Populism ignores the need for real super reform

Last week, Tony Abbott and Kevin Rudd pandered to a small but influential group of superannuated members of the Australian Defence Force. In doing so, they ignored those who really missed out in the old military super schemes and failed to consider genuine reforms that are now needed both to military super and super for the rest of the community.

The initial cost of changing the Defence Force Retirement & Death Benefits Scheme's indexation factor from prices to earnings might appear modest, but the estimate by the review I chaired in 2007 was that, even if restricted to those aged over 65, the change would increase unfunded liabilities by more than $4 billion. The cost would be much greater again if the change was extended to public servants in the old Commonwealth Superannuation Scheme. (And the case is exactly the same. The original schemes in both cases promised pensions indexed to earnings, but this changed to prices when age-pension indexation was similarly limited in the 1970s. The change was not reversed when age pensions were once again aligned to earnings by the Howard government.)

MilitarySuper is by far the largest contributor to our growing unfunded super liabilities and it is inevitable that it will be replaced ... notwithstanding the shift in risk to members. 

What DFRDB pensioners rarely admit is that they were the privileged members of the scheme. The vast majority of ADF contributors to the DFRDB Scheme received nothing from their employer and only got back their own personal contributions, with no interest paid at all. Only those with more than 20 years' service were entitled to employer benefits - and what generous benefits they were: an indexed pension paid immediately on discharge, not preserved to real retirement. Many left the ADF as soon as they completed their 20 years, picking up an indexed pension before they turned 40 to supplement incomes from their post-ADF careers. Their pensions might now seem modest, but many have been getting them for decades and they could have invested the money for real retirement (and supplemented them by extra savings as they took on new careers).

It was these dreadful weaknesses that led to the DFRDB Scheme being closed to new members and replaced by the Military Superannuation and Benefits Scheme in 1991 after a review by Sir William Cole. This scheme, known as MilitarySuper, ensured all ADF members gained entitlement to employer-financed benefits, and also required the benefits to be preserved to age 55.

MilitarySuper has now also had its day. As broader superannuation policy now promotes contributions-based, funded schemes, MilitarySuper (an unfunded, benefits-promise scheme) needs to be replaced by a new arrangement, just as the Public Sector Superannuation Scheme, which replaced the CSS for public servants in 1990, has since been replaced. That was what we recommended to the Howard government in 2007: a fully funded, contributions-based scheme that further favoured the majority of the ADF who serve for under 15 years, ensuring very generous employer contributions towards their eventual retirement years. Our recommendations were endorsed by all the service chiefs, the Defence Department and the then minister, but the cabinet deferred consideration ahead of the 2007 election.

Our report only became public after the election and the Rudd government understandably wanted time to consider it. The global financial crisis shortly afterwards showed rather dramatically that moving from benefits-promise schemes to funded contributions-based schemes shifts risks to individual members, and our recommendations have since languished. As a consequence, of course, MilitarySuper's unfunded liabilities have continued to grow significantly, adding to the challenge the Future Fund is designed to address.

MilitarySuper is by far the largest contributor to our growing unfunded super liabilities and it is inevitable that it will be replaced by a funded, contributions-based scheme sometime, notwithstanding the shift in risk to members (as everyone else in the community accepts). We recommended not only closing MilitarySuper but allowing its current members to transfer to the new scheme, thereby reducing unfunded liabilities but also requiring real money to be transferred from the Future Fund into members' super accounts. This particular recommendation, which was not central to our report, led to some robust debates among officials because of arcane budgetary implications and uncertainty about the risk of gaming, as people would be allowed to choose between the two schemes.

A more important debate concerned our recommendation that long-serving ADF members continue to be allowed to access indexed pensions. The issue here is relevant to broader super policy. Who can and who should bear what risks? We proposed that long-serving members be allowed to buy indexed lifetime pensions from their accumulated contributions at a price determined regularly by the government actuary. The Finance Department advised that this would leave the government with a contingent liability, notwithstanding that all the other recommendations would halt the growth in (or even lower) the current real - and unfunded - liabilities.

The Henry tax review has since advised that the government needs to intervene to help Australians manage their longevity risk. This is by far the greatest weakness in our current super system: our reliance on lump sums and our lack of indexed lifetime annuities. The government does intervene now, of course, but expensively and clumsily by giving away age pensions to those with insufficient super or who use up their super savings before they die. A much better option is the one we proposed: allowing people to buy lifetime annuities from the government at a price determined by the actuary. Even better, if we want a really good retirement income system, would be to make it compulsory to place a proportion of super savings at the preservation age into lifetime pensions payable from age-pension age.

Andrew Podger is a professor of public policy at the Australian National University. Disclosure: he receives a CSS pension.

andrew@podger.com.au