Archived SUBMISSION TO THE REVIEW OF INDEXATION ARRANGEMENTS IN AUSTRALIAN GOVERNMENT CIVILIAN AND MILITARY SUPERANNUATION SCHEMES

Transcription

1 SUBMISSION TO THE REVIEW OF INDEXATION ARRANGEMENTS IN AUSTRALIAN GOVERNMENT CIVILIAN AND MILITARY SUPERANNUATION SCHEMES August 2008

2 TABLE OF CONTENTS Executive Summary 3 Chapter 1 The Occupational Nature of Australian Government Superannuation Arrangements 5 Superannuation is a condition of employment 5 Indexation of pensions as a condition of employment 6 Chapter 2 The Form of Benefits 7 Benefits paid from the CSS 7 Benefits paid from the PSS 7 Chapter 3 The Value of Benefits 9 Superannuation Pensions in payment 9 Total superannuation benefits 10 Factors Impacting on the Value of Benefits 12 Chapter 4 Comparison with State and Territory Superannuation Schemes 15 Chapter 5 The Interaction with Australian Government Safety Net Benefits_16 Other Australian Government measures 16 Interaction of superannuation pension and Age Pension 16 Changing the superannuation pension indexation method 18 Chapter 6 The Cost to the Government of Changing Indexation 19 Current superannuation scheme costs 19 Aligning indexation with the Age Pension methodology 19 Indexation by the higher of CPI or MTAWE 21 Impact on Notional Employer Contribution Rates 22 ATTACHMENTS Attachment A: Australian Government Superannuation Schemes 23 Attachment B: Pension Indexation A Historical Perspective 26 Attachment C: Explanation of Costs 27 Page 2 of 28

3 Executive Summary The Department of Finance and Deregulation is responsible for advising the Government on policy issues related to the superannuation schemes for Australian Government employees. The main schemes are: the Commonwealth Superannuation Scheme (CSS) and the Public Sector Superannuation Scheme (PSS), which are both defined benefit schemes; and the Public Sector Superannuation Accumulation Plan (PSSAP), which is a fully funded accumulation scheme. In addressing the Terms of Reference, the focus of this submission is primarily on the CSS and the PSS, which are the two main defined benefit schemes for Australian Government civilian employees. Some reference is also made to the smaller schemes administered in the Finance and Deregulation portfolio. 1 Costings address both civilian and military schemes. This submission, in particular, addresses: The occupational nature of superannuation (Chapter 1) - superannuation is provided as part of a person s terms and conditions of employment. Changing the indexation method would represent an improvement in the employment contract of existing and former Australian Government employees who are members of the CSS or the PSS by increasing their total remuneration package. This would increase the employment costs of agencies, which would be difficult to offset by productivity gains. The form and value of benefits (Chapters 2 and 3) indexation is one element of the total benefit provided to members. The total benefit will also depend on factors such as the member s personal level of contributions and length of employment with the Australia Government. The indexed pension will not always represent the total value of benefits that a member has received at retirement as some of the total benefits may have been taken as a lump sum. Arrangements for indexation in State and Territory schemes (Chapter 4) Pensions payable from the State defined benefit civilian superannuation schemes are also indexed by the Consumer Price Index (CPI). Interaction of the Age Pension and superannuation scheme payments (Chapter 5) Many members receiving a CSS or PSS pension may be entitled to receive a full or part-rate Age Pension. This would however, depend on their individual circumstances, such as whether they have other retirement income. 1 This is the scheme established under the Superannuation Act 1922 (1922 Scheme) and the scheme under the Papua New Guinea (Staffing Assistance) (Superannuation) Regulations (the PNG Scheme). Page 3 of 28

4 The cost to the Government of changing indexation (Chapter 6) - Changing the indexation method would have a potentially significant budget and balance sheet impact. If the methodology was changed to align with that for the Age Pension there would be an estimated immediate increase in the unfunded liability of the order of $28 billion (around $17.3 billion for civilian and around $10.3 billion for the military schemes). This cost would rise to some $57 billion by 2020 (around $34 billion for civilian and around $23 billion for the military schemes). The costs of higher indexation in the medium to long term would have to be found from the Budget as the Future Fund is only funded to meet unfunded liabilities arising from current indexation arrangements. Page 4 of 28

5 Chapter 1 The Occupational Nature of Australian Government Superannuation Arrangements Australian Government employees have had employer provided superannuation since 1922, which compares favourably with community standards. The Government provides superannuation benefits to retired Australian Government employees in its role as an employer. Superannuation is a condition of employment Superannuation is provided as part of an employee s terms and conditions of employment. The current notional employer contribution rate (NECR) for the CSS is 28.2% and for the PSS it is 15.6% as set out in the PSS and CSS Long Term Cost Report Members of the PSSAP receive employer contributions of 15.4%. These compare to a Superannuation Guarantee minimum employer contribution rate of 9% under the Superannuation Guarantee (Administration) Act Members of the CSS and the PSS have a statutory entitlement to a defined level of superannuation benefits at retirement. This is outlined in the establishing legislation of the schemes. Members of various other Australian Government superannuation schemes also have defined benefits at retirement, as described in Attachment A. Key features of Australian Government defined benefit arrangements include: member contributions from after tax salary 3 ; superannuation benefits largely calculated on the basis of member contributions, salary, age and length of service; the Government bears a large portion of the investment risk for the PSS; employer financed superannuation benefits that can be taken in the form of a lifetime indexed pension; and indexed reversionary pensions payable to the spouse and children of a deceased member. More recently, the Government has established accumulation arrangements for new civilian employees and new Parliamentarians. 4 This is consistent with trends in the private sector. Key features of these arrangements include: superannuation benefits linked to level of member and employer contributions; the employee bearing the investment risk; and benefits paid in the form of a lump sum no pension is payable from the PSSAP. 2 The NECR for the Defence Force Retirement and Death Benefits Scheme (DFRDB) is 33.5% and for the Military Superannuation and Benefits Scheme (MSBS) it is 24.7% - these are sourced from the MSBS and DFRDB Long Term Cost Report Except for the Judges and Governors-General schemes, where no member contributions are made. From 1 July 2008, CSS and PSS members can elect to make no contributions. 4 The Review into Military Superannuation Arrangements has recommended that the MSBS be closed and a new accumulation scheme be established. The Government is yet to respond to this Review. Page 5 of 28

