The Financing and Costing of Government Superannuation Schemes
II FUNDING
In the private sector, superannuation benefits are almost always funded in advance through a trust which is separate from the employer. There are strong tax incentives for doing so, primarily that the investment income of complying superannuation funds is taxed at only 15%. Moreover, this type of funding is compulsory for benefits provided under the Superannuation Guarantee arrangements. Such a funding approach is common in many other countries but is by no means universal; alternatives include book reserving (where reserves are set aside on the employer's balance sheet) and pay as you go (where superannuation benefits are paid by the employer directly to the employee when they arise).
There are a number of reasons why such external funding is regarded as desirable.
Security
The assets built up in the fund provide security to the members so that their superannuation is not dependent on the future of the employer. Thus people close to retirement cannot lose their superannuation simply because their employer gets into difficulties. For younger people the security of their superannuation is perhaps less important as if they lose it then they may be able to make good the loss during their future working lifetime. However, with modern patterns of work people may expect to spend perhaps 20 years of their life in retirement, after a working life of 40 years. If their retirement is to be reasonably comfortable, then they will need to make significant provision for it throughout their working life. It is not practicable for this provision to be wholly made in the later years of working life. Therefore, even for people in their middle years, the security of their superannuation is a matter of great concern, and it is not satisfactory for it to be wholly dependent on the future prosperity of their employer.
Cost Saving
If money is set aside in advance then it will earn interest, and the cost will be less. The effect of compound interest over long periods is very substantial - if money is saved regularly over a 40 year period then around three quarters of the eventual accumulation will be interest, with only one quarter being the original contributions.
While this may be an argument for advance provision, it is not an argument for external funding, as most companies would believe they can make good use of capital and so achieve corresponding interest on the money. Indeed, to the extent that there are costs in financial market intermediation, most companies are incurring additional costs by the fact that they are providers of capital through their superannuation funds, but users of capital as companies.
Cost Allocation
Companies need to know their labour costs in order to price their products correctly, and superannuation is a part of the cost of labour. If superannuation is funded then the annual contributions to the superannuation fund may be taken to be a reasonable estimate of the costs of superannuation each year. However, this is not always reasonable; for example, if a fund has generated a substantial surplus then the company may not need to make any contributions for some years. Conversely, there are a number of funding methods (particularly the Current Unit Credit method) which may substantially understate the employment costs of superannuation in the early years. It is for these reasons that accounting standards are tending to divorce the accruing cost of superannuation in the employer's accounts from the cash contribution to the fund.
Stability of Cost
Actual superannuation payments can vary substantially from year to year depending on retirements and resignations. Funding provides an effective way of smoothing these fluctuations, as the fund essentially operates as a fluctuation reserve to smooth them out. However, the existence of the fund does introduce some volatility of its own, through the volatility of investment performance. This effect is most marked for funds which are mature, and has shown clearly in the large surpluses that arose in many funds following the exceptionally high real investment returns of the 1980s.
In any case the variation in superannuation payments is not substantially greater than other variations in company outgoings, such as capital expenditure. It can be managed within a company's accounts by the same techniques that are used to manage other variable outgoings - prudent budgeting, cash flow management, contingency reserves.
Portability
If superannuation is externally funded then when a person changes jobs it may be easier for them to transfer their superannuation from their old employer to their new one. A simplistic analysis would certainly suggest this: the Federal and State Governments are the only significant employers who do not allow superannuation to be transferred when an employee leaves, and these are also the employers who do not fund their superannuation. The issue in fact is probably more one of benefit design, and the extent to which benefits are defined at retirement rather than exit from service.
With defined benefits, the employer acts as 'guarantor' of the promised benefits; the fund is merely a mechanism for provision of the benefits. (The term guarantor is used here for convenience; as will be seen later it has limitations in its application to defined benefit funds.)
The extent of the employer's guarantee is a matter of benefit design, and will vary from scheme to scheme. In the private sector in Australia the commonest scheme design has been one in which a guaranteed lump sum benefit was provided on exit from service by means of retirement, death or disablement. No guarantee is provided on resignation, where the benefit is just an accumulation of contributions with interest.
With this design of scheme, once an employee leaves service their benefit guarantee finishes, and their benefit can be taken or transferred to another fund. Even if the scheme allows the money to be retained in the fund, the fund is operating merely as an investment vehicle for the money, not a scheme for the provision of benefits.
Government schemes have tended to provide benefits in the form of a life pension, and so the benefit guarantee continues up till death. In these schemes an earlier payout represented an early termination of the guarantee, and the question then arises as to whether such a termination should be permitted, and if so, on what terms. It has been rare for such a termination to be permitted on favourable terms.
Matching
With defined benefit funds it is not possible to match the funding to the liability. However, with an accumulation fund an advantage of funding is that it matches the provision to the accruing liability and so protects the employer against market fluctuations. (It is perfectly possible to have an accumulation scheme which is only partially funded, for example a scheme where the benefit is a multiple of members' accumulated contributions - if the members' contributions are funded there is no need to fund the remainder of the benefit in order to determine the benefit beyond doubt.) If an employer is willing to bear the market risk then the employer may well prefer a defined benefit scheme as more accurately targeted to the retirement needs of employees.
< PREVIOUS | ^ TOP ^ | NEXT >