What are Commonwealth unfunded superannuation liabilities and who do these benefit?

Welcome to Finance and Fury, the Say What Wednesday edition.

This week’s question comes from Douglas:

“Long time listener of your Podcast and it has great insights and thought-provoking ideas.

Can you dive deeper in to who are the beneficiaries of the Future Fund from and what the unfunded superannuation liabilities means and list who besides politicians this fund does benefit?”

Douglas brought up a good point – that the commonwealth unfunded liabilities don’t just go towards politicians which was the main focus of the episode two weeks ago – has requested deeper dive into who gets paid from the Future Fund - Commonwealth Super Liabilities

Today’s episode – look at the Commonwealth unfunded liabilities – and the beneficiary funds

Unfunded liabilities - Related to the gross debt that the Australian Government holds on behalf of unfunded superannuation liabilities – Essentially – how much money is owed but isn’t there ready to be made available for payment This comes form a special type of account called Defined Benefits To start with – you have the Funding types of superannuation accounts – Fully funded – what most people would be familiar with - a superannuation scheme in which the employer contribution to the fund (or the employees contribution) is the same as their entitlement – Essentially – what is being contributed into the fund is sufficient to ensure that the assets of the fund cover the actual value of what the members are entitled to – this type of account is typically referred to as an accumulation scheme – where you have contributions that are accruing values Unfunded — a superannuation scheme in which the employer makes no contribution to the fund – nothing is sitting there but yet people are entitled to an allocation of funds Occurs for government works or defence workers Funding is provided only as required for payments to retiring employees – this is how defined benefit schemes with the government operate Defined benefit schemes — a superannuation scheme in which the retirement benefit to employees is specifically defined – set based around a notional calculation – or formula – usually based on a formula in terms of years of service with the employer (or years of membership of the fund) and average salary level over the few years before retirement a defined benefit super scheme - meaning your Super benefit is defined in advance by a set formula. This formula is based on: Your contribution rate, Your final average salary (FAS), Your length of PSS membership Calculated on a notional formula – each year the balance is calculated to increase while you remain employed Technically - (for defined benefit schemes) can be fully funded – but I believe QSuper (which closed down their DB accounts to new members – and many Unisuper as well – are funded – or partially funded defined benefit schemes – as they have a duty of being fiscally responsible as trustees Many different types of defined benefit accounts that the tax payer was on the hook for with these unfunded liabilities – These are managed by the Commonwealth Superannuation Corporation (CSC) now – CSC was established on 1 July 2011 as trustee of government related superannuation entitles - Types of DB schemes – or unfunded liabilities the Public Sector Superannuation Scheme (PSS) and the Commonwealth Superannuation Scheme (CSS) However - the Commonwealth Superannuation Scheme and ­Public Sector Superannuation Scheme closed to new members in 1990 and 2005 respectively Then you have the Military Superannuation and Benefits Scheme (MSBS) - MilitarySuper closed to new ADF entrants on 30 June 2016 Both have transferred to accumulation type accounts since then Beyond this - CSC administers five other ‘unfunded’ superannuation schemes: the Defence Forces Retirement Benefits Scheme (DFRB) - closed to new members on 30 September 1972 the Defence Force Retirement and Death Benefits Scheme (DFRDB) - closed to new members on 30 September 1991 the Defence Force (Superannuation) (Productivity Benefit) Scheme (DFSPB), the 1922 Scheme – closed but replaced by CSS and PSS on 1 July 1976 the Papua New Guinea Scheme (PNG) - closed public sector scheme with no contributing members Essentially – these have all been closed for a while - the number of members should fall over time – all closed and replaced with accumulation (or fully funded accounts) Over the past few decades – this unfunded liability has become one of the largest government debts held are the unfunded public-sector superannuation liabilities. All arising from legacy defined benefit superannuation funds where the government holds back on making contributions and only meets the liability when the benefits are paid. Effectively, the bill is passed onto future generations to be paid and future governments to deal with   most of these funds were closed in the last 25 years (some quite recently) so the number of people with defined benefit entitlements reduces every year. However, the value of liabilities has continued to grow

What is the size of the bill?

Even though these types of accounts have been largely closed to new entrants – the liabilities are growing – Rice Warner’s research shows that the total net value of current unfunded super liabilities was $143 billion at June 2015 - This is after allowing for the Future Fund’s assets of $117.2 billion, which cover about 70% of the Federal Government’s accrued defined benefit liability However – in 2020, the Commonwealth’s gross unfunded liability (excluding the Future Fund) is expected to reach expected to be $224 billion Again – this relates to defined benefits pensions accrued under historical superannuation schemes So the Future Fund assets will offset part of this unfunded liability - However, nominal superannuation interest reflects the imputed value of interest on the unfunded liability and this expense is increasing over time, by 16.9 per cent in real terms between 2018-19 and 2022-23 - reflecting the increasing trajectory of the unfunded superannuation liability – why the gov wants to let the Future fund sit there for some time A sharp drop in interest rates that has blown out the federal government's unfunded superannuation liability by $50 billion – creates a situation where the government will need to wait additional years – more than anticipated to spend returns from the Future Fund to cover these unfunded liabilities In the interim – while these liabilities continue to be unfunded - taxpayers (or Gov through issuing more debt) will have to finance the payment of superannuation lump sums and indexed pensions to retiring public-sector (including defence) employees Hence the need for the future fund – But thanks to the performance of the Future Fund has meant that the Commonwealth’s unfunded liability has remained relatively stable over the last few years However, the projected earnings of the Future Fund in this low-interest environment means that the Commonwealth’s net unfunded liability may keep growing Based in part on Federal Budget papers - the shortfall between the Commonwealth’s unfunded liability and the Future Fund’s projected earnings is projected rise unless the future fund earns a return of at least 4.8% p.a. Comes back to how these unfunded liabilities are valued - A simple definition of an unfunded liability is a debt that cannot be repaid with the assets and earnings of assets allocated to that debt Lower investment returns on the available assets mean that Australia’s unfunded superannuation debt will grow unless government contributions to the future fund are increased and/or investment returns are stronger than anticipated All defined benefit funds must be valued by an actuary – and by the formula we mentioned before – Anyone who got into them before they closed has a good deal The future liabilities must be discounted to present values using a discount rate – similar to equities for future cash flows Historically - the rate on ten-year government bonds has been used as the discount rate However, in this low interest era, this has led to a large increase in the liabilities due to the lowering of the discount rate – make the denominator (or the value below the line) smaller – the value of the calculation increases – estimates that the States defined-benefit funds shows that the discount rate is lowering – increasing the unfunded liabilities In addition - The liabilities also allow for a future rate of salary growth – part of the formula – so if public servants get pay rises larger than expected – AWOTE - the liabilities will also rise. As these DBs can pay indexed pensions to retiring public servants - The values of these will grow if longevity improves more rapidly than currently expected – for instance – people living longer than expected based around the ALE actuary tables

 

Essentially - The future fund was the solution to these liabilities coming due – additional response was to close down these types of accounts and to new entrants – go towards politicians, public servants (including defence workers) –

But again – the Future Fund is designed to fund the future of a select group of Australians 

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