6 Indexation of pensions as a condition of employment The legislation underpinning the CSS and the PSS provides for pensions from those schemes to be indexed twice yearly. 5 Increases are in line with the All Groups Consumer Price Index (CPI) for the weighted average of the 8 capital cities as published by the Australian Bureau of Statistics. Pensions are increased at the beginning of July and January, according to any increase in the CPI for the six months to the preceding September and March respectively. That is, pension increases occur 3 months after the end of the relevant period. A change to the indexation arrangements for superannuation pensions paid from the CSS and PSS would require legislative change. Such a change would represent an improvement in the employment contract of Australian Government employees who are members of these schemes by increasing their total remuneration package. This would mean agencies would face increased employment costs that would be difficult to offset by productivity gains. Without supplementation from the Budget, these increased employment costs would have to be met from agencies existing budgets or through a reduction in another element of employees remuneration, such as salary. This is notwithstanding that an increasing number of employees will not be members of the CSS or the PSS in the future. Employees who commenced after 1 July 2005, and are members of the PSSAP, would not benefit from a change in indexation, as the PSSAP does not provide indexed pensions at retirement. For retired employees, a change in indexation arrangements would, in effect, represent a retrospective upgrade to their terms and conditions of employment. The change would increase their superannuation savings, which would be funded wholly by the Government. Improving the employment contracts of present and former employees by changing the method of indexing superannuation pensions would increase the current notional employer contribution rates, thereby increasing taxpayer funded employer costs. 5 Section 148 of the Superannuation Act 1976 in relation to the CSS and Division 6 of the PSS Trust Deed in relation to the PSS. Page 6 of 28

7 Chapter 2 The Form of Benefits Generally, the Australian Government defined benefit superannuation schemes, whilst having some common design characteristics, are tailored to the specific employment patterns of their members. For example, the CSS and PSS were largely designed for career public servants; the military schemes are tailored to the needs of military service. A brief overview of each of the Australian Government superannuation schemes is at Attachment A. The nature and form of the benefits payable from the CSS and the PSS is described below. Benefits paid from the CSS Prior to 1 July 2008, a member of the CSS was required to make mandatory member contributions of 5% of gross superannuation salary, paid from after tax salary. From 1 July 2008, a member can elect to make no contributions. A member can also make additional supplementary contributions. Member contributions are paid into the CSS Fund and accumulate with fund earnings. In addition, a member receives employer productivity contributions of around 3% of superannuation salary, which are paid into the CSS Fund and accumulate with fund earnings. The balance of the member s employer financed benefit is unfunded; that is, it is not funded until the member s benefit becomes payable. The unfunded employer component of the member s benefit must generally be taken as a lifetime CPI indexed pension. However, the accumulated 5% member contributions and the funded employer productivity contributions can be taken as either a lifetime non-indexed pension or a lump sum. The CPI indexed pension is calculated as either: A CSS age pension if the member retires after minimum retiring age (usually age 55). This is calculated as a percentage of final superannuation salary, based on the period of contributory service of the member and discounted for early retirement before age 65 6 ; or 2.5 times the accumulated 5% member contributions and interest multiplied by a pension factor, if the member resigns from employment before their minimum retiring age and preserves their benefit in the CSS until retirement age. This is commonly known as the 54/11 benefit. Benefits paid from the PSS Prior to 1 July 2008, a member was required to contribute at a rate of between 2% to 10% of their gross superannuation salary, with contributions paid from after tax 6 Generally, CSS age pension accrual rates are 2% per annum for first 20 years of membership, 1% per annum for the next 10 years, and 0.25% per annum for each of the next 10 years. The maximum percentage is 52.5% of final salary. In addition, the member receives their funded contributions as a lump sum, which may be converted to a pension. Page 7 of 28

