Indexation

Currently RBF Life Pensions are indexed to the Consumer Price Index (CPI) twice per year. The CPI figure used is the Average CPI of all State Capitals. The expectation (and a strong selling point) for all members on joining the RBF Defined Benefits Scheme was that the value of the ensuing pension would be maintained over time so that the pensioner's spending power would be maintained. It has become apparent over time that the CPI is not a good measure of the rising costs faced by retirees, and that a better method of indexation was required to achieve this. For some other pensions in other jurisdictions, indexation to the rise in average weekly male earnings has been adopted as a better way of maintaining the pension's value.

The Case for Better Indexation
Consumer Price Index (CPI)
Report of actuarial study of improvements to pension indexation
Actuarial study - Explanatory Note
Graph of actuarial study results
Indexation Loss calculator
Sharing in the rising living standards of the Australian Community
Cost of Living versus Standard of Living
Government Reasons for Refusing Better Indexation
Progress with State Indexation Campaign prior to the 2014 State Election

1. The Case for Better Indexation

This article was previously published in Super-News in May 2011.

Our previous President, Tony Robinson, has produced the following summary which presents for members some of the significant arguments for our long standing case to gain equity in the manner by which our RBF pensions are indexed. This has of course also been forwarded to our various State politicians.

RBF Defined Benefit Pensions should be indexed by the greatest of

a) Increases in the CPI

b) Increases in Male Total Average Weekly Earnings, or

c) Increases in the New Pensioner Beneficiary Living Index

The present method of adjusting RBF Pensions, i.e. bi-annually by any increases in the CPI, is seriously flawed because the CPI does not measure increases in the cost of living as was intended. As a result the value of the Life Pension is being eroded over time. Proof of this fact is contained in the published report of the Senate Select Committee in April 2001 titled “A Reasonable and Secure Retirement?”

Prominent Tasmanian Senators John Watson and The Hon. Nick Sherry were the Chair and Deputy Chair respectively. Both were well versed in superannuation matters, giving emphasis to the status of this inquiry.

The Committee recommended that (inter alia) :

The Government examine the feasibility of adopting an indexation method other than the Consumer Price Index (CPI) to more adequately reflect the actual increase in the Cost of Living, and
For equity reasons, the changes made to Commonwealth public sector schemes should also apply to State public sector schemes, where appropriate.

Under the heading "Conclusions and Recommendations" in the report the following quotes are to be found and explain the reasons for making such recommendations.

The Committee considers that Commonwealth public sector and defence force superannuants do have grounds on which to claim that they are entitled to a reasonable and secure retirement as part of the employment package offered by what was understood to be “a genuine career service."

It was a founding assumption that, as a condition of service (which required compulsory contributions by employees), the schemes would provide for adequate superannuation in retirement. It was also a founding assumption that, as identified in the Pollard and Jess reports, annual indexation of benefits would preserve the purchasing power and value of benefits through adequately reflecting the rise in the cost of living.

"It is never-the-less clear, as revealed in evidence, that the term Cost of Living is not consistently applied.

"The Committee notes the evidence given by the Australian Bureau of Statistics (ABS) the CPI is not a measure of the cost of living.

The Committee also notes that the 'Basket of Goods' used by the ABS to measure the cost of living does not appear to reflect the actual expenditure patterns of the retired.

Because of the CPI’s proven inadequacy to keep abreast with actual costs of living, the age pension is now adjusted bi-annually through a wage-based indexation mechanism.

In a search of the ABS website in November 2009 it was found that for the preceeding 62 quarters the average increase in the CPI was 0.7% compared to an average increase of 1.1% for average weekly ordinary time earnings (AWOTE). This means that AWOTE has on average each quarter increased more than half as much again (57%) as the CPI.

Supporting evidence from the University of Sydney can be found in a discussion paper entitled “The Role of the Consumer Price Index in Contemporary Wage Setting” by Chris Briggs in 2004. Following are some excerpts from the paper.

The CPI was traditionally designed as a cost- of- living index because its `principal purpose' was to be an `input to the highly centralised wage and salary determination process' (ABS 1997). Most recently, under the centralised wage systems of the 1980s, the CPI was the focal point of national wage adjustments.

The CPI was restructured following a review in 1997, reconfigured from a cost- of- living index into a general index of price inflation. The CPI now carries an explicit statement from the ABS that it is not and should not be used as a cost- of- living index.

A gap has opened up between average annualised wage increases) in agreements and the CPI.

