Monday, 4 February 2013

Tassie's unfunded superannuation liability

The state’s largest liability and the least understood is the liability for unfunded superannuation.

The liability arises because the employer (ie the State and its associated entities) does not set aside employer contributions as is customary for most superannuation schemes.

Instead the employer pays amounts as and when the benefits fall due, upon retirement or resignation, either in a lump sum or as a pension.

These unfunded schemes all fall into the category of defined benefit schemes (or DB schemes) as distinct from the more customary accumulation (or defined contribution) schemes.

The superannuation guarantee which required employers to set aside 3% of wages (now 9%) on behalf of employees, didn’t apply to DB schemes. This proved to be a cash bonanza for the Government. It was not required to set aside any superannuation for current employees if they were members of the defined benefit scheme. The superannuation guarantee obligations did not add to the government’s obligations, rather existing obligations to fund members’ benefits were counted towards any super guarantee obligations.

The government established an account into which yearly appropriations were made ostensibly with the aim of providing enough, by 2035, to extinguish the unfunded liability.

In other words even though there wasn’t a statutory or other legal requirement to set aside amounts, the government set up a Superannuation Provision Account (SPA).

Throughout SPA’s existence the account had no cash backing as it had all been ‘internally borrowed’ by the Government and spent on other more pressing needs (see part 1 for details of this charade).

Defined benefit funds, whether funded, partly funded or completely unfunded, all share a common characteristic, and that is the final benefit paid is not determined by  the amount of contributions plus earnings as is the case with an accumulation scheme, but essentially is a function of the final average salary and the years of service of the member.

All DB schemes are closed to new members. RBF administer five such schemes, the largest known as the Contributory Scheme, partly funded by members’ contributions, comprises 98% of the total unfunded liability.

The smaller partly funded schemes administered by RBF include schemes for ambos, firies and parliamentarians, all now closed.

In addition there are two completely unfunded schemes, for Judges and Housing Department employees, all long closed to new members, where members’ contributions , if any, simply end up in the Consolidated Fund, the Government’s pot of money.

To reiterate, 98% of unfunded liabilities relates to the Contributory Scheme. The other schemes are minor.

The year 2011/12 saw a large increase, almost 40%, in the unfunded superannuation liability. The Treasurer’s Annual Financial Report has the details:

For the General Government GG the liability has risen from $4,966 million to $6,925 million and for the Total State Sector TSS which includes GG plus all the GBEs the increase has been from $5,600 million to $7,748 million. Most of the liability rests with GG. The liability is a net figure arrived at by deducting the value of the plan assets (employee contributions and earnings thereon) from the gross estimated value of future amounts owing to DB members.

The following table presents the gross value of future DB obligations, the value of plan assets and the consequent net unfunded liability for GG and each of the GBE/SOCs with DB obligations that together comprise TSS.

90% of TSS obligations relate to GG (teachers, nurses, police persons etc) whilst another 9% relates to the three electricity entities and Forestry Tasmania (FT).

The liabilities for the three electricity entities are easily serviced given the operating cash flows of those entities, but FTs liability is of concern because it is unable to generate positive operating cash flows and is unlikely to do so for at least five years, if ever. The Government’s planned injection of $110 million into FT over 4 years is needed to pay not only FT’s wage bill but its DB superannuation obligations.

The value of plan assets comprises part of the RBF’s Funds under Management (FUM).When added to the amount in RBF’s accumulation scheme, its total FUM is just over $4 billion.

The change in the unfunded liability over the past few years is best depicted in a graph produced by the Auditor General.

The blue columns represent the gross unfunded superannuation liability of GG. It has virtually doubled over a 6 year period to $8,342 million. (NB this is the gross liability for GG).

The value of the plan assets is represented by the red columns. Little change has occurred over the period, a reflection of the GFC. Any additional members’ contributions have either offset investment losses or used to pay the funded share of benefits.

The green line is simply the difference between the blue and red columns, the net unfunded liability. It is now $6,925 million for GG.