8 salary. From 1 July 2008, a member can elect to make no member contributions. Member contributions are paid into the PSS Fund and accumulate with fund earnings. Employer productivity contributions of around 3% of superannuation salary are paid into the PSS Fund and accumulate with fund earnings. The balance of the member s employer financed benefit is unfunded; that is, it is not funded until the member s benefit becomes payable. A PSS benefit accrues as a fully defined lump sum benefit. It is calculated by multiplying the member s benefit multiple by his or her final average salary (FAS). 7 FAS is generally the average of a member s salary for superannuation on the three birthdays preceding exit. A member s benefit multiple depends on the rate of member contribution they make. The rate of accrual is generally as follows: Table 1: PSS accrual rates Member Contribution Rate Employer Benefit Accrual Total Benefit Accrual Member Contribution Rate Employer Benefit Accrual 8 0% 11%.11 6% 17%.23 2% 13%.15 7% 18%.25 3% 14%.17 8% 19%.27 4% 15%.19 9% 20%.29 5% 16%.21 10% 21%.31 Source: PSS Trust Deed and Rules Total Benefit Accrual For example, a person who contributed for 30 years at 5% of salary and whose final average salary on retirement was $50,000, would have a benefit multiple of 6.3, that is, 30 *.21. The lump sum benefit would be $315,000, that is, 6.3 * $50,000. Retirement benefits in the PSS can be taken as either: A full lump sum benefit. A lifetime CPI indexed pension (calculated by dividing the lump sum benefit by a pension age factor). A combination of CPI indexed pension and lump sum. At least 50% of the lump sum benefit must be taken as a pension. 7 The total benefit is subject to a maximum benefit limit, which is typically 10 times final average salary. 8 The rate of accrual is also subject to a ten year rule. That is, for a ten year period of membership in the PSS not necessarily a continuous period or the first ten years the maximum employer benefit accrual is based on an average member contribution rate of 5%per annum, regardless of whether actual member contributions are above that amount. Page 8 of 28

9 Chapter 3 The Value of Benefits Superannuation benefits from the CSS and PSS are broadly calculated with reference to a member s contributions and their salary, age and length of membership. 9 This chapter provides information on the value of benefits provided by the CSS and the PSS, which provide most of the pensions in payment. However, some information is also provided on the 1922 Scheme (which preceded the CSS and was closed in 1976 see Attachment A). The CSS and the PSS had 122,701 pensions in payment at 30 June 2007 compared with 7,226 in the 1922 Scheme. 10 Superannuation Pensions in payment Table 2 provides a breakdown of the average value of the various types of pensions paid from the 1922 Scheme, the CSS and the PSS as at 30 June Table 2: Average annual pensions in payment 1922 Scheme CSS PSS Age Retirement Pensions $28,057 $27,242 $17,938 Involuntary Retirement Pensions $18,137 $22,464 $16,578 Invalidity Pensions $32,490 $24,589 $21,763 Reversionary Pensions $21,541 $16,889 $13,831 Average all Pensions $23,999 $23,945 $17,603 Source: ComSuper Reversionary pensions paid to dependants are lower than other pensions, as they are typically 67% of a member s pension at death. They are indexed to CPI for the life of the dependant. 11 As at 30 June 2007, there were 29,334 reversionary pensions being paid from the 1922 Scheme, the CSS and the PSS, which is about 23% of all pensions currently being paid. The distribution of CPI indexed pensions for the CSS and the PSS is shown below in Table 3. These figures also include reversionary pensions. 9 In the 1922 scheme, the age retirement benefit was payable from 1973 as a lifetime CPI indexed pension based on units held at retirement with a maximum pension of 70% of salary. The percentage was lower for higher income earners. There was also a separate component, known as the Provident Account, where the benefit payable was a lump sum of 3 times the accumulated member contributions. 10 Data sourced from the Commissioner for Superannuation Annual Report and ARIA Annual Report Unless the dependant is a child of the member, where age limits apply. Page 9 of 28

10 Table 3: Distribution of annual pension amounts as at 30 June 2007 Indexed Pension Amount 1922 Scheme Number Percentage CSS PSS Total Total Less than $10, ,015 5,161 19, % $10,000-$20,000 2,420 33,263 4,648 40, % $20,000-$30,000 2,298 30,744 2,600 35, % $30,000-$40,000 1,125 17,500 1,190 19, % $40,000-$50, , , % $50,000-$60, , , % $60,000-$70, , % $70,000-$80, % Greater than $80, % Source: ComSuper Total 7, ,023 14, , % 12 It is important to note that the amount of these pensions in payment will not always represent the total value of benefits provided from the CSS and the PSS nor be the only source of retirement income for members. This is because: superannuation benefits from the CSS and the PSS are often taken as a combination of lump sum and pension; members may not have had a full career in the Australian Government public service. Accordingly, they may have additional superannuation provided by other employers; members may be entitled to receive a part-rate Age Pension; and members may have saved for their retirement outside superannuation. These factors are considered further in this chapter and in Chapter 5. Total superannuation benefits The pensions paid to members will typically be one part of the total benefit received from the CSS or the PSS. This is because many members of the CSS and the PSS take a proportion of their total benefits in the form of a lump sum, which then lowers the pension paid. Data is not available on the total number of current pensioners who took some of their superannuation entitlement as a lump sum. However, information on this is available for new superannuants. Table 4 demonstrates that most members who commenced 12 Does not add to 100% due to rounding. Page 10 of 28

