Referral
1.1
On 18 March 2021, the Senate referred the following matter to the Senate Foreign Affairs, Defence and Trade References Committee for inquiry and report by 24 June 2021:
The accuracy of information provided to Defence Force Retirement and Death Benefits (DFRDB) members, including:
(a) the accuracy of information provided to DFRDB members about the effects of commutation on future retirement pay entitlement, the consequences of this, and what remedial action (if any) could be taken;
(b) whether retirement payments were indexed as required by legislation and, if not, what remedial action (if any) could be taken;
(c) policy and legislative issues, including provisions for:
(i) use of certain life expectancy tables,
(ii) permanency of reductions to commuted pensions, and
(iii) indexation arrangements; and
(d) recommendations on any potential changes to administrative arrangements, policy or legislation;
(e) advice on costs associated with any recommendations;
(f) all relevant existing information and previous reviews in relation to DFRDB, including the findings of the Ombudsman’s investigation;
(g) the level of understanding among DFRDB members about how the legislation works, and ways to improve this; and
(h) any related issues.
Conduct of the inquiry
1.2
Details of the inquiry were placed on the committee website at: http://www.aph.gov.au/senate_fadt. The committee also contacted a number of relevant individuals and organisations to notify them of the inquiry and invite submissions by 30 April 2021. Public submissions received are listed at Appendix 1.
1.3
The committee held a hearing on 20 May 2021 in Canberra. A list of witnesses who gave evidence at the public hearing is available at Appendix 2. Submissions and the Hansard transcript of evidence may be accessed through the committee website.
1.4
The committee thanks the organisations and individuals who provided submissions and participated in the committee's hearing.
Background
What is DFRDB?
1.5
The Defence Force Retirement and Death Benefits (DFRDB) scheme operates to provide retirement benefits to members of the Australian Defence Force. (ADF). It commenced on 1 October 1972 and closed to new members on 30 September 1991 and has been closed to re-entering members since 1 July 2016. Originally overseen by the DFRDB Authority, from 2011, it has been managed by the Commonwealth Superannuation Corporation (CSC).
1.6
The DFRDB scheme was a 'specially designed pension arrangement which differed from other public sector superannuation schemes to accommodate the particular needs of the ADF'. For example:
retirement pensions were based on rank, took into account earlier retiring ages and were designed to supplement civil employment earnings
commutation provided access to capital for relatively young retirees who were transitioning to civilian life.
1.7
The CSC 2019-20 Annual Report indicated that as at 30 June 2020 there were 51,560 DFRDB pensioners (excluding Defence Forces Retirement Benefits (DFRB)) and 1,029 contributors.
Joint Select Committee
1.8
Before the DFRDB scheme commenced, the DFRB scheme was in operation. On 2 September 1970 the Joint Select Committee on Defence Forces Retirement Benefits Legislation was established 'to inquire into and report upon the Defence Forces Retirements Benefits legislation…'. The final report of this committee, tabled on 18 May 1972, noted that the appointment of the committee 'reflected the concern of private members and of Senators of all parties with the operation of the present legislation. In particular the very high contribution rates that were being required of certain pre-1959 entrants to the scheme, the delays in completion of the statutory actuarial reviews and the ever growing complexity of the legislation were causing concern'.
1.9
In broad terms, the committee recommended a new military superannuation scheme be established to replace the existing pre-1959 and post-1959 DFRB schemes and that the assets of the DFRB Fund be transferred to the Consolidated Revenue Fund.
1.10
The Department of Defence (Defence) confirmed that the DFRDB scheme legislation 'was derived from the 1972 report of the Joint Select Committee (the Jess Committee) which made 20 recommendations to the Government of the day. The majority of the recommendations were accepted, with modifications to some'. Defence highlighted that the government of the day accepted most but not all of the recommendations.
What is commutation?
1.11
Commutation, is 'the option to take a lump sum up front in exchange for a reduced retirement pay, [and] had been included as a feature of the original DFRB scheme on the basis that an ADF member often required a lump sum on discharge to assist with re-settlement and transition to civilian life'. Originally:
A DFRB member could request commutation, but the request had to be approved by the DFRB Board. The Board would only approve commutation for specific purposes (e.g. purchase of a house) and had discretion to not allow commutation if a medical examination indicated a person was unlikely to reach life expectancy. This led the Jess Committee to recommend that commutation be an unfettered right in the new scheme.