Why the steep 40% increase in the 2011/12?

It’s almost entirely due to the interest rate, or discount rate as it’s called, used to convert the series of future benefit payments into a single lump sum representing the present value of future obligations.

It’s not always intuitively obvious how the discount rate works.

Take a simple case, $1,000 in one year’s time. What is that payment worth today? With a 3% discount rate $971 and with a 6% rate $943, only 3% less.

But what about a payment of $1,000 due in say 24 years time? Using a 3% discount rate it’s worth $492 today but with a 6% discount rate it’s valued at 50% less, $247.

Given that DB obligations stretch for 50+ years the present value of future obligations is extremely interest rate sensitive.

In 2010/11 a discount rate of 5.5% was used to calculate the present value of DB obligations.

In 2011/12 a discount rate of 3.45% was used as interest rates fell. This caused the gross unfunded liability for GG to jump to $8,342 million.

The Auditor General showed how sensitive the present value of the DB obligation was to changes in interest rates.

Using a discount rate of 2.45% instead of 3.45%, the liability would have been almost $1.5 billion higher.

With lower interest rates the nominal (ie undiscounted) payments don’t change a lot, if anything they may reduce if low interest rates persist as indexation factors applied to salaries of current contributors and pensions for retired members will be less as a cosequence.

The Treasurer’s Annual Financial Report 2011/12 sets out the estimated nominal amounts due over the next 50 years.

In case of GG the total payments due (undiscounted) is estimated to be $19.46 billion a reduction from the figure of $21.895 billion in the previous year. This is because the scheme is closed, all members are a year closer to death’s inevitability and current contributors’ % salary growth was reduced causing a decrease in their estimated end benefit.

The Auditor General presented a graph showing GG nominal obligations over time.

The red line may not be quite accurate as the peak in about 18 years time will be about $525 million per annum.

It looks like a lot of money.

But there is better news.

·       The figure of $525 million is a nominal figure, in other words unadjusted for inflation.

·       The $525 million is the gross benefit payment. GG’s share, the unfunded portion will be less, maybe only 75%.

The GGs share in 2012/13 will be $201 million only about 4% of GG’s total cash outlays in this year.

In 18 years time the GG's unfunded share, say 75% of $525 million or $394 million may only be 6% of GG total cash outlays assuming 2.5% pa  inflation over that time.

But the unfunded % may rise, GG may have to contribute more than 75%. It is obliged to fund any shortfall. Certainly plan assets have been stagnant over the past few years, and the red line in the last graph if it were drawn a little more accurately would show a steeper increase in the annual DB obligation over the next 10 years.

In terms of obligations as a % of GG outlays the peak may be in the next 10 years even though the nominal peak for obligations may be 18 years away.

How does GG know the unfunded % it needs to contribute to RBF?

When the Contributory Scheme was designed 40 years ago the unfunded % was five sevenths or 71.43%.

GG is told by the State Actuary whether the % needs to change. The following table lists the changes:


For members retiring after 8th July 1976 GG needed to contribute 85% for as long as the member was entitled to a benefit.

Over time there were other changes as the value of plan assets rose and fell. Recently the % has risen to 75% and it would not surprise to see it rise further in the near term.

Most of TSS’s unfunded liability lies with GG. The overall TSS liability is shown together with GG liability in the following:

The only additional problem with the broader TSS liability is, as we have seen, FT’s consummate inability to service its obligations.

Had the DB scheme simply been a lump sum scheme it would not have been seen as being extravagant, maybe equivalent to a fund with 15% employer contributions.

However it is the ability of members to take their benefit as a pension according to a fixed formula that provides members with a windfall gain and GG with afunding problem.

Being able to purchase an indexed life pension of $x pa with a lump sum of $12x (the private sector equivalent using today’s interest rates would be at least $20x) means a member can achieve a return of all capital plus interest over say 13 years (just a rough rule of thumb).

Or to put it another way, the present value of a pension in some cases (depending on commencement age) is more than 50% higher than the lump sum, were it taken in lieu.