The CPI is no longer an accurate measure of changes to cost- of- living and forging a tight nexus between wages and the CPI would be highly unusual within the current wage- setting environment.

Wage movements in the agreement sector have become increasingly disconnected from price movements and the CPI.

The CPI, and cost- of- living, remain relevant factors in determining wage movements but both the CPI and wage- setting have changed so substantially that it is difficult to sustain a case that wages should be tightly linked to the CPI.

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2. Consumer Price Index (CPI)

Submission to the 16th Series Review of the Consumer Price Index

Revised 9 March 2010

By Mr Tom Hayes of ACPSRO

Downloadable Versions: (requires Adobe Reader)

Full Document (PDF, 179KB)
Summary (PDF, 118KB)

Executive Summary

It is an injustice to public sector retirees whose pensions are indexed to movements in the CPI:

That CPI indexation no longer maintains the purchasing power of their pensions as intended by Professor Pollard when he recommended CPI indexation in 1973; and
That the ABS makes almost no attempt to correct long held beliefs in the community that CPI indexation does maintain the real world purchasing power of a pension.

Prices that go into measuring the CPI are “pure” prices. That is they have been discounted for any perceived improvement in the quality of a product. Pure prices are not shelf prices. Shelf prices are what must be paid to purchase a product.

Discounting prices for changes in quality is in keeping with international best practice but it has wrecked the CPI as an index of what is needed to maintain the real world purchasing power of a pension or a benefit. This is because the CPI no longer even approximates the movement in the shelf prices of a basket of goods. As a result a pension indexed by CPI cannot maintain purchasing power as experienced by pensioners and as understood by most Australians.

It is a sad lapse by the ABS that it does not maintain any data about the extent of the adjustments it makes to shelf prices for changes in the quality of products. This frustrates any academic analysis of the issue.

Quality adjustments are thought to account for a reduction in the annual increase in the CPI of between 1% and 2%. An erosion of a pension by just 1% pa will after eighteen years depress that pension by 20% in the eighteenth year. If the erosion is 1.5% pa it will take only twelve years for the reduction in the pension to equal 20%.

The present arrangements for the indexation of public sector pensions go back to the March 1973 report, Enquiry into Superannuation Pension Updating, by Professor A. H. Pollard. Significant erosion of CPI indexation as a means of maintaining purchasing power must have come after that time. Any fair and conscientious reading of Pollard’s report in its entirety shows that he had not the slightest inkling that the real world purchasing power of a pension indexed to CPI could be eroded as it is today by quality corrections.

Pollard devoted a whole chapter to discussing the desirable criteria for the adjustment of a pension. He wrote about the need for pension updating:

to enable officers of long service to maintain a reasonable standard of comfort after retirement;
to give peace of mind; and
to free the retiree from the ever present fear that a long retirement might bring severe financial problems in its latter years. (p. 15)

His conclusion was:

The requirements of paragraph 2.1 are only satisfactorily met if an employee can be certain that adjustments will take place to what is considered to be an adequate pension on retirement, that those adjustments will take place frequently and that as a result of the adjustments he will continue to be able to buy the same range of goods and services despite increased costs. Costs increase almost continuously and maintenance of the purchasing power of a pension is therefore not achieved if pension adjustments are infrequent.

I therefore consider the appropriate criteria for pension adjustment in changing economic circumstances to be that

first,

there should be certainty of adjustment i.e. adjustments should take place automatically;

second,

the purchasing power of the pension should be maintained;

and third, (which follows from the second)

pensions should be adjusted frequently.

How could have Pollard written “to be able to buy the same range of goods and services despite increased costs” if he and his advisers had been aware of the impact of quality adjustments as implemented today?

The belief that CPI indexation compensates for increases in the cost of living and maintains purchasing power in terms of shelf prices has been prevalent throughout the community for many years. This goes back to when the world was a much simpler place. The Australian Government (which must include the ABS) has done little to disabuse the public or its servants of this increasingly flawed belief. It has allowed many tens of thousands of its servants to plan their retirement in the expectation that CPI indexation would maintain purchasing power of their pensions as expounded by Professor Pollard.

Possibly worse, the Government is able to exploit unjustly persistent public misconceptions about what CPI indexation delivers in its various statements opposing any improvement in the indexation of public sector pensions.

On 10 February 2005 the then Treasurer, Mr Costello made public the Government’s response to the recommendations of a Senate Select Committee. In response to the Committee’s recommendation that the indexation of public sector pensions be improved the Treasurer said:

This recommendation is not supported.

