Possible options if benefit reductions are needed

UniSuper’s Trustee is engaged in detailed contingency planning to prepare for a range of scenarios following the end of the monitoring period which commenced in 2009. This planning includes liaising with stakeholders, employers and regulators. The Board will make a decision as to whether or not benefit reductions are required this year, depending on the position and outlook.

A number of members have asked how the Board might go about reducing defined benefits if this proves necessary. It is important to understand that the Board won’t know whether benefit reductions will be required (and if they are required, what reductions would be made) until it receives the first actuarial report after the monitoring period ended on 31 December 2012, and has a period of 6 months from receipt of this actuarial report in which to make this decision.  However, as part of its contingency planning, the Board has been taking actuarial and legal advice about the range of options that could be considered and continues to do so.

Here is a summary of the way benefit reductions might be made and some of the options:

Benefit reductions can be designed to affect past or future benefits, or both

With any defined benefit plan, a member has benefits that grow over time. This means that at any point in time a member will have an estimated benefit that has built up during their time in the DB to date.  In addition to this built up (accrued) benefit, a member can also expect to build up (accrue) further benefits during the rest of their time in the DB (until their retirement or exit date).  Clause 34 could affect either the benefits members have built up to date (accrued benefits) or the way their benefits will accrue in the future, or both.

Broadly speaking, benefit reductions can be designed in three ways, so that:

  1. Only the benefits that members would accrue in future are affected.
    This means that the benefits existing members of the Fund have accrued to date would not be affected. Instead, the benefits of current DBD members, pensioners and future new members would grow more slowly from the date the benefit reductions are made.
     
  2. Only the benefits that members have accrued to date are affected.
    This would mean that the benefits existing members of the Fund have accrued to date would be reduced at the date the benefit reductions are made. The accrual of future benefits for existing DBD members, pensioners and new members would not be affected.
     
  3. Both the benefits that members would accrue in future and the benefits that members have accrued to date are affected.
    This would mean that the benefits existing members of the Fund have accrued to date would be reduced at the date the benefit reductions are made. The benefits of current DBD members, future new members and pensioners would grow more slowly from the date the benefit reductions are made.

Possible options for reducing benefits

In this section, we examine some of the possible changes that could be made if benefit reductions are required. The list below is not exhaustive. It is only a guide to some of the possibilities that may be considered.

At this point, it’s important to emphasise again that it is too soon to know whether or not benefit reductions will be required, and if benefit reductions are considered necessary, what the nature of those benefit reductions would be.

Each of the possible changes summarised below could be implemented alone, or in combination with one or a number of the other options or further options that may emerge.

Changes to a member’s benefit salary

How it works now: To calculate a member’s benefit salary for the purposes of the DBD formula, UniSuper takes an average of the member’s salary over the last three years and adjusts it in line with CPI.

How it might be changed: For the purpose of calculating benefit salary, salaries could cease to be adjusted in line with CPI. Alternatively or as well, the averaging period could be extended to five years or salaries used to calculate benefit salary could be frozen at their current level for a period of time. Note that none of these changes would affect a member’s actual salary; they would only affect the way a member’s salary is taken into account for the purposes of the DBD formula.

Changing the impact a member’s age has on their entitlement

How it works now: What’s known as a lump sum factor is part of the DBD formula for each member. This lump sum factor is based on the member’s age and is larger the older a member is.

How it might be changed: The lump sum factors could be reduced.

Reducing members’ benefits proportionally

How it works now: At present, each member’s benefit is determined by the DBD formula.

How it might be changed: Each DBD member’s total benefit as calculated under the current DBD formula could be reduced by a specified percentage, either immediately or on a deferred basis.

Supplementary benefit entitlements

How it works now: Some DBD members are currently entitled to supplementary benefits. These are calculated according to a separate formula and are added to the member’s standard DBD benefit.

How it might be changed: These supplementary benefits could be frozen or removed.

CPI indexation for indexed pensions

How it works now: Indexed Pension payments are adjusted in line with CPI each year.

How it might be changed: Indexed Pensions could cease to be adjusted in line with CPI for a period of time or they could be adjusted by less than CPI.

Changing new pension factors

How it works now: What’s known as a pension factor is part of the DBD formula for members eligible to take a DBD indexed pension.

How it might be changed: The pension factor for new pensions could be reduced.

The Board’s process

If the Board makes a decision that benefit reductions are required, it must reduce benefits on a basis that is fair and equitable across DBD members and pensioners as a whole. There are a number of factors that could be considered in determining whether an approach to benefit reductions is fair and equitable such as how any change affects different membership profiles or addresses the sources of the funding shortfall. Any decision would be made with consideration of actuarial and legal advice.

Key points

  • The Board won’t know whether benefit reductions will be required or not until it receives a report from the actuary, and then has six months in which to make the decision.
  • Whether or not benefit reductions are required will depend largely upon market performance and outlook.
  • The Board is likely to make a decision within six months of receiving the actuarial report into the financial condition of the DBD at that time.
  • If benefit reductions are required, they could affect the benefits members have accrued to date, or the rate at which their benefits will grow in the future, or both.
  • This information provides an overview only of some of the options that may be considered if benefit reductions are required. The Board continues to plan and seek advice.