The important points to make about the unfunded liability are therefore:

·       In nominal terms the obligations total $20 billion.

·       Reducing the future nominal payments into a single present value representing those future obligations is extremely sensitive to the discount rate used.

·       Of more relevance are the annual outlays by GG.

·       The peak annual outlays to satisfy DB obligations will be in approximately 18 years.

·       As a % of total cash outlays GG’s unfunded share is currently 4%  and will rise to at least 6% over the next 10 years, a 50% increase as a % of inflation adjusted GG outlays, not catastrophic but certainly a figure requiring close monitoring.

·       The Government by abandoning the SPA account hasn’t changed anything because there wasn’t any cash anyway.

The above uses figures for unfunded superannuation liability from the Treasurer’s Annual Financial Report (TAFR) which should be thought of as the final complete set of accounts with accompanying notes for GG and TSS in accordance with accounting standards and the Uniform Presentation Framework which allows comparisons between States.

Other financial statements produced on a regular basis by the Government, in Budget papers, the preliminary outcomes report (usually issued in August) and the revised estimates report (the 2012/13 was the first such report released in December 2012) aren’t strictly in accordance with accounting standards (there aren’t detailed notes for starters) and they use a different discount rate to calculate the unfunded superannuation liability.

Whereas the TAFR is required to use the long term Government bond rate at balance date 30th June (5.5% in 2010/11 and 3.45% in 2011/12) as the discount rate, other financial statements produced for GG and TSS have been using a discount rate calculated by Treasury of 6% which they regard as being a more appropriate bond rate over the life of the liability based on historical data and hence a more appropriate discount rate than the current bond rate.

In 2011/12 the different calculations for the net amount of unfunded super for GG were $6,925 million (using the 3.45% rate) and $4,802 million (using the 6% rate). Quite a significant difference, over $2 billion.

We have noted above that different values of the unfunded superannuation liability have little practical effect on GG’s sustainability as the annual obligations for GG don’t alter.

Why does the Government persist with two measures of unfunded superannuation? The two measures inevitably lead to different measures of the State’s net worth. Is it $11 billion or $13 billion?

Hardly anyone notices. Who cares?.

We’re all grownups, we can handle reality, there's no need for two sets of books.

In any event, who can possibly understand the two sets of books as presented?

The TAFR was issued in October 2012 and the GG’s net unfunded liability at that time as we have seen, was $6,925 million. The state’s net assets were $11,066 billion.

This was a full set of accounts pursuant to all the prevailing accounting standards and conventions (including accounting standard AASB 119 relating to Employee Benefits)

Barely 6 weeks later the government issued a short form set of accounts titled 2012/13 Revised Estimates Report. One of the immediately recognisable entries was the reversal of the increased superannuation liability in TAFR.

It suggests GG will achieve an Operating Result of $2,233 million in 2012/13. The unfunded superannuation liability was reduced to $4,773 million (by 30th June 2013) and the state’s net assets were boosted back above $13 billion ($13.513 billion estimated at 30th June 2013) as shown below.


The explanation for this $2 +billion entry was by way of a footnote which might make sense to a few cognoscenti.

In essence the Note is saying unless financial reporting requires strict adherence to accounting standards which may lead to a large unfunded liability based on a low discount rate, rather than frighten the horses and the rating agencies, a higher discount rate based on the premise that history will repeat itself allows the unfunded liability to be reduced by the amount shown.

The unfunded liability is part of net financial liabilities and one of the state fiscal strategies is to keep the ratio of net financial liabilities to revenue in the broader State non financial sector below 115%. This is a liability reduction strategy.The sudden rise in the unfunded liability in the TAFR using the low discount rate meant the % grew to an undesirable 131%. This was soon fixed up after the Revised Estimates report in December 2012 using a higher discount rate as explained above.

The following table shows the miracle turnaround from a ratio of 131% in 2011/12 to an expected ratio of 97% in 2012/13 falling to 88% in 2014/15, relying on a  higher discount rate to achieve the reduction in the liability ratio.