The Government at this time has no plans to change the indexation method for Australian Government civilian superannuation pensions. The Government believes that indexation using the Consumer Price Index (CPI) represents an equitable and satisfactory method over a period of years for increasing pensions, and protects the living standards of retired Australian Government employees.

In a recent article published by the Australian Bureau of Statistics (ABS) entitled Analytical living cost indexes for selected Australian household types: update to June 2004, the ABS measured and compared changes in the CPI against changes in prices of out-of-pocket living expenses experienced by different categories of households, including self-funded retiree households. The results have revealed that the CPI compares favourably with the cost of living index for self-funded retiree households over the six-year period to June 2004.

The Bureau’s research indicates that for the period from June 1998 to June 2004 the CPI increased by 19.7 per cent. This compared favourably with the living cost index for self-funded retiree households, which increased by 18.6 per cent over the same period. Based on these results, the ABS article concluded that ‘the CPI provides a reasonable estimate of changes in living costs for each of the selected household types over this period.’

The ABS findings reinforce the Government’s belief that the CPI does provide a reasonable measure of the cost of living.

Mr Costello’s response is misleading. The references to ABS living cost indexes provides no indication that those indexes are measured at constant value, that is after quality adjustments have stripped out a large part of what has happened to shelf prices. The most misleading part is at the end of the first paragraph. Mr Costello says that CPI indexation protects the living standards of retired Australian Government employees. In any practical sense and by Professor Pollard’s criteria it does no such thing and panders to the popular misconception of what CPI indexation delivers.

The index which we know as the CPI no longer reflects consumer prices as understood by an ordinary person. It is a derivative of consumer prices but not more. There is lot of obsolete and misleading baggage that comes with the name “Consumer Price Index”. It is high time that the index was renamed to reflect its primary purpose. The title needs to contain the word “inflation.” It certainly should not contain the word “price”. The most appropriate new name would seem to be “Retail Inflation Index”

The ABS should:

Maintain good records of the quality corrections that are being applied to shelf prices and facilitate public and academic study of those records.
Run an extensive public education programme about quality corrections and the impact they have on the ability of CPI indexation to maintain the purchasing power of a pension in terms of shelf prices.
Despite the obstacles change the name of the CPI to “Retail Inflation Index” to reflect the primary purpose of the index and to help put an end to out of date understandings/expectations of the CPI.

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3. Report of actuarial study of improvements to pension indexation

This article was previously published in the Nov 2012 Super-News.

The Tasmanian Association of State Superannuants (TASS) have requested The Heron Partnership to undertake an actuarial study comparing the pension indexation for Retirement Benefit Fund (RBF) pensioners in the State Government superannuation plan, that uses the Consumer Price Index against the indexation method currently applied to the Age Pension paid by Centrelink.

This report sets out a comparison of the indexation methods using historical data over the previous 10 years and a comparison of the expected future pension payments over 10 years using appropriate assumptions for the future long term rate of indexation under the current and proposed methods.

Our comparisons show that over time, the Age Pension indexation method results in significantly higher pension payments than the current RBF indexation method. The gap between payments under the two methods is expected to continue to widen in future.

The full report can be accessed here.

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4. Actuarial Study - Explanatory Note

November 2012.

This note explains how changes to methods of calculating CPI mean that CPI no longer approximates the movement in actual shelf prices, or street prices, of a basket of goods. It explains that CPI is designed to measure price inflation for the household sector as a whole and is not the conceptual ideal measure for assessing the changes in the purchasing power of the disposable incomes of households.

Click here to view this explanatory note in it's original format as a PDF.

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5. Graph of actuarial study results

November 2012

The above graph "The erosion in value of CPI indexed Tasmanian RBF superannuation when compared with MTAWE indexed superannuation" starkly depicts the constantly declining value of the CPI indexed pension when compared with a MTAWE Indexed pension. This is the best indication we have how far todays CPI is falling behind what is happening to street prices, the prices consumers have to pay in the shop.

Click here to view a full-size PDF version of the graph.

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6. Indexation Loss Calculator

A personal indexation loss calculator, developed by the Superannuated Commonwealth Officers Association (SCOA) can be accessed here.

This is a tool to calculate your estimated personal loss due to an unfair indexation method.

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7. Sharing in the rising living standards of the Australian community - indexation of public sector superannuation pensions

Ten years ago the Federal Government established the principle that retired Australians should share in the rising living standards of the Australian community. This generous and farsighted policy was then implemented in part by linking the Age Pension to movements in average weekly earnings.