1.12
Defence explained commutation in the following way:
Commutation is the early payment of part of a member's retirement pay in the form of a lump sum. The decision to commute is entirely voluntary and is neither an advance nor a loan, but rather an immediate payment in exchange for a permanent reduction in pension. The lump sum forms part of the member's overall superannuation benefit and the pension is permanently reduced to recognise that lump sum recipients obtain long-term advantage from the immediate use of their lump sum.
1.13
Defence explained that '[w]hen the DFRDB Act 1973 was legislated, the commutation provisions were mirrored off the DFRB scheme'.
1.14
Eligible DFRDB members 'may elect to commute part of their retirement pay entitlement into a lump sum at the time of their discharge regardless of their age (which could have been as early as 36), or further employment'.
1.15
S24(1) of the DFRDB Act provides the legislative basis for commutation: 'A person who is, or is about to become, entitled to retirement pay may, by notice in writing given to CSC, elect to commute a portion of his or her retirement pay in accordance with this section'.
1.16
It was noted that 'receiving commutation requires an active choice to be made. To receive a commutation lump sum, members needed to fill in a commutation election form and submit it to CSC within 3 months before retirement, or in the 12 months after discharge'.
1.17
If a member elects to commute, paragraph 24(3)(b) of the DFRDB Act contains a statutory process of calculating the resulting reduction to retirement pay:
the commutation lump sum is divided by the person's 'expectation of life factor' to produce the annual reduction for commutation. The expectation of life factor is worked out according to their age and gender using a table in Schedule 3.
Numbers choosing to commute
1.18
The Commonwealth Ombudsman (Ombudsman) noted that the numbers choosing to commute dropped slightly in recent years but remains high (at or above 85 per cent).
1.19
Defence reported that data from the CSC 'shows that during the period from 1996 to 2019 there were 19,591 DFRDB members eligible to commute and on average, approximately 94 per cent (18,513) elected to commute'.
Review by the Commonwealth Ombudsman
1.20
The DFRDB has been subject to a number of reviews and these are detailed in the Defence submission. The most recent review was undertaken by the Ombudsman which looked specifically at the information provided to DFRDB members with respect to commutation.
1.21
On 5 April 2019 the Minister for Veterans' Affairs and Defence Personnel wrote to Ombudsman asking that he consider undertaking an inquiry into the DFRDB scheme. After considering the request, on 10 April 2019, the Ombudsman wrote to the minister indicating that he had decided to commence an own motion investigation under the own motion powers Ombudsman Act 1976.
1.22
The Ombudsman told the committee that he agreed to do so 'on the basis that there were serious allegations about how the scheme was administered'. The key issue was 'whether DFRDB members, or some of them, had been misled as to their DFRDB entitlements and were, consequently owed compensation'.
Scope of the investigation
1.23
The Ombudsman limited the scope of the investigation to the 'administration of the DFRDB Scheme, and particularly the issue of commutation. The primary focus of the investigation [was] the accuracy of the information provided to DFRDB members'.
1.24
The Ombudsman informed the committee that as well as inviting submissions, they met with stakeholder groups and interviewed more than 30 people. The submissions showed:
the majority of DFRDB members who made submissions to our Office chose to commute and some of these decisions were based on a correct understanding of the scheme;
a small number of submitters understood the scheme's operation and decided not to commute;
many submitters felt they were misled to believe that the reduction to their retirement pay, resulting from commutation, was temporary and would cease when they reached their life expectancy factor age – some members felt frustration, disappointment and anger when this turned out to be incorrect;
a large proportion of submitters asserted that they relied on Defence's advice to their detriment, and were owed compensation, however a small number of submitters told us that Defence's advice did not cause financial detriment, and some expressed that awarding compensation to the DFRDB members who chose to commute would be wrong.
1.25
Mr Michael Manthorpe, Commonwealth Ombudsman, clarified for the committee that:
My investigation was focused on the accuracy of information about commutation that was provided to DFRDB members by scheme administrators in relevant departments. This reflects the scope of my functions under the Ombudsman Act, which authorises me to investigate matters of administration, as opposed to matters of policy, concerning the design of the scheme.