Even though the table has yet another obscure footnote, it is hardly made plain that apples and oranges are presented on the same line, hoping the reader might become a convert to a belief in miracles. Is there any point presenting such a table other than to mislead?

Another flow on effect of a higher liability is the other side of the accounting entry. An increase in the liability needs to be recorded in the P&L Statement as the cost of the DB scheme for that year.

In simple terms the DB cost is broken into three components:

·       the service cost which is the estimated cost of GG financed benefits accrued during the year.

·       the nominal interest which is a net figure calculated by the interest on the gross liability less the return on the funded portion, the plan assets.

·       changes caused by different actuarial assumptions, salary growth for existing contributors, earnings rates on plan assets, CPI etc.

The first two are allocated to the operating P&L (to calculate net operating balance) whilst the third component is classed as a non operating amount and included in the P&L after the calculation of operating profit.

It is the calculation of the nominal interest on the unfunded superannuation that may lead to different amounts being included in operating profit.  This is of relevance if the operating profit figure is, as is currently the case, used as a measure of fiscal sustainability.

In other words, whether to use a higher rate based on historical returns to calculate the return on plan assets or the current lower long term bond rate as stipulated by accounting standards. The higher the return on plan assets, the lower the net nominal interest on unfunded superannuation liability and the greater the operating profit (or net operating balance to be precise) and hence the greater the measure of sustainability.

But it’s all a bit illusory.

It is the annual cash obligations that are most crucial, not the absolute level of the liability nor the amount of the movement in the unfunded liability which gets allocated to calculate the net operating balance figure.

The unfunded liability is large but not crippling, as shownabove currently only about 4% of total GG cash outlays.Its peak effect, possibly 6% of cash outlays will be felt in the next 10 years.

We need better ways of measuring and monitoring sustainability, ways that are more commonly understood.

Two sets of books add a layer of farce and detract from comprehension.

Before reviewing the fiscal strategies and associated measures, a comparison of net debt and net financial liabilities with other States will be attempted in the next blog.


  1. Absolutely fascinating...and frightening!

  2. So - who exactly is responsible?

    1. At the end of the day the Governments and Treasury have been responsible, both for not funding the liability and for allowing the RBF to be mis-managed for so long.

  3. Hi John
    I always find your assessment of the RBF interesting. What do you think of the recent announcement by the Treasurer that he has asked RBF, Tasplan and Quadrant to prepare a proposal on a single superannuation entity for Tasmania....i.e. Quadrant and RBF rolling into Tasplan to create a $7bn+ fund?

    1. I think RBFs accumulation fund (the defined contributions fund) will transfer to a public offer fund and the funds you mention are the most likely. I doubt it will go to a retail fund, nor will there be any consideration for the transfer/sale.

      I reckon Member’s approval will be required, the Trustees can’t simply transfer Member’s accounts to other funds when Members have signed up in the way they have.

      There’s no way the defined benefits fund will be transferred anywhere. One can’t transfer an unfunded benefit.

      Hence it is likely the government, or RBF to be more specific, will retain the funded portion of the defined benefits scheme, or about $1.5 billion.

      Among the assets retained will almost certainly be RBF’s interest in the Hobart Airport.

      Three reasons for this.

      First it would be hard to get e receiving fund to agree that the airport is worth anywhere near what RBF reckons it’s worth .

      Second given the small size of the merged fund the airport would represent too large an asset.

      Third given the asset is an interest in a closed fund with a wind up date in four years time, it is most likely the owner at the time will end up crystallising a large loss, or being the unwilling acquirer of an extra share.

    2. Totally agree on the Hobart Airport issue. I know that they paid more than twice what any other fund was prepared to pay. Still can't believe more wasn't made of that shonky deal publicly. The government used their employees retirement monies to purchase an asset from themselves at a grossly inflated valuation. Macquarie didn't care, because they profited from the deal from a fee perspective, the asset value itself was not important.

    3. By the way, membership approval is not required when it is a successor fund transfer, the only thing required will be a change in legislation.

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