The 60% of retirees who receive the full age pension were thus beneficiaries of this policy as age pension rates increased in real terms by 20% over the following 10 years.

This was not the case, however, for the 20% of retirees who depend on government service related superannuation pensions. Both Federal and State pensions are CPI indexed, which freezes each pension at the standard of living that existed when each pensioner first retired. They fall progressively further behind community levels as each year passes.

The Tasmanian Association of State Superannuant’s efforts to obtain wage related indexation for its members faces a major hurdle while the Commonwealth declines to extend its own policy to its own retired servants.

In the past, three Senate Committees have agreed that simple fairness demands that government superannuants should share in rising living standards.

In the publication "Guide for Pensioners", Ex-Senator Paul Calvert, as President of the Senate and as a Tasmanian Senator wrote -

In 1997, the Coalition Government legislated to link Age Pension rates to 25% of Male Total Average Weekly Earnings (MTAWE) in addition to the Consumer Price Index (CPI). The MTAWE link ensures that pensioners share in improved community living standards, as measured by wages".

The implication here is that Public sector superannuants, whose pensions are indexed to CPI, do not share in improved community living standards.

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8. Cost of Living versus Standard of Living

Originally published in Super-News in March 2009

Over the years TASS along with other organisations has been arguing the case for indexation of our pensions by an index related to movement in wage rates rather than the present 'cost of living' index (CPI). We have used the argument that like the Centrelink pensions our pensions should be indexed at the same rate as the 'standard of living' not the 'cost of living'. A number of our members have asked that we outline the differences between the two indices.

The Cost of Living is the cost of maintaining a certain fixed standard of living. The Commonwealth Department of Statistics calculates this cost of living by averaging out the costs of a basket of goods. If the cost of this basket increases by 2% then the CPI or Cost of living is also said have increased by 2%.

The standard of living relates to the increasing wealth of the nation. As the National wealth increases, so does the standard of living. That is the average person has a higher standard of living.

Take two hypothetical cases.
Both retired with the same pension in say 1980.
The first has a pension indexed by CPI (as ours is) while the second is indexed by Male Total Average weekly Earnings (MTAWE). The first (CPI) would receive a pension in dollar terms that would allow the same standard of living as that back in 1980. Wage earners will have enjoyed a significantly increased standard of living over the same period.
The second case indexed by MTAWE would receive a pension which in dollar terms would keep the same relative value as other wage earners. That is it would allow for a similar increase in standard of living as the general public.
There are many indices used to measure the standard of living but one important one is the Male Total Average Weekly Earnings. (MTAWE).

The Federal Government some years ago recognised that if Centrelink pensions were only increased by CPI, then the recipients would be locked into a pension that ignored the National increase in the Standard of Living. For this reason they are indexed by "the higher of MTAWE or CPI". It has been our argument that as our pensions are only indexed by CPI, our superannuants are locked into the same standard of living as the day they retired and are falling further and further behind
the living standards of the general public.

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9. Government Reasons for Refusing Better Indexation

This information was previously published in Super-News in May 2011.

List of Reasons Advanced by Government for Refusing RBF Pension Indexation Improvements and TASS responses.

Reason 1 - The Government is of the view that the indexation of pensions by CPI is the most appropriate method for a number of reasons. The CPI measures the national price level for a representative basket of goods and services. By keeping RBF pensions indexed to the CPI, the real value of the RBF pension is maintained, relative to that basket. Although the basket of goods and services for each household will be different, the movement over time in the prices of the goods and services included in the CPI basket is an appropriate measure of the changes in overall prices faced by the vast majority of households.

TASS Response - It was a founding assumption evidenced by our member’s statements and also identified in the Pollard and Jess reports that indexation would reflect the rises in the cost of living. The CPI is not a measure of the cost of living as declared by the bureau of Statistics

Reason 2 - CPI indexation was a core design element of the RBF Defined Benefit Scheme. Had a different indexation basis been chosen, other aspects of the scheme design may have been different. For example, if Average Weekly Ordinary Times Earnings (AWOTE) had been used, pensions would increase at a greater rate as the growth in average weekly earnings is generally higher than CPI. This would result in higher costs to the Government in meeting pension benefits and to compensate for this, the scheme design would need to have changed and other benefits may have been less generous or employees required to contribute a higher percentage of salary.

