Indexed pensions cost rising
The latest three-yearly actuarial reviews of the Commonwealth’s defined benefit pensions funds confirm what federal employees fortunate enough to be members already know. Historically low interest rates and volatile investment returns increase the attractions of the indexed pensions on offer.
Over the most recent three years, the total unfunded government liability has increased by $35 billion to $216 billion. The 2018 budget papers predicted a peak at around $315 billion in 2050. These cost increases have occurred even though the politicians’ scheme, public sector and military fundswere closed to new entrants in 2004, 2005 and 2016 respectively.
Changes in actuarial assumptions have contributed a large part to the latest increase in estimated liabilities. Lower interest rates forced the actuaries to reduce the discount rate used to calculate present values from 6 per cent to 5 per cent a year. This is still a high discount rate interest given that only $150 billion of the estimated liability is backed by Future Fund assets.
There are no assets to help finance the remaining $66 billion of the estimated liabilities that until at least 2050 will increase even if Future Fund returns continue at current high levels. The unfunded liability is also likely to increase because the remaining defined benefit fund members are much better informed about the value of taking an indexed life time pension with surviving partner benefits.
Changes in superannuation rules, favourable age pension treatment and lower personal income tax rates have added to the attractions for those yet to claim their benefits to take a government guaranteed pension not involving any fees and changes. The pensions, based on long outdated 1922 mortality factors, also help current retirees with much longer life expectancies to avoid the risk of running out of money.
The temptation of high interest rates which encouraged federal defined benefit fund members to cash out their entitlements in the past are no longer relevant. More recently, the value of taking an indexed pension has increased because benefits taken this way don’t count as assets for the age pension assets test.
State governments were quicker off the mark than the Commonwealth in closing off new entry to their indexed pension funds, with NSW doing so in 1985. They also offered less generous preservation options than the Commonwealth. These preservation options are still increasing the Commonwealth’s unfunded liabilities.