11 receiving a pension from the CSS and the PSS between 1 July 2002 and 30 June 2008 took part of their total benefit as a lump sum. Table 4: Split between pensions and lump sums for CSS and PSS members who retired between 1 July 2002 and 30 June Retirement Year PSS Number of new Pensioners 1,018 1,090 1,413 1,649 1,565 1,637 Current Average Pension $18,580 $19,178 $18,955 $20,388 $20,761 $23,360 Number who took full Pension Current Average Pension $20,605 $21,033 $21,212 $22,632 $26,617 $29,178 Number who took part Lump Sum ,062 Current Average Pension $15,833 $16,353 $16,237 $18,543 $17,130 $20,210 Average Lump Sum $51,098 $56,992 $58,036 $54,209 $43,800 $54,952 CSS Number of new Pensioners 3,293 3,103 3,055 3,315 3,411 2,931 Current Average Pension 14 $33,688 $34,073 $36,829 $39,940 $42,421 $45,339 Number who took full Pension Current Average Pension $35,454 $36,854 $40,181 $47,036 $47,839 $56,535 Number who took part Lump Sum 2,975 2,736 2,753 3,016 3,082 2,696 Current Average Pension $33,499 $33,700 $36,461 $39,237 $41,843 $44,363 Average Lump Sum $140,450 $143,756 $163,730 $178,049 $202,285 $228,104 Source: ComSuper The growth in lump sums taken in the CSS, in part, reflects the high investment returns in recent years. This, in turn, impacts on the value of the 54/11 benefit taken by members. 15 By way of comparison, research by the Association of Superannuation Funds of Australia Limited (ASFA) 16 indicates that the average superannuation retirement 13 Pension amounts reflect the annual amounts that were being paid in the financial year not the amount that a pensioner commenced to receive on retirement. 14 Includes both CSS CPI indexed pension and CSS non-indexed pension. 15 ComSuper data shows that between 1 July 2002 and 30 June 2008, 11,520 CSS members took the 54/11 benefit. This is approximately 66% of members who commenced pensions from the CSS during this period. 16 ASFA Media Release 11 February Page 11 of 28

12 payouts in 2008 are likely to be $155,000 for men and $73,000 for women. The combination of average lump sum and pensions paid in 2008 from the PSS and the CSS compares favourably with these amounts. Factors Impacting on the Value of Benefits The total value of a member s superannuation benefit in the CSS and the PSS can be affected by the following factors: member s salary at or near retirement; level of contributions made by the employee; the length of service; and age at retirement. Salary of a member In the CSS, where the member retires after their minimum retiring age, and is entitled to a CSS age pension, their benefit is calculated as a percentage of final salary. In the PSS, an employee s benefit is calculated as a percentage of their final average salary. All other things being equal, a person with a higher final salary in the CSS or a higher final average salary in the PSS, will receive a higher final benefit than a person with a lower final salary or final average salary. Member contribution rate In the CSS, the contributions and interest on these contributions affects the value of the 54/11 benefit but not the CSS age pension benefit, since the latter is based on years of service. In the PSS, the final benefit depends upon the contribution rate of the member. The more that a person contributes as a percentage of their salary, the higher will be the member s benefit multiple and, therefore, total benefit. According to the 2005 PSS and CSS Long Term Cost Report the average member contribution rate in the PSS, at that time, was 5.3%. Length of service Early retirement or short service will reduce the superannuation benefit at retirement. A member of the CSS who retires with 30 years of service at 60 years of age, could expect a pension equal to 45% of their final salary at retirement (plus an additional benefit based on their accumulated funded contributions and earnings). If this person only had 15 years service their pension would be 27% of their final salary at retirement (plus the additional benefit). A member of the PSS who retires at 60 years of age with 30 years service, could expect a pension of between about 41% and 80% of their final average salary at retirement if they converted all of their lump sum into a pension. However, after Page 12 of 28

13 15 years membership in the PSS, the annual pension would only be between about 20% and 38% of final average salary. 17 Age conversion factors in the CSS and the PSS Conversion factors are used in the CSS 18 and the PSS for converting a lump sum to a pension. Table 5 shows the factors for retirement at ages 55, 60 and 65. For example, a PSS member who retires at age 60 could convert a lump sum of $550,000 into an indexed pension of $50,000 per annum. Table 5: Age conversion factors in the CSS and the PSS Age CSS conversion factor 19 PSS conversion factor Source: Superannuation Act 1976 and PSS Trust Deed and Rules The factors that are used in the CSS and the PSS are attractive when compared to those that would be available commercially. Actuarial advice obtained by the Department suggests that for a male age 60 to obtain an initial pension of $50,000 per annum that is indexed by CPI, and provides a reversionary pension of 67%, they would require a lump sum amount of $1.26 million. 20 The equivalent CSS and PSS pensions would require lump sum amounts of $500,000 and $550,000 respectively. The age conversion factors in the CSS and the PSS make pensions quite valuable. The value of pensions is further increased as they are indexed for the life of the member and their dependants, however long that may be. Analysis 21 undertaken by the Department shows that for a lump sum amount of $300,000, the total income derived from a PSS pension would exceed an account-based pension by about $400,000 over the life of the member and their dependants. The PSS pension would be paid for an additional 12 years. To obtain an equivalent income stream, the account based approach would need to start with an additional amount of around $85,000 (that is, a lump sum of the order of 28% higher) 17 The range represents member contributions of 2% and 10% for the entire service period. 18 As discussed in Chapter 2, this only applies to the 54/11 benefit. 19 For comparative purposes the CSS factor has been calculated as 1/CSS pension factor where the person has not made an election under section 137A of the Superannuation Act Based on actuarial advice, this pension uses a pension conversion factor of The assumptions underpinning the analysis are: Investment returns of 7.5% per annum in respect of the account-based pension. CPI indexation of 2.5% per annum. Member is male aged 60 with a 57 year old spouse. Mortality is in line with the Australian Life Tables No account is taken of tax-effects and fees. Page 13 of 28