TASS Response - This assertion implies that a balanced package of legislative provisions was created around use of CPI adjustments and this package cannot be disturbed. Yet the reality is that the Act has undergone major amendments in 1982, 1987, 1993 and 1999; whenever Governments have felt the need for change. Such changes included:-

Closure of the Superannuation Accumulation Fund.
Allowing contributors to take all of their benefits as a lump sum.
Less generous pension conversion factors being available to scheme members who joined after 1 July 1994, and
A change in the definition of benefit salary from final average salary over one year to final average salary over three years.

Concurrent with these reduced benefits changes was a reconfiguration of the CPI in 1997 from a cost of living index into a general index of price inflation only, therefore the original package no longer exists.

Reason 3 - “The growth in MTAWE reflects the labour productivity and various supply and demand issues that affect the labour market. These issues are not related to the Cost of Living which the CPI is designed to capture.”

TASS Response

The CPI is not a measure of the Cost of Living according to the Bureau of Statistics.
Whilst growth in average wages may occur in a variety of ways, the stand out recurring feature of the Australian system has been regular Cost of Living adjustments. Over the years this type of increase may have been applied to the now abandoned basic wage, or the minimum wage, or total Wages: Cost of Living increases have also flowed on to Tasmania's Service Incremental Payment Scheme by consent of the Tasmanian Government.

Reason 4 - Each superannuant of the Defined Benefit Scheme had a choice as to how they received their benefit. It would therefore be highly inequitable to alter the indexation basis as you propose as this would provide additional benefits to RBF pensioners, but not to those who took all or part of their benefit as lump sum or allocated pension on the basis that their RBF pension would be indexed by CPI. This could; lead to those who: chose to take lump sum, benefits making representations to the Government that they have been disadvantaged as they would not have made that choice had they known that the pension indexation arrangements would change.

TASS Response -
Obviously individuals have a free choice in this regard when they retire and are responsible for the decision they make.
If Parliament sees merit in changing superannuation law to benefit pensioners then lump sum recipients do not suffer proven loss as a result. In fact if they had been prudent and used their pay-out to reduce a high interest bearing debt; purchased a successful business; or invested wisely they could be better off financially.

Reason 5 - The CPI is the basis currently by all other jurisdictions including the Commonwealth, to index their superannuation schemes.

TASS Response - Of greater significance is the fact that other pensioners such as social security and veterans affairs pensioners constitute an immense group in size who justifiably enjoy indexation better than CPI increases. There are other instances to be found which recognise that the CPI is not a proper instrument to measure increases in the cost of living. For example, the Tasmanian Judges Contributory Pensions Act 1968 provides that pensions are increased once a year in accordance with movements in judicial salaries. And if an RBF member resigns prior to age 55 with more than 5 years service but cannot satisfy early conditions of release provisions, the Commonwealth's preservation rules apply. This means that the employer share of the end benefit must be preserved until preservation age is reached. The unfunded employer share of the benefit must be preserved in a compulsory preservation account and indexed twice a year in accordance with increases in the national CPI or average weekly ordinary time earnings - whichever is the greater.

Reason 6 - In December 2008 the Commonwealth Government commissioned a review of the pension indexation arrangements for seven Australian Government civilian and military superannuation schemes, the "Review of Pension Indexation Arrangements in Australian Government Civilian and Military Superannuation Schemes".

In this report the author Mr Matthews advises that although "he received many submissions that the CPI is failing to maintain the purchasing power of pensions", he "did not find any conclusive evidence that the CPI understates inflation as it affects Australian households in general." Furthermore, Mr Matthews also advises that he has "looked at the issues objectively and cannot find that there is a case for an employer to be required to update a former employee's retirement income in line with changes in community living standards-that is, to provide former employees with a share of productivity increases."
Mr Mathews also concluded that "neither have I found that it is inequitable that pensions are not increased in line with Age and Service Pensions. These are different benefits provided for different purposes and are not comparable. If they were to be compared, it is notable that although the Age and Service Pensions may be increased to achieve a minimum benchmark, civilian and military pensions have advantages that do not apply to the Age and Service Pensions. For example, civilian and military pensions are guaranteed lifetime benefits that are payable from younger ages than the
Age and Service Pensions."

TASS Response -

Strange indeed that Senator Sherry should commission Mr. Matthews to review indexation arrangements for Government Superannuants given that the former had co-authored, with others, a comprehensive report on the same matter in 2001.
Mr. Matthew’s rather wide ranging views appear to stray from the core issue of indexation.
The Government has not attempted to illustrate that other reports used by TASS had erred in their contrary findings.

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10. Progress with State Indexation Campaign prior to the 2014 State Election

Click on the following to see PDFs of the documents.

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