(July-2003) Will more bad returns send funds down the gurgler?

While Australia’s major super fund trustees and executives have felt the pressure of coping with the negative returns which have characterised the past 18 months, it is arguable that those administering defined benefits funds within the public sector have felt even more pressure.

Why? Because for many public sector defined benefits schemes, the negative returns have magnified unfunded liability levels, effectively placing them back at the top of various fiscal and political agendas.

Thus, as better returns from both domestic and international equities in the final quarter looked likely to put a number of public sector funds back into positive territory for 2002/03, some late massaging of the final wording of Budget statements was anticipated in a number of jurisdictions.

In the public sector, an unfunded scheme is one in which the employer-financed benefit component is met on an ‘emerging cost’ basis when the employee retires, resigns or dies. Over recent years, governments have sought to close off access to defined benefits schemes and have encouraged fully funded accumulation schemes.

The managers of public sector super funds are always loath to discuss the question of unfunded liabilities, but few deny it remains a hot political issue and the main reason why governments, most recently the Northern Territory Government, have opted to close off access to defined benefit schemes.

The degree to which unfunded liabilities re-emerged as an issue this year was evidenced by reports that local councils in Victoria would be required to increase rates by more than five per cent, in part, to cover the unfunded liabilities of the state’s Local Authorities Superannuation Fund.

But while unfunded liabilities remain an issue, the vast majority of public sector funds performed at around the industry average or slightly better. What’s more, most were hopeful of a strong last quarter, allowing them to finish the year in the black.

Steve Gibbs, CEO of the Public Sector and Commonwealth Superannuation schemes (PSS/CSS), is optimistic that his two funds will end the year in positive territory.

He acknowledges, however, that any positive return on the part of PSS/CSS will be largely as a result of the decision, taken more than a year ago, to reset asset allocations and adopt a more conservative approach. This included minimising exposure to international equities and fully hedging on currency.

Equally optimistic about a strong finish to the year is NSW Local Government Superannuation Scheme CEO Brett Westbrook. “What is more, we are in the happy position of not being forced to go to employers talking about increasing contributions because of unfunded liabilities.”

Don McLean, CEO of Australia’s largest public sector scheme, NSW State Super, is also bullish about finishing the year on a good note. “Four out of the five First State funds are in positive territory and it may be five out of five depending on how we finish the final quarter,” he says.

InTech senior asset consultant Corrin Collocott says negative returns have played a significant role in some public sector funds moving from fully funded to unfunded positions. “But I guess that demonstrates why valuation surveys should be carried out over three-year time-frames,” he adds.

He says the difficulty for public sector fund trustees is that the question of unfunded liabilities tends to get a lot more attention in an election year when, in fact, unfunded liabilities are more a product of extreme market movement than management.

The consensus among trustees, fund managers and advisers is that most state governments in Australia are now comfortable with their level of exposure to unfunded liabilities. That is unlikely to continue to be the case, however, if funds encounter another 12 months of negative returns.