14 In this example, average high investment returns (of the order of 10% per annum) would have provided a superior financial outcome for the account-based pensions According to the Australian Prudential Regulation Authority superannuation data the ten year average return on assets for entities with at least $100 million in assets from was 6.7%. (Source: APRA Insight Celebrating 10 years of superannuation data collection Issue ). Page 14 of 28

15 Chapter 4 Comparison with State and Territory superannuation schemes Indexed pensions from the superannuation schemes for civilian employees have been indexed using various methods since at least Changes that have been made to the indexation arrangements over time are described in Attachment B. Pensions payable from State defined benefit civilian superannuation schemes are also indexed by CPI. The timing and frequency of indexation varies across these schemes, as summarised in Table 6. Table 6: Comparison of indexation arrangements Australian and State Government superannuation schemes Jurisdiction Scheme Basis Frequency Australian CSS CPI- All Capital Cities Bi-annual Government 23 PSS Victoria Revised Scheme CPI-All Capital Cities Bi-annual WA State Pension CPI-Perth All Groups Bi-annual Scheme NSW State CPI Sydney All Annual Superannuation Scheme Groups Queensland Q Super State CPI Brisbane All Annual Accounts Groups NT / ACT 24 N/A N/A N/A Tasmania Retirement CPI-All Capital Cities Bi-annual Benefits Fund Defined Benefit Scheme SA Pension Scheme CPI-Adelaide All Bi-annual Groups Source: Department of Finance and Deregulation research Some schemes in the wider community also index their superannuation pensions by the CPI. For example, pensions from the Westpac Staff Superannuation Plan, are indexed each year in line with the September CPI to a maximum of 5% or such higher increase as the Trustee and the Westpac Bank approves. 23 Pensions from the PNG scheme, the 1922 Scheme and the military superannuation schemes are also indexed in the same way as the CSS and PSS. 24 Northern Territory superannuation arrangements are lump sum. However, some NT and ACT Government employees are members of the CSS and some ACT Government employees are members of the CSS or PSS. Page 15 of 28

16 Chapter 5 The Interaction with Australian Government Safety Net Benefits Australia s retirement income policy is designed to ensure that Australians have a certain level of income available to them in their retirement years. Australia s three pillar retirement income system comprises: compulsory superannuation savings; voluntary superannuation and other private savings; and a publicly funded, means tested, Age Pension and associated social security arrangements. In retirement, members of the CSS and the PSS may receive retirement income from each of the three pillars depending on their personal circumstances. Most people s income in retirement will be funded from a combination of superannuation, other private savings and a full or part-rate Age Pension. Superannuation and other savings enable individuals to achieve a higher standard of living in retirement than the Age Pension alone. Superannuation incomes received by retired members of the CSS and PSS can be topped up by a full or part-rate Age Pension depending on individual circumstances. The Age Pension is important for those retirees who were unable to save enough through their working life, for people who had extended periods out of the workforce or who had broken periods of employment. Other Australian Government measures A number of changes have been made to superannuation, taxation and taxpayer funded Age Pension arrangements over the last 10 years. For example, pensioners and self-funded retirees have benefited from bonus payments and new supplementary payments. Part-rate pensioners have benefited from changes to the pension taper rates. There have also been taxation changes such as the Senior Australians Tax Offset and those as a result of Better Super. The Australian Government also provides support to older Australians through subsidies and services for health and aged care. Services and concessions include the Pharmaceutical Benefits Scheme and subsidised health care, through Medicare. Interaction of superannuation pension and Age Pension The level of retirement income payable from the CSS and PSS is broadly related to the member s personal contributions, period of eligible employment with the Australian Government and salary at or near retirement. Any other income or assets do not affect the total benefits payable to retiring members. By contrast, the Age Pension is means-tested on both income and assets and does not depend on previous labour force attachment or individual contributions. Page 16 of 28

17 Income from Australian Government civilian superannuation pensions is counted as income for the purposes of the income test for the Age Pension. Income over the maximum Age Pension income test threshold reduces the rate of pension by 40 cents in the dollar (single) or 20 cents in the dollar each for couples. That is, for every $1 of extra income, the Age Pension is reduced by 40 cents for a single person and 40 cents (20 cents each) for a couple. The rate at which the Age Pension is reduced is known as the taper rate. The average annual indexed pension as at 30 June 2007 was around $17,603 in the PSS and around $23,945 in the CSS. If a single person with these incomes had no other income, and had assets below the asset test threshold, they would be entitled to a part-rate Age Pension of approximately $8,611 and $6,074 respectively. Their average total income would, therefore, be about $26,214 and $30,019 respectively. The graph below depicts the interaction between the current rate of single age pension and a pension received from the CSS or the PSS, where an individual has no other income and his/her assets are below the assets test threshold. The full Age Pension for 20 March to 19 September 2008 is $ per fortnight for a single person (or around $14,216 per annum). A single person can have income up to $138 per fortnight (or around $3,588 per annum) and still receive the full Age Pension under the income test. However, where the person s income exceeds this threshold amount, the Age Pension payable is reduced in accordance with the income taper rate. Total Income $60,000 $50,000 $40,000 $30,000 $20,000 $10,000 Single Age Pension and PSS or CSS Pension (no income other than PSS or CSS Pension) Annual PSS/CSS Pension Total payment $0 $0 $10,000 $20,000 $30,000 $40,000 $50,000 $60,000 PSS or CSS Pension Source: Department of Finance and Deregulation research For example, where a person has a PSS or CSS pension of $10,000 per annum, they would also be entitled to receive a part-rate Age pension of approximately $11,652 per annum. Where the person has an annual PSS or CSS pension of $20,000 they would be eligible to receive a part-rate pension of approximately $7,652 per annum. Page 17 of 28