1.26
The Ombudsman noted that the following issues which go to the 'nature of the legislation passed by parliament and matters of government policy' were out of scope of the investigation:
Whether legislation is fair and just, including provisions for:
Use of certain life expectancy tables
Permanency of reductions to commuted pensions
Whether government ought to take different policy decisions or make amendments to legislation.
1.27
The Ombudsman noted:
While these matters are not within scope, the submissions we received indicated a high level of dissatisfaction with current policy settings, as expressed through the statutory arrangements. A section has therefore been included to summarise the out of scope issues arising in the submissions received. There was also evidence of confusion among DFRDB members about how DFRDB legislation works. We have endeavoured to provide clarification on the operation of the legislation.
Design of the scheme
1.28
Issues raised with the committee focused on dissatisfaction with the design of the scheme. This included the effect of commutation on retirement pay (see Chapter 2) as well as indexation arrangements and some others including the use of the expectation of life factor tables (see Chapter 3).
Permanent reduction in retirement pay
1.29
The DFRDB legislation provides two options, to commute with a reduced pension or not to commute. Commutation and its effects are explained above. See Chapter 2 about the information provided to DFRDB members on commutation and Chapter 3 in relation to this design aspect of the scheme.
Indexation
1.30
Defence noted that since the introduction of the DFRDB in 1973 'there have been a range of reviews to consider the most appropriate method of indexation for DFRDB members' and:
While some reviews differ in the exact methods to be used, they broadly agree that a fair method if indexation allows for pension recipients to maintain the purchasing power of the pension over time.
1.31
Defence further explained that in 1973, the Jess Committee recommended that 'pensions paid from DFRDB should be indexed annually to maintain relativity with Average Weekly Earnings. However, only ad hoc increases in line with Average Weekly Earnings were made to pensions between 1973 and 1976'.
Legislative background
1.32
The Ombudsman went through the legislative background to indexation in his report as briefly described below:
in 1977 the DFRDB Act was amended by the Defence Force (Retirement and Death Benefit Amendments) Act 1977 which allowed the pension to be indexed from 1 July 1976 resulting in pensions increasing if there was an upward movement in the CPI (but not decreased if there was a downward movement);
the Superannuation and Other Benefits Legislation Amendment Act 1986 temporarily reduced the annual CPI indexation by 2 per cent from 23 October 1986 to 20 October 1989 at which point the published CPI indexation was again applied each year;
from 1 January 2002, retirement pay indexation frequency was increased to twice a year;
in 2014 the Defence Force Retirement Benefits Legislation Amendment (Fair Indexation) Act 2014 added Division 2 of Part XA of the DFRDB Act which applies to pensioners over 55 years of age, to ensure DFRDB indexation arrangements in this group operate similarly to the indexation arrangements that apply to the age pension.
1.33
The submission from Defence also outlines a number of reviews into this issue. Defence confirmed that since 2014 'there have been no further changes or reviews into the indexation methodology for DFRDB pensions'.
1.34
In summary, currently:
For members who are under 55, the relevant indexation rate is the Consumer Price Index (unless the CPI is negative, in which case the pension is unchanged. This ensures pensions are not reduced if there is downward movement in the CPI).
For members who are 55 and over, the relevant indexation rate is the higher of CPI or the Pensioner and Beneficiary Living Cost Index. There is an additional safeguard which means the increase must be sufficient to ensure a hypothetical ‘indicative’ pension does not fall below 27.7 per cent of Male Total Average Weekly Earnings.
1.35
While concerns about the statutory indexation formula increasing the commutation reduction over time fell within the scope of the Ombudsman's investigation, concerns about the statutory formula were beyond the scope but were summarised. See Chapter 3 for discussion of issues raised in relation to indexation.
Structure of the report
1.36
The report consists of five chapters:
Chapter 1 is the referral, conduct of the inquiry and some background information;
Chapter 2 covers the information provided to DFRDB members in relation to commutation;
Chapter 3 details the design issues with the scheme raised with the committee;
Chapter 4 covers suggestions and costs; and
Chapter 5 details the committee's conclusions and recommendations.