CHAPTER 9
DEFINED BENEFITS SCHEMES AND ACTUARIAL STANDARDS
Introduction
9.1 A defined benefits fund is one in which the final benefit payable
to a member does not wholly depend on the earnings of the fund, as is
the case with accumulation funds where benefits are based on employer
and employee contributions and the fund's earnings. There are a variety
of defined benefits funds.
9.2 Generally, the final benefit depends on the final wage or salary
of the member and the number of years that the member has been in the
fund. A number of defined benefits funds are 'unfunded', as the employer
does not make regular contributions to the fund, although the member does,
and the final benefit, other than the member's contributions and interest,
is paid by the employer.
9.3 Common examples of such funds are those relating to the public sector,
(ie. most public servants) and Members of Parliament. In such funds there
is no calculation of the value of the employer contribution and the interest
earned on the employer's contributions had they been made.
9.4 Another variety of defined benefit fund is that where both the employer
and the employee contribute to the fund but the final benefit payable
is not based on the earnings of the fund. Rather, a certain level of benefits
is payable regardless of the earnings of the fund. Such funds are known
as funded defined benefits funds.
9.5 While there are no difficulties with calculating the value of the
employer's contributions and the total earnings of the fund in funded
schemes, the employer's ultimate contribution is unknown as the defined
benefit payable may be significantly above the amount of the fund's earnings.
The most common example of such schemes are public sector funds that are
not exempt funds for the purpose of the Superannuation Industry (Supervision)
Act 1993.
9.6 A final variety of defined benefits funds are funds in which the
employer is responsible for all contributions to the fund, such as Superannuation
Guarantee contributions, and the employer pays a benefit that is defined,
again usually by the final salary and years of service. Such funds are,
again, unfunded schemes. An example of such funds are those applicable
to members of the judiciary in certain States.
9.7 The proposed surcharge threshold, currently $70 000, is based on
the assessable income of the person plus superannuation contributions
made in respect of the member. This presents problems in unfunded defined
benefits schemes where the actual value of the employer's contributions
to the final benefit is not known.
9.8 In relation to unfunded schemes, the Superannuation Contributions
Surcharge (Assessment and Collection) Bill 1997 defines an unfunded defined
benefits scheme to be a scheme where some or all of the funds necessary
to pay the defined benefit will need to be contributed to the fund by
the employer when the benefit becomes payable.
9.9 For such schemes, an amount, known as the notional surcharge amount,
is to be added to a debit account of the member and this amount, plus
interest calculated at the 10 year Treasury bond rate, is to be deducted
from the member's account when benefits become payable. The amount that
is to be deducted could be very substantial and will increase with income.
9.10 The submission by the Judicial Remuneration Coordinating Committee
suggested that for a Supreme Court judge with a 15 year surcharge liability
the amount could be as high as $270 000. [1]
Such an amount would be deducted from the benefits payable to the person
when they left the fund. Evidence presented to the Committee raised a
number of points in relation to the proposed surcharge as it relates to
defined benefits schemes.
9.11 The Association of Superannuation Funds of Australia stated in its
submission to the Committee:
There may be potential to recognise vesting at the level of the individual
in defined benefits schemes but the treatment of contributions for surcharge
purposes for defined benefit funds remains unclear. [2]
Notional Employer Contributions
9.12 The notional employer contribution (NEC) is to be used to assist
in the calculation of the amount that is to be debited to a member's account.
Under the Superannuation Contributions Surcharge (Assessment and Collection)
Bill 1997, the NEC for a year will be as certified by an eligible actuary
according to Australian actuarial practice.
9.13 The Institute of Actuaries of Australia and the Deputy Australian
Government Actuary advised the Committee that the Government has requested
the Actuarial Advisory Committee, to prepare guidelines for the calculation
of the NEC. The Actuarial Advisory Committee comprises representatives
of the Institute of Actuaries of Australia, the Australian Taxation Office
and the Australian Government Actuary. [3]
9.14 It is not clear what the guidelines will contain and whether there
will be one guideline for an entire fund or different sub-sets of guidelines
for different classes of members within the fund. On this issue, Mr Ward,
representing William M. Mercer Pty Ltd, indicated that:
Actuaries will find it very difficult to come up with a fair and equitable
approach in defined benefits funds. Yet the problems do not only rest
with defined benefits funds; they also cross the bounds into accumulation
funds. [4]
9.15 In regard to the general principles to be used in regard to determining
the NEC, Mr Francis of the Institute of Actuaries of Australia stated
that:
I believe the principles for determining a notional surchargeable contribution
for an unfunded defined benefits scheme are virtually the same as those
relating to a funded defined benefits scheme: it is still necessary
to make your best estimate assumptions about what is going to happen
in the future. [5]
9.16 Evidence given to the Committee indicated a number of possible approaches
to calculating the NEC in respect of a member of a fund, being either
individual calculation, which would be very costly; creating separate
rules for various classes of members; or, the simplest method, introducing
a single rule that would apply to all members of funds. In relation to
the last method, Mr Ward stated:
If, on the other hand, the institute and the government agree there
will be a standard formula that applies, using some form of actuarial
mumbo jumbo behind it, it may be somewhat cheaper, but then it will
be far more difficult to say that that was the most equitable approach
for a particular fund benefit design and a particular fund membership.