18 The income taper cuts off at an annual income of approximately $39,507. That is, an individual (who is not a member of a couple) with an annual PSS or CSS pension of under $39,500 would receive a part-rate Age Pension, provided they had no other income and assets below the asset test threshold. In this context, Table 3 shows that some 89% of civilian superannuation pensions at 30 June 2007 were below $40,000 per annum. A separate test applies for couples. The maximum rate of pension for 20 March to 19 September 2008 is $ for each member of a couple (or around $11,876 per annum). Where a couple did not have other income and had assets below the assets test threshold, the couple would receive an Age Pension of approximately $23,752 per annum. Where one member of a couple had a PSS or CSS pension of $10,000 per annum the annual part-rate Age Pension payment would be approximately $22,250 per annum (combined). 25 If one of the couple had an annual PSS or CSS pension of $20,000 the annual part-rate Age Pension payment would be approximately $18,250 per annum (combined). Where a couple receives an annual PSS or CSS pension of approximately $66,000 or more there would be no payment of the Age Pension. Changing the superannuation pension indexation method Changing the indexation method for pensions to a higher rate of indexation, will increase pensions payable over time. However, for those civilian scheme pensioners who do qualify for a part-rate Age Pension, their total income would not increase by the full increase in the pension, as there would be a reduction in their part-rate Age Pension because of the taper rate for the Age Pension. The total income benefit in changing the indexation method for superannuation pensions would, therefore, be greater for those CSS and PSS members with superannuation pensions that exceed the income test threshold. It would also be greater for those members receiving a CSS or PSS pension that is less than $138 a fortnight for a single person. This latter category is likely to be people who did not have a long period of employment with the Australian Government. Table 3 shows that these two categories of members comprise a small proportion of all civilian superannuation pensions. 25 This assumes that the couple had no other income, and had assets below the asset test threshold. Page 18 of 28

19 Chapter 6 The cost to the Government of changing indexation Changing the method of indexation has a potentially significant Budget impact. Changes will affect the Government s unfunded superannuation liability and pension payments to members. It will also affect employer costs. The unfunded liability represents an estimate of the present value of the total accrued superannuation liabilities in respect of employment service up to a particular date. Changing the indexation method changes the cost of that accrued service. Higher indexation will increase pension payments and the unfunded liability. This chapter provides estimates of the cost implications for two alternative indexation methods as canvassed over time by individuals and pensioner representative organisations. These cost estimates are based on advice from actuarial advisors of the Department of Finance and Deregulation and the Department of Defence. 26 Attachment C outlines the basis of the costings, including the reasons for the variation from a previous estimate. Current superannuation scheme costs In the civilian and military defined benefit superannuation schemes, the majority of the employer contribution is unfunded (not funded until the member s benefit is paid). The Government s total unfunded superannuation liability is estimated to be around $108 billion as at 30 June The value of this liability is projected to continue growing (in nominal terms) into the future, reaching around $147 billion by Aligning indexation with the Age Pension methodology A common request is for the current CPI indexation method to be changed to align with the Age Pension methodology. Indexation of the Age Pension is determined under the Social Security Act Essentially, the Age Pension base increases in line with the growth in CPI and is subject to a minimum dollar amount of 25% of Male Total Average Weekly Earnings (MTAWE). If the CPI indexed Age Pension base is less than 25% of MTAWE, then the Age Pension paid is increased to that level. To reflect the Age Pension methodology, the actuarial advisors have assumed that superannuation pensions will grow by 4% per annum. This compares with an annual growth of 2.5% per annum, which is used by the actuaries as the basis for CPI indexation Mercer (Australia) Pty Ltd in respect of the civilian schemes and the Australian Government Actuary in respect of the military schemes Budget Paper No.1, page Budget Paper No. 1, page For example, refer to the CSS and PSS 2005 Long Term Cost Report. Page 19 of 28

