$25 billion superannuation hole

Fairfax is reporting that listed companies are having to pour up to $25 billion into their defined benefits schemes because of investment losses associated with the global financial crisis.

This is yet another reminder that there are basically two types of schemes, defined benefit and accumulation, and the risks and benefits with each is different.

Defined benefit schemes

A defined benefit scheme is where the money in the scheme ( or in the Commonwealth Government’s case, the lack of money in the scheme) belongs to the trustee.

[On this note, I mention the Future Fund. The only reason for its existence is to meet future superannuation liabilities for Commonwealth public servants, and therefore try to be less of a burden on taxpayers in the future.]

The member of the scheme is paid a benefit on retirement based on a formula (hence the term “defined benefit”) which is usually based on such things as number of years of service, position, earnings etc. Some formulae are quite simple, but others, such as Comsuper are remarkably complex.

The significance of defined benefit schemes for companies is that the trustee wears the risk. Occasionally, if the scheme makes a lot of money, then the trust deed might provide that the surplus is paid back to the company, as happened with Westpac some years ago, and not to members. However, if things go awry, then the trustee (meaning the employer) has to stump up the cash.

Defined benefit schemes can be complex, difficult to value, in the family law context at times not able to be split, but often worth more to a member than an accumulation fund, because the risk is always with the trustee.

Typically, defined benefit schemes were the first type of scheme. Therefore they are often quite well endowed, due to historical earnings.

Because of the risk issue, employers including governments have tried to cap new memberships in the defined benefit schemes, eg the Queensland Government scheme Qsuper, and tried to encourage members to leave for accumulation schemes, even with sizeable incentives to members- eg Telstra some years ago.

Accumulation schemes

These now reportedly represent 90% of memberships. Essentially they are like bank accounts. Provided the returns are there, then with the accumulation of deposits, with compound interest, they grow.

The risk is wholly that of the members.