A confidential report into the privatisation of government superannuation provider GESB reveals that big obstacles were encountered early in the process, yet the plan proceeded without solutions.
A REPORT into government superannuation fund GESB has revealed that the proposed $8 billion mutualisation went right down to the wire despite big differences of opinion over the cost to the government and an impasse over the tax status of GESB’s biggest scheme, the $5.2 billion West State Super.
Then Labor treasurer Eric Ripper stopped the mutualisation at the 11th hour when it became clear that GESB could not be privatised until both of these issues were resolved.
It was a brave act to stop this process. The mutualisation of GESB, Australia's 13th biggest fund administrator with about 300,000 account holders, was a significant reform for Mr Ripper’s government which was backed by the Liberal opposition to privatise a significant state enterprise and give superannuation choice to public servants.
But the report, by public servant Rod Whithear who was commissioned by former treasurer Troy Buswell, shows the high cost of the process was becoming ever clearer as the July 2008 deadline for mutualisation drew closer.
In each of the four months prior to the planned privatisation, the report details the financial support GESB required of the government in the form of seed capital, pricing support or reserves which had been calculated by the fund administrator’s advisers or negotiated with the Department of Treasury and Finance.
In March 2008, for instance, Mr Whithear shows that GESB’s adviser Mercer estimated that the entity required $352 million in seed capital, $30.5 million in pricing support and $137.9 million in reserves: a total of $515.5 million.
In April, that number changed slightly to $517.1 million, but its composition was very different. On the 23rd of that month, Mercer revised seed capital down to $267.2 million, pricing support was now $60.5 million, a new capital support cost of $8.4 million had been added, and reserves had jumped to $181 million.
By May, a month from mutualisation, that had changed again. The total was $612.1 million, blown out by an increase in reserves to $273.3 million.
Reservations
At this stage there were already rumblings in the public service about the mutualisation cost.
In February of 2008, WA Business News had already highlighted these concerns. Most contentious was the huge reserves that were to be shifted from the state’s balance sheet to the private entity GESB Mutual.
GESB is a complicated mix of varying schemes – from modern day accumulation funds, where money is put in and grows with the market, to old-fashioned defined benefit schemes, which are, in the main, liabilities the government owes to members based on their final salary.
But even the defined benefit schemes had money flowing in, from members who made their own contributions to guarantee a better payoff at retirement and from state agencies that were corporatised and no longer part of the official public service.
The reserves were contentious because of way the scheme was administered. All the GESB money was pooled in one big fund. At the end of the year, the accumulation funds were calculated on the basis on money paid in and market performance, less costs. After that the reserves for each fund and numerous other reasons, including the development of new products, were determined. The money left over was assigned to the defined benefit schemes' funded liabilities. If there was shortfall, as there was in 2009, then that deficit was added to the government’s liability.
Close watchers of the fund argued that the reserves were really generated from defined benefit schemes. GESB annual reports appear to confirm this because the fund’s deficit closely matched the reserves put aside.
This arrangement worked when GESB was all government controlled, but if the reserves went to the private vehicle it meant they were no longer available to the government.
This is the key part of the $467 million figure Mr Whithear identified as the cost of choosing mutualisation over his recommendation to keep the funds under government control, outsource management and allow members the choice to leave if they wish.
Mr Whithear recommends all but one of reserves put aside at the end of 2008-09 be reset to zero, leaving just $44 million. It’s recommended the rest, $339 million, is to be used to reduce the $393 million deficit recorded against funded liabilities.
Tax problems
There was one other huge complication – West State Super.
This scheme, representing the majority of GESB’s funds and 230,000 of its members, is a tax-exempt fund. That means that its members pay tax when they exit the fund, rather than up-front like most contributors to superannuation.
Mutualising this scheme would end its tax-exempt status, triggering an estimated $700 million tax bill.
Despite this, GESB kept plugging away for the transfer, optimistically hoping that either the Commonwealth would waive the tax, despite former federal treasurer Peter Costello dismissing the idea in 2007 (as did current Treasurer Wayne Swan).
But that was not the only issue.
The Whithear report reveals that financial modelling in 2006 showed that as much as 75 per cent of West State’s members were better off in the longer term under the existing arrangements, which deferred tax until they exited the scheme at retirement.
Mr Whithear questions why this proposal was ever pursued.
“The fact that this proposal has remained under active consideration for several years after this modelling was conducted is more difficult to fathom,” he states in the report.
But without the transfer of West State Super, which represented most of GESB’s members and funds, the future privatised GESB would have looked pretty emaciated.
As Mr Whithear points out, if GESB had been mutualised without West State Super, six out of seven members would have stayed as the government’s responsibility. This would have meant replicating much of the administrative operations of GESB inside Treasury, somewhat defeating the purpose of GESB’s privatisation.
Economies of scale
Another vexing issue identified by Mr Whithear in his report is the huge number of small account holders.
Due to the nature of the state’s public service, people come and go – often working just for a short time as an employee of the state. As a result, about 100,000 of the estimated 280,000 GESB members, have accounts that are less than $1,000. A further 70,000 accounts are between $1,000 and $10,000. Due to the nature of the state’s superannuation system, those funds are stuck with GESB.
Mr Whithear believes that most if not all of these 170,000 members have sub-economic accounts. Without the benefit of choice, employees who have left the public service have had their superannuation stranded with GESB without being able to benefit from the economies of scale that pooling their combined pension savings would create.
These uneconomic accounts are stagnating because the costs they pay are high compared to the amount of funds in the account, eating away any growth they achieve. Worse, according to Mr Whithear, is that even with the relatively high fees they pay, they can’t cover their costs, meaning other members subsidise these small accounts. The report states that 72 per cent of members with accounts over $1,000 paid 96 per cent of the costs.
This is not good news.
The obvious answer, according to Mr Whithear’s thinking, is to legislate to offer choice to and use the GESB marketing budget to advertise to this huge amount of people to take these small funds and consolidate them with their other superannuation accounts.
Clearly the mutualisation of GESB was designed as a way of offering superannuation choice to these and other government employees.
But choice could have been offered without mutualisation. Indeed that is the recommendation of Mr Whithear.
“The case for mutualisation had been primarily built on the economies of scale possessed by GESB, and arguments that it needed to retain and expand this scale to remain viable,” the report says.
“It is now obvious that the scale possessed by GESB in terms of the number of accounts (and the administration fees that flow from those accounts) is underpinned by a majority of uneconomic accounts.
“Up to 170,000 members should therefore consolidate their superannuation elsewhere.
“Given this, the case for mutualisation folds, and alternative solutions need to be pursued to procure alternative superannuation administration services to address the loss of scale (and GESB revenue) flowing from superannuation consolidation.”