20 The estimated immediate increase in the unfunded liability for the civilian and military superannuation schemes as a result of aligning the indexation methodology with the Age Pension methodology from 1 July 2009 would be in the order of $28 billion (around $17.3 billion for the civilian schemes and around $10.3 billion for the military schemes). By 2020, the impact on the unfunded liability is expected to increase to around $57 billion (around $34 billion for the civilian schemes and around $23 billion for the military schemes). In this context, the Department of Finance and Deregulation notes that the Australian Government does not have identified assets available to offset an additional unfunded liability of this order. The Future Fund currently only has sufficient assets to meet superannuation liabilities at and beyond 2020 arising from current indexation arrangements. Accordingly, the costs of higher indexation in the medium to long term would have to be found from the Budget. This would require the Government to reprioritise spending on other initiatives or programs. In addition to the impact on the unfunded liability, there will also be an increase in pension payments to members as shown in Table 7. The cash effect of changing the indexation method would be relatively small in the first few years. However, the additional cash expenditure would continue to grow and peak after 2020, which is when the Budget will face the spending challenges associated with an ageing population and other pressures. 30 Table 7: Additional cash payments 1922 Scheme, CSS DFRDB and MSBS Total and PSS $0m $0 $ $24m 31 $1m -$23m $26m $16m $42m $75m $36m $111m $131m $59m $190m $656m $255m $911m Source: Actuarial advice received by the Department of Finance and Deregulation and the Department of Defence. As discussed in Chapter 5, the total income of scheme pensioners who qualify for a part-rate Age Pension would not increase by the full amount of the increase in their superannuation pension. This is because there would be a reduction in their part-rate Age Pension because of the income taper rate for the Age Pension. The cash impact on the Australian Government will be reduced accordingly. 30 Intergenerational Report 2007, Commonwealth of Australia, April This is due to benefits being taken in the form of periodic pension payments rather than a lump sum (immediately impacting on cash payments) due to the assumed increase in the proportion of PSS employer component being taken as a pension. Page 20 of 28

21 For example, analysis by the Department of Finance and Deregulation for civilian scheme pensioners shows that the additional cash payments outlined above in respect of those schemes would reduce by around 15% per annum as a result of the Age Pension income test. Indexation by the higher of CPI or MTAWE Another common request is for the current CPI indexation methodology to be changed so that indexation is based on the higher of CPI and MTAWE. This would be more favourable than the Age Pension indexation methodology. Indexation by the higher of CPI or MTAWE will produce a long term indexation rate higher than aligning the indexation of superannuation pensions with the Age Pension methodology. As such, the actuarial advisors have assumed that this will produce a long term average indexation rate of 4.6%. The estimated immediate increase in the civilian and military unfunded liabilities of this indexation method is in the order of $40 billion (around $25 billion for the civilian and around $15 billion for the military). By 2020, the impact on the unfunded liability is expected to increase to around $82 billion (around $49 billion for the civilian schemes and around $33 billion for the military schemes) The additional cash payments in superannuation pensions associated with this indexation arrangement is set out in Table 8. Table 8: Additional cash payments 1922 Scheme, CSS DFRDB and MSBS Total and PSS $0m $0m $0m $12m 32 $6m -$6m $58m $30m $88m $130m $59m $189m $211m $93m $304m $965m $385m $1,350m Source: Actuarial advice received by the Department of Finance and Deregulation and the Department of Defence. As with the previous scenario, analysis by the Department of Finance and Deregulation for civilian scheme pensioners shows that the additional cash payments outlined above in respect of those schemes would reduce by around 15% per annum. 32 This is due to benefits being taken in the form of periodic pension payments rather than a lump sum (immediately impacting on cash payments) due to the assumed increase in the proportion of PSS employer component being taken as a pension. Page 21 of 28

22 Impact on notional employer contribution rates (NECR) Changing the current CPI indexation methodology would increase the NECR of the civilian and military superannuation schemes as set out in Table 9. Table 9: Impact on the NECR Relative to the figures quoted in the 2005 Long Term Cost Reports (LTCR) for the civilian and military superannuation schemes, the NECR under the alternative indexation methodologies would increase to the following (note, the rates are inclusive of employer productivity contributions): NECR (% of Superannuation Salaries) CSS PSS DFRDB MSBS 2005 LTCR 28.2% 15.6% 33.5% 24.7% Aligning CPI indexation methodology with Age Pension methodology Higher of CPI or MTAWE 34.8% 19.7% 41.9% 33.2% 38.1% 21.2% 46.3% 36.8% Source: Actuarial advice received by the Department of Finance and Deregulation and the Department of Defence. Page 22 of 28

23 Australian Government Superannuation Schemes Australian Government civilian superannuation arrangements Attachment A The Australian Government has, since 1922, provided its civilian employees with superannuation benefits as part of their terms and conditions of employment. The schemes which provide superannuation in the form of defined benefits are: The first Commonwealth public sector scheme was the scheme established under the Superannuation Act 1922 (1922 Scheme). 33 It provided a defined benefit pension scheme and an accumulation Provident Fund. The scheme was closed to new members in 1976 and contributors were transferred to the CSS. The Papua New Guinea (Staffing Assistance) (Superannuation) Regulations (PNG Scheme) which provides retirement benefits for employees of the administration of the Territory of Papua and New Guinea. The scheme was closed to new members in The Commonwealth Superannuation Scheme (CSS), a hybrid accumulation / defined benefit scheme, which was established under the Superannuation Act The scheme was closed to new members from 1 July The Public Sector Superannuation Scheme (PSS), established by the Superannuation Act 1990, and the Trust Deed and Rules under that Act, which commenced on 1 July The scheme was closed to new members from 1 July The CSS and the PSS are both partially unfunded schemes. They provide benefits that satisfy a participating employer s 34 superannuation guarantee obligations and are regulated superannuation schemes for the purposes of the Superannuation Industry (Supervision) Act 1993 and associated Regulations. Australian Government employees who were not members of the CSS and the PSS schemes received employer provided superannuation either: as a member of a funded superannuation scheme provided by the employer, such as Australia Post; or under arrangements included in the Superannuation (Productivity Benefit) Act 1988 (the PB Act). The PB Act, which was established on 1 July 1988 and closed on 30 June 2005, ensured that other persons employed by the Australian 33 Entry to the pension scheme required employees to pass a medical test after which members paid compulsory contributions, which increased with the term of the membership. Those who had a medical impairment were excluded from the pension scheme and became members of the Provident Account, on payment of compulsory contributions of 5% of salary. 34 Participating employers are Australian Government Departments and agencies that are part of the Commonwealth, as well as authorised bodies that are not legally part of the Commonwealth such as Commonwealth authorities under the Commonwealth Authorities and Companies Act Page 23 of 28