[6]
9.17 The question of equity should a standard formula be used was also
raised by members of the Committee with the probability of there being
those who would be advantaged by the application of a standard rule and
those who would be disadvantaged.
9.18 The issue of the timing for the issue of the guidelines relating
to the calculation of the NEC was also raised. Mr Francis of the Institute
of Actuaries of Australia, when questioned as to when the guidelines were
likely to be available, stated:
But I certainly do understand your point that the legislation is silent
on the issue, and that the timing is such that, if the intentions are
met, the act will be passed before these guidelines are finalised and
known to you. [7]
9.19 Another issue raised is whether the notional debit calculated under
the NEC can be adjusted when the defined benefit actually becomes payable
and what will happen in the situation where the notional debit exceeds
the actual amount of surcharge payable. When the proposition was put to
the Deputy Australian Government Actuary that there will be no adjustment
between the notional debit and the actual surcharge payable, he replied
that "I expect that to be the case." [8]
9.20 The proposed role of the actuaries in determining the rate at which
the NEC is to be calculated was also raised before the Committee. The
argument has been put that the substantial role to be performed by the
actuaries is, in effect, a delegation of the Commonwealth's power and
that the amount of surcharge payable may ultimately be determined by actuaries.
The Bar Association of Queensland submitted that:
Any surcharge or tax which depends for its computation on matters to
be determined by persons other than the Parliament is seriously able
to be argued as an impermissible delegation of the taxing powers of
the Commonwealth Parliament. [9]
9.21 The submission made to the Committee by the Association of Superannuation
Funds of Australia (ASFA) also supported this view, commenting that:
...the scheme as currently proposed will have a private, professional
body, the Institute of Actuaries, and individual actuaries effectively
setting tax rates for individuals. [10]
Commutation Rules
9.22 The deeds of superannuation funds generally provide for benefits
to be payable as either a lump sum or a pension and provide for a pension
to be commuted to a lump sum or a lump sum to be commuted to a pension.
The rates at which the commutation occur are defined in the trust deed
of the fund.
9.23 There are some funds that do not allow the commutation of a pension
to a lump sum, principally where there are no employee contributions (some
funds mainly relating to members of the judiciary). The issue has been
raised of the effect of the surcharge on the rate of commutation that
will apply to defined benefits schemes where the amount of surcharge payable
exceeds any lump sum entitlement of the member. In such a case part or
all of the member's pension entitlement would need to be commuted to enable
the surcharge to be paid when the surcharge liability arises, which will
be at the time the member leaves the fund.
9.24 The issue is whether the commutation rate in the fund's deed, if
such a rate exists, would be the same as that determined under the proposed
surcharge scheme or whether the proposed surcharge commutation rate would
override that in the fund's deed.
9.25 The Deputy Australian Government Actuary submitted that the commutation
rate for the surcharge would be determined by actuaries. He expressed
the opinion that for defined benefits funds there could be a difference
between the commutation factor contained in the deed and the one required
for payment of the surcharge. The Deputy Australian Government Actuary
stated:
Certainly, it is common in the unfunded public sector for those factors
not to be true commutation factors. In the private sector, most commutation
factors are closer to the truth. [11]
...
When you get to retirement, it would require a change to the legislation
under which the super funds are set up. You would have to be able to
commute on that basis; it would not be part of this legislation. [12]
9.26 The possibility of legislation altering the commutation factor of
a public sector defined benefits scheme to allow a sufficient proportion
of a pension to enable the deferred surcharge to be paid was the issue
raised by the Deputy Australian Government Actuary.
Particular Schemes
9.27 Concerns have also been raised about the effect of the surcharge
on certain superannuation schemes.
