The Financing and Costing of Government Superannuation Schemes
V COSTING METHODS
There are a variety of different actuarial methods available for the costing of superannuation schemes. The main methods in common use are described in an Appendix. Some of these methods are of use only in fully funded schemes, as they are designed to produce a reasonable rate of contribution to a scheme to ensure that its benefit payments may be met. For an unfunded scheme the assessment of costs needs to cover three things.
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Since these schemes may be largely unfunded, the level of future outlays may vary significantly. In particular, it is quite likely that the level of costs may rise in the future - particularly if any new scheme or any benefit improvement is introduced for existing employees only. It is therefore essential to have a long term projection of the outlays on the scheme from year to year, in a form which enables a meaningful assessment to be made of whether the scheme is affordable.
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Superannuation is an important element of remuneration, and needs to be understood as such. It is therefore necessary to have a reasonable measure of the costs of superannuation for determining the total costs of remuneration for government employees. This is important in a relative sense so that the remuneration packages of government employees may be compared with the remuneration packages of other employees in the country. However it is also important in an absolute sense, so that decisions about the allocation of resources can be made on a fair basis. For example, it is often desirable to compare the cost the Government incurs in carrying out a particular function with the private sector cost of carrying out that function (eg to assess the efficiency of the Commonwealth or to assess the merits of outsourcing the function). The full costs of superannuation for the Commonwealth employees need to be included if a fair assessment is to be made.
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An assessment needs to be made of the value of the accrued liabilities in respect of superannuation entitlements for Commonwealth employees. In effect, these accrued liabilities represent the liabilities for superannuation entitlements in respect of service already rendered to the Commonwealth. It is reasonable to separate the accrued liabilities from the future liabilities because the future liabilities are a part of future terms of employment, and should be considered in the same light. Thus the Government has greater flexibility to negotiates over the future liabilities, whereas the accrued liabilities are an existing commitment which it would be very difficult for the Government to avoid - indeed such an avoidance is likely to be seen as bad faith, and an indication of untrustworthiness or financial unsoundness in the Government.
It is desirable that the methods used for items two and three above are consistent, ie that the assessment of the cost of accruing superannuation from year to year is the same as the increase in the value of the accrued superannuation liability.
Cash Flow Projections
The long term projection of budget outflows can be presented in various ways. Presentation in actual dollar terms is likely to be misleading because the impact of inflation on the later figures is substantial. This can of course be overcome by presenting the figures in today's dollars ie removing the effect of inflation from the figures. However, even these figures may be somewhat misleading . The Australian Population is expected to grow over the long term, and this growth is likely to translate into some growth in government employment, as the government programmes will have a greater population to service. This anticipated growth will of course be reflected in a growth in the future benefit payments.
In the past, it has been common for actuarial reports on the Commonwealth schemes to show benefit payment costs as a proportion of salary of current employees. This has been reasonably effective while the public service was stable. However, it loses its effectiveness when there are substantial changes to the existing public service because no corresponding changes occur to the pensioners. Thus for example Telecom has recently been redefined as no longer part of the Public Service, but people who have previously retired from Telecom are still receiving pensions from the CSS. In any case, salaries of public servants are not a reasonable measure of the impact of an outgo on the budget; they bear no relation to the country's ability to finance these benefits, nor to anything else in the budget apart from the salaries item itself. Therefore, it seems more reasonable to use a measure which is related to the prosperity of the country, ie to show the costs as a percentage of Gross Domestic Product (GDP). Any significant rise in the costs as a percent of GDP would clearly need to be carefully prepared for, as it would show a significant increase in the potential impact of the superannuation payments on the Commonwealth budget.
Funding Methods
For many superannuation benefits, there is no obvious way of determining how much of the eventual benefit is to be deemed to have accrued at a particular point in time. The rules of the scheme provide for a benefit to be paid, for example, on retirement at or after age 60, and how that benefit is to be calculated. They do not specify how much of that benefit is to be regarded as accrued by the age of 40 for someone who joined at age 30. There are two main methods of determining how much of the liability is to be supposed to have accrued. The Projected Unit Credit method proportions each benefit by service. In other words, for a member who joins at age 30, the proportion of their possible benefit payable at age 60 that is deemed to have accrued at age 40 is one third. This method produces, in respect of individual employees, a superannuation costs which rises as a percentage of salary, because each year has to buy the same proportion of the final benefit, but the earlier years have the benefit of greater interest earnings thereafter.
The Entry Age Normal method accrues each benefit on the basis that it is paid for as a uniform percentage of salary over the person's lifetime. This produces a somewhat faster rate of accrual of the liability than the Projected Unit Credit method.
Both methods are theoretically satisfactory and will also work effectively in practice.
There is no requirement in Australia to include an assessment of accrued liabilities as part of an actuarial valuation of a superannuation scheme. Indeed for schemes funded using the Entry Age Normal it is usual for the valuation not to include an assessment of accrued liabilities. Various solvency indices are normally calculated, but these are not regarded as assessments of the accrued liability. (For example, a fund may have a solvency index greater than 100%, but no surplus will be shown.) Where an assessment of accrued liability is required to be made (eg on sale of part of a business) the Projected Unit Credit method is nearly always used to assess the accrued liability. Thus the current position in Australia is that accrued liabilities are nearly always assessed on the Projected Unit Credit method, but contribution rates are often assessed using the Entry Age Normal method. This has little to commend it, as the contribution calculations are then based on a faster accrual than the liability calculations.
World practice is moving towards the Projected Unit Credit method, and this is in fact mandated by American accounting standards. In Australia the use of the Projected Unit Credit method has received some legislative support in the regulations for the determination of Pre-88 Funding Credits. (These regulations are used for the assessment of liabilities for schemes which were underfunded at 1988 when the 15% contribution tax was introduced - they receive a tax credit off the amount of their underfunding at that time.)
For these reasons it seems appropriate in Australia at the present time to use the Projected Unit Credit method for the assessment of the cost of the schemes for employment purposes, and also for the assessment of the accrued liabilities.
Clawback
The liability figure needs to be set in the context of the Commonwealth as a whole. The unfunded liability figure represents the capitalised value of the liability of the Commonwealth in respect of service already provided to the Commonwealth. However, if the Commonwealth did not discharge this liability, then it would suffer increased Age Pension outlays and reduced taxation receipts. This impact on the Age Pension and tax parts of the budget are therefore an offset to the unfunded liability, this offset being described as clawback. The amount of the clawback is the capitalised value of the additional costs that would fall elsewhere on the Government (either by increased outlays on old age pensions, or by reduced tax receipts) if the unfunded liabilities were not discharged.
It is worth noting that this clawback also arises in respect of private sector superannuation. Indeed, one of the main justifications for the tax concessions afforded to superannuation is the taxation revenue and reduced age pension outlay that will arise when the superannuation benefits become payable. In effect, the tax concessions represent a part of the savings of the country from the Commonwealth Government, and the Government will redeem these savings at the same time as the individual does through taxation on the individual benefit and a lesser payment of age pension. So far as the unfunded liabilities are concerned, it is useful to identify the portion that represents the Government component of the liability rather than the member component.
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