24 Government, who were not CSS or PSS members, were provided with at least the Superannuation Guarantee level of employer superannuation, usually through a funded superannuation scheme More recently, the Australian Government has established its own fully funded accumulation scheme, the Public Sector Superannuation Accumulation Plan (PSSAP). The PSSAP was open to new employees from 1 July The employer contribution rate for members of the PSSAP is 15.4% of the member s superannuation salary. Other Australian Government superannuation arrangements The Australian Government also has superannuation schemes for other classes of employees, such as defence force personnel, Parliamentarians, Federal judges and Governors-General. These are discussed below. Military superannuation schemes 35 The military superannuation schemes have been designed to meet the specific needs of defence force staff. In particular, the defence schemes take into account the wide variation in defence force staff retirement age, rank structure and make special provision for staff who retire on invalidity grounds. 36 The Defence Forces Retirement Benefits Scheme (DFRB), a defined benefit scheme, which was established in The scheme was closed to new members in The Defence Force Retirement and Death Benefits Scheme (DFRDB), a defined benefit scheme, which replaced the DFRB Scheme. The scheme was closed to new members in The Military Superannuation Benefits Scheme (MSBS), a hybrid accumulation / defined benefit scheme, which was established in The scheme remains open to new members. Parliamentarians Before 9 October 2004, it was compulsory for all Senators and Members who joined the Parliament to become members of the Parliamentary Contributory Superannuation Scheme (PCSS). The PCSS provides former members of the Federal Parliament with retirement benefits in accordance with the provisions of the Parliamentary Contributory Superannuation Act 1948 (the Act). The PCSS, a defined benefit scheme, which was established in 1948 and was closed to new members from 9 October Report of the Review into Military Superannuation Arrangements, Appendix E, provides further information on these schemes. 36 April 2001, A Reasonable and Secure Retirement? The benefit design of Commonwealth public sector and defence force unfunded superannuation funds and schemes, Report of the Senate Select Committee on Superannuation and Financial Services, pp Page 24 of 28

25 Parliamentarians who commenced at or after the 2004 Federal Election receive employer contributions of 15.4% into an accumulation scheme of their choice. These arrangements are contained in the Parliamentary Superannuation Act Judges The Judges' Pensions Act 1968 makes provision in relation to the entitlements to pensions of persons who hold office as judges of the High Court of Australia, the Federal Court of Australia and the Family Court of Australia and certain other office holders. The Judges' Pensions Act 1968 provides for the payment of defined benefits in the form of pensions to members. A retired Judge who is at least 60 years of age and has served as a Judge for not less than 10 years will be entitled to a pension under the Pensions Act. Governor-General Before 1974, the office of Governor-General was regulated only by the Constitution. The Governor-General Act 1974, amongst other things, introduced a pension scheme for retired Governor-Generals. The Governor-General Act 1974 provides a defined benefit pension scheme whereby a retired Governor-General is entitled to a pension equivalent to that paid to a retired Chief Justice of the High Court (ie 60% of the salary of a serving Chief Justice). Page 25 of 28

26 Attachment B Pension Indexation A Historical Perspective Superannuation pensions payable from the relevant civilian schemes are payable for the life of the member and their eligible dependants. The level of reversion varies between schemes but in the case of the PSS and CSS it is generally 67% of the former member s pension, with an additional 11% payable for eligible children up to a maximum reversion of 100%. Pensions from the superannuation schemes for civilian employees have been indexed using various methods since at least At that time there was only one scheme covering Australian Government employees, the 1922 Scheme. Until 1973, indexation occurred on an ad hoc basis. Increases were limited to the employer funded component of the benefit. Regular and automatic indexation of pensions for Australian Government employees commenced in July 1973, following an independent enquiry undertaken by Professor A H Pollard. The method of indexation adopted in 1973 provided for the Commonwealth s share of pensions to be adjusted automatically each year from 1 July. The adjustment was 1.4 times the increase in the All Groups CPI number for the weighted average of the 6 State capital cities in the previous March to March period 37, subject to the proviso that this did not exceed the increase in seasonally adjusted Average Weekly Earnings per employed male unit for the same period. From 1 July 1976, as part of the arrangements for the introduction of the CSS, the indexation arrangements were changed so that: the entire pension paid from the 1922 Scheme; and the main employer financed pension paid from the CSS, were updated annually from 1 July by the increase in the CPI over the March to March period. In 1986 a technical change was made to the indexation provisions to recognise that the CPI covered the 8 capital cities. When the PSS was introduced on 1 July 1990 it provided for the full pensions paid from that scheme to be indexed in the same manner. The current method of twice yearly indexation commenced from 1 January Under that method pensions are now increased in July each year according to the increases in the CPI in the previous September to March quarter and in January according to the movement in the CPI in the March to September. 37 The first increase, in 1973, used the period June 1971 to March Page 26 of 28