Military
9.28 A submission to the Committee by the Armed Forces Federation of
Australia raises a number of issues regarding the potential impact of
the proposed surcharge on members of the armed forces. One issue relates
to the position of members who voluntarily discharge themselves from the
services prior to completing 20 years service. The submission states:
These members do not qualify for retirement pay. They receive a refund
of their own contributions and their entitlement to the 3% productivity
benefit and the Superannuation Guarantee Charge top-up is rolled over
until the member reaches 55. Under this scheme the member would be liable
for a surcharge on benefits he/she will never receive. The Federation
strongly asserts it is unjust to include the DFRDB [this is one of the
superannuation schemes applicable to military personal which was superseded
for new members by a new scheme] in notional employer benefit in calculating
the superannuation surcharge for these members. [13]
9.29 The submission also argues that when the new scheme was introduced
in 1991, the Government gave an "Iron Clad Guarantee" that members
of the Defence Force Retirement and Death Benefits Scheme (DFRDB) 'would
not be touched'.
9.30 The final point made in the submission is that:
Although allowances are not to be included to increase superannuation
benefits, the very same allowances will be used to assess the members'
liability for a superannuation surcharge. [14]
9.31 The arguments relating to DFRDB and the allowances were also supported
in a submission made by the Returned and Services League of Australia
Limited. [15]
Possible Alternatives
9.32 In its submission to the Committee, the Institute of Actuaries of
Australia suggested that for defined benefits funds it should be possible
for a member to pay their notional surcharge each year and therefore avoid
the consequences of compounding interest on their notional debit (ie.
where interest is payable on the interest accumulated in the debt). While
the amount of the notional surcharge may be difficult to calculate, this
could be addressed in the actuarial guidelines. In its submission, the
Institute of Actuaries of Australia stated:
Employers could be given an option of paying a 'surcharge contribution'
to the fund each year to allow progressive payment, rather than an accumulation
of a debt. We note that this may involve a deferral of revenue. [16]
9.33 The same argument could also be made in respect of a member of a
superannuation provider who wished to pay an annual amount of surcharge
rather than see a debt accumulate.
Government position
9.34 The Government's position in regard to defined benefits funds was
outlined by the Treasurer in a Press Release dated 5 February 1997. The
Press Release stated, in part:
The same broad administrative arrangements for the annual surcharge
assessment will apply to both funded and unfunded defined benefits funds.
The principal issue in relation to defined benefits funds is the method
for determining the annual employer contribution in respect of each
employee.
9.35 The Press Release then explained the role of the NEC and continued:
The Government believes this is the most practicable approach to adopt.
This method will be flexible enough to apply to a diversity of funds
regardless of the degree of funding or the form in which benefits are
provided. It is capable of providing a smooth progression of contribution
rates, avoiding the volatility of actual contributions and the discontinuities
possible in vested benefit approaches. Submissions to the Actuarial
Advisory Committee indicated that there is a significant support for
an actuarially determined contribution rate in the superannuation industry.
9.36 Regarding the role of actuaries, the Press Release noted that a
certificate relating to the amount of the NEC was to be prepared in relation
to members of defined benefits funds and continued:
The certificate would be prepared by a qualified actuary acting under
professional standards. In this regard, the government has requested
the Institute of Actuaries of Australia to prepare in consultation with
the Australian Government Actuary and the ATO, an actuarial standard
on this issue.
9.37 The Explanatory Memorandum to the Superannuation Contributions Surcharge
(Assessment and Collection) Bill 1997, in a section dealing with the application
of the surcharge to defined benefits funds, states:
Unfunded defined benefits schemes will receive assessments each year.
They will not be required to pay the surcharge at this time.
Instead unfunded defined benefits schemes will be required to maintain
a surcharge debt account for each member of the scheme. Each year the
provider will be required to debit the account of each member who is
affected by the surcharge. The amount debited to the account will be
the amount of surcharge assessed for that year [17].
9.38 The Explanatory Memorandum then addressed the issue of the interest
payable on such debits and stated:
This is to be achieved by debiting the account with an amount using
the 10 year Treasury bond rate. [18]
[GO TO CHAPTER 10]
Footnotes
[1] Submission No. 64, p. 4.
[2] Submission No. 23, ASFA, p. 15.
[3] Evidence, p. S194.
[4] Ibid., p. 185.
[5] Ibid., p. 258.
[6] Evidence, p. 185.
[7] Evidence, p. 254.
[8] Evidence, p. 202.
[9] Submission No. 71, p.2.
[10] Submission No. 23, p. 15.
[11] Ibid., p. S199.
[12] Ibid.
[13] Submission No. 51.
[14] Ibid.
[15] Submission No. 55.
[16] Submission No. 39, pp. 6-7.
[17] Explanatory Memorandum to the Superannuation
Contributions Surcharge (Assessment and Collection) Bill 1997, p. 25.
[18] Ibid.
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