The risks associated with the Defined Benefit Division
Normally the only risk for a DB fund is that employer goes out of business and no additional contributions can be made if the assets of the fund do not match the defined benefits. With UniSuper the fund is NOT guaranteed, the members must understand the risk that the guaranteed contributions and net earnings may not be sufficient to fund the benefits. If these risks adversely come to pass the benefits will be reduced again.
The risks for the fund are clearly laid out in the summary of the Actuarial Investigation as at January 2013, which was attached to the Financial Statements year ended June 2013. These statements are only available to members on request. Some but not all these risks have been disclosed in Annual Report and in the current PDS but most were not in the earlier PDS under which many members joined and based their decision to stay in the fund.
The published Summary of the Actuarial Investigation Jan 2013 is attached (Attachment 2) and comments on the risk to the payment of benefits identified in that summary are set out below.
- Investment risk. This is seen as the most significant risk. If there is poor investment performance over a protracted period or changes in inherent nature of markets, the return may be less that assumed in the calculation of the benefits. Neither the assumed performance nor actual performance is reported for the DBD. This is the same major risk that directly impacts on accumulation fund balances.
- Inflation risk. Should inflation increase above the assumption, the pensions that are being paid would increase and the funds required would be higher. Likewise inflation less than the assumption would reduce funds required. Neither the inflation assumption or impact of a change on the funds required, is given in the Annual Report or PDS.
- Salary growth risk overall. Should salaries overall increase faster than the assumption, more funds would be required to meet the benefits which are related to salary. The converse, should overall salary growth be lower than the assumption, means less funds would be required. Neither assumed nor actual salary growth is reported in the Annual Report or PDS.
- Salary growth risk individual. From the design of the fund detailed in the previous section it is clear that those with higher salary growth are advantaged in the DBD so if member’s salary growth is at the lower end the returns will be less as shown in Part 1 above.
- Self insurance. The DBD self insures for death, disability and temporary disablement benefits. If the amounts paid out are greater than assumed then the more funds are required to meet these benefits. There are no reports on the amounts paid under these benefits compared to the assumptions. In the accumulation section of the fund, insurance is deducted separately and this must be taken into consideration in comparing DBD and accumulation.
- Longevity. The fund has lifetime indexed pensions often continuing to a spouse after the member’s death. To calculate the funds required, an assumption is made on longevity and if members’ life expectancy continues to increase above the assumptions then more funds will be required to meet the pensions. There is no reporting on the actual experience against this assumption but calculations in Part 1 above show that if all pensioners survive 25 rather than 20 years, the fund must earn 7.4% per annum on pensioners’ original lump sums to meet the benefits.
- Eligible employees decide to move to accumulation. This is the risk mentioned above that only advantaged employees, those with higher salary increase, stay in the fund while others move to accumulation within their first 24 months. This risk cannot be quantified as the age structure of members is not reported. This risk is hard to reconcile with the UniSuper quote from the latest explanatory brochure which states on page 4 “Importantly the DBD does not require young members to remain in the DBD to cross subsidise the benefit accruals of older members”.
- Large downsizing or retrenchment while Vested Benefit Index is under 100% (VBI is funds available as a % of vested benefits). When the VBI is under 100%, members are still paid out the full benefits and full pensions continue to be paid. This further erodes the VBI. This was the situation fromJune 2008 until 2013. The impact on the VBI of these payments has not been reported.
- Effective operation of Clause 34. The actuary saw a risk that the implementation of benefit reductions under clause 34 had not been tested and could be hindered or constrained. Clause 34 has to operate properly to maintain the DBD as financially viable over the longer term. This infers that the trustee must have the ability to further reduce benefits should the need occur.
- Allowing members to voluntarily transfer to accumulation while vesting under 100%. The actuary warns against this for the same reasons as in h) above, as the funds available for benefits for others would be eroded. The converse of this is that there is no risk in allowing voluntary transfer when the vesting is above 100%.
- Rebalancing accumulation accounts adversely impacting on the DBD assets. This makes it clear that the DBD takes up all errors in accumulation accounts, residual costs in the fund and losses/profits by the management company, as the funds available for the DBD members are the total funds less the amounts of accumulation balances.
The potential scale of the problems (if any) of this risk is hard to quantify.
However, there is no reporting on costs, profits/losses of the management company or accuracy of crediting to accumulation funds of, for example, tax. In the Financial Statements there are over $200 million of deferred tax liabilities and the profitability of the management company is not shown. This risk may not be material but knowing it is being effectively managed is important.
The summary of the actuarial report June 2011 also raised the following risk:
- Insolvency risk. As the superannuation guarantee moves from 9% to 12%, there is a reduction in the margin between the DBD trust deed benefits and the minimum requisite benefits under Superannuation legislation. This increases the potential for technical insolvency. This is not mentioned in the latest actuarial summary but is clearly explained on the latest PDS as a risk of reduction in accrued benefits.
- There is a regulatory risk that has not been mentioned by UniSuper or its actuary but is covered in An Uncertain Future:
- APRA require the fund to hold a reserve for the pension payments as is required of others providing indexed pensions. The vested pensions for the 6000 pensioners are shown in the Financial Statements to be 25% of the vested benefit for the total 76,000 DBD members. The requirement to build and maintain this reserve could have a significant impact on required rate of return.
Much of the impact of the above risks depends on the actuarial assumptions. These assumptions are not disclosed in the Annual Report and partially disclosed in the Financial Statements and Actuarial Summary (Attachment 2). The impact of changes can be significant and note 28 to the June 2012 Financial Statements states:
“This in turn led the Actuary to reduce the investment return assumption on a best estimate basis from 8.0% to 6.7% net of tax, and using the more conservative funding basis, from 6.75% to 5.25% net of tax. The reductions in investment returns assumed to be earned by the assets of the DBD, have resulted in a reduction of approximately 5% in the VBI and a reduction of approximately 10% in the ABI”
The member is being asked to make a judgement on all these risks and decide to stay in the fund or move to accumulation. Likewise a retiring member has to make a judgement on the impact of the risks when deciding whether to take a pension or lump sum. As shown above, it is hard to see how an informed decision could be made on the information made available in the Annual Report or PDS.
As the risks have not been adequately explained to members, all existing members should be given the opportunity for a short period to exit to accumulation or commute their lump sum.
This leads to Part 3 of the report, which outlines information that would be of use in making the decision to stay or move and to take a pension or lump sum.
The material in this paper is of the nature of general comment only and does not represent professional advice. It is not intended to provide specific guidance for particular circumstances and it should not be relied on as the basis for any decision to take action or not take action on any matter that it covers. Members especially older members close to retirement who need to preserve their benefits for retirement and should not be taking significant risks with those funds, should obtain appropriate professional advice before making any such decision. To the maximum extent permitted by law, the author disclaims all responsibility and liability to any person, arising directly or indirectly from any person taking or not taking action based on the information in this paper.