceeds of the next stage of the Telstra sale, and any funds from future budget surpluses, are directed into the fund. It is estimated therefore, that the Future Fund will have reached more than 75% of its Target Asset Level by 2009 when it is proposed the new scheme be introduced. The Review Team’s recommendations are likely to require about 10% of the Fund to be transferred into the new military superannuation scheme on commencement, if that is to be the source of the funds required.
The Review Team considers that this immediate funding of the benefits for current and preserved members of the MSBS will have a positive effect on recruitment and retention.
Transitional impact – accrued liabilities
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 (around $550m) offset by the costs of MSBS preservers transferring (around $350-400m).
The Actuary has provided estimates of this impact based on considered assumptions of how different demographic groups within the ADF and amongst MSBS preservers would respond to the choice on offer. As explained in the Actuary’s Report at Appendix H, the expected saving from transfers by current ADF members relates, in part, to rational choices likely to be made by many young members to take the real funds under the new scheme which keeps their future options open and to forgo possibly higher MSBS benefits in the future in the form of indexed pensions from age 55. After all, these members do not yet know whether they will stay in the ADF for a long period.
The Actuary has also provided estimates based on an alternative set of assumptions involving a lower rate of transfer (essentially, assuming more inertia against change). The two sets of estimates are set out in Table 10–2.
Table 10–2: One-off cost impact on accrued liabilities
|
|
Base Estimate $m |
Alternative Estimate $m |
|
Cost of current ADF members choosing to transfer |
-550 |
-500 |
|
Cost of preserved MSBS members choosing to transfer |
350 to 400 |
250 to 300 |
|
TOTAL Costs |
- 150 to - 200 |
- 200 to - 250 |
In summary, while there is considerable uncertainty about these estimates, it is likely that they will involve a net saving of over $100m in reported accrued liabilities.
Additional technical measures
Table 10–3 identifies the estimated costs, both in terms of the employer contribution rate and any one-off impact on accrued liabilities, of the Review Team’s recommendations on the additional technical issues set out in Chapter 9.
Table 10–3: Costs of additional technical measures
|
Item |
Impact on employer contribution rate % of total ADF salary base |
One-off Impact on Accrued Liabilities $m |
|
Abolition of MSBS Maximum Benefit Limits |
Negligible1 |
60 |
|
Interdependent Relationships |
Negligible2 |
Negligible2 |
|
Changing Final Average Salary to Final Salary for MSBS death and disability benefits |
Negligible1 |
Negligible |
|
Wages indexation of DFRDB pensions - for those over 55 - for those over 65 |
. 0.83 0.53 |
. 4,200 2,600 |
1. These impacts on the employer contribution rate have been included in the estimates in Figure 10–1 and Table 10–1.
2. These estimates do not include any costs should the Government decide to recognise Interdependent Relationships under the existing schemes.
3. These will decline rapidly as DFRDB contributors leave the ADF.
Changes to DFRDB indexation could not be met within the envelopes of current costs and existing unfunded liabilities, and has therefore 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 apply to the Commonwealth Superannuation Scheme for public servants. Nonetheless, the large one-off increase on the unfunded liability would be paid out over many years with only a modest budgetary impact in the first few years, as illustrated below:
Table 10–4: Budget Impact of DFRDB indexation options
|
|
DFRDB pensions for over 55 year olds $m |
DFRDB pensions for over 65s only $m |
|
1st year’s impact |
3 |
1 |
|
2nd year’s impact |
14 |
7 |
|
3rd year’s impact |
27 |
13 |
|
4th year’s impact |
41 |
21 |
|
5th year’s impact |
55 |
28 |
|
35th year’s impact |
702 |
458 |
|
40th year’s impact |
721 |
480 |
|
Total impact on future unfunded liabilities |
4,200 |
2,600 |
Departmental expenses
Implementation costs
The introduction of the proposed accumulation plan and the proposal that the defined death and disability arrangements be administered by DVA will require additional resources over about three years for a range of agencies.
Table 10–5 sets out preliminary estimates by the agencies affected of the transitional costs involved, on the basis of introduction of the new scheme in early 2009.
Table 10–5: Departmental expenses for transition
|
|
FY 2007-08 |
FY 2008-09 |
FY 2009-10 |
Total |
|
Department of Defence |
$5.0m |
$8.9m |
$4.5m |
$18.4m |
|
ComSuper |
$4.3m |
$4.0m |
$0.0m |
$8.3m |
|
Board of Trustees |
$0.5m |
$1.5m |
$1.0m |
$3.0m |
|
Department of Veterans’ Affairs |
$1.1m |
$1.3m |
$0.6m |
$3.0m |
|
Total |
$10.9m |
$15.7m |
$6.1m |
$32.7m |
Note Due to the cap on Defence’s civilian staffing numbers, Defence may need to seek additional staff coverage for the implementation of any recommendations.
Ongoing costs of administration
Overall, the new scheme should require no net increase in administrative costs: there may be some savings over time due to the simpler scheme design and a heightened rehabilitation focus (that should return injured individuals to the workforce earlier than current arrangements). The Review Team has not developed estimates of the costs or savings for individual agencies, but notes that there will be some additional ongoing costs in relation to the emphasis on rehabilitation (Recommendation 4b), the proposed education and awareness program (Recommendation 11), and as a result of an increase in the number of trustees for military superannuation (from five to seven), and their on-costs (Recommendation 9b). These increased costs are likely, in the medium to long term, to be outweighed by savings in relation to:
- the administration of a simpler scheme design;
- some injured individuals returning to the workforce earlier;
- the requirement for fewer overall medical assessments; and
- efficiencies from having only one agency dealing with both compensation and superannuation medical assessment regimes and appeals processes.