Public Sector Pensions - Indexation Arrangements to be Reviewed

Super Minister Sherry has announced a review of the indexation arrangements which apply to public sector pensions. 

For some time there has been persistent agitation that the current indexing arrangements – which index public sector pensions to CPI changes – should be changed.  The argument is that retirees consume a different bundle of goods and services to those which form the CPI bundle and that the indexing arrangements for retirees should reflect price changes in the goods and services retirees actually consume.

While the argument is seductive and, at first glance, reasonable, there is a significant danger.  If there is a move away from using the CPI, the index adopted will be an index which increases at a faster rate than the CPI – for example, by giving greater weight to health and medical costs – these costs seem inevitable to increase at greater than CPI rates.

The reality is that no government – which values its political life – would adopt an index which increases at a slower rate than the CPI.  By simply holding a review, the government is creating an expectation, amongst a powerful political lobby, that the indexing arrangements will change; and they can only change to adopt an index which increases at a faster rate than CPI. 

The consequence would be a blow-out in the total liability of public sector pensions which could be very significant.  An index which exceeds the CPI index by 1 or 2 percentage points can, over time, have a very significant impact on the value of future pension obligations; the power of compound interest applied to liabilities!

The Future Fund, which is intended to cover public service pension liabilities, may be insufficient if those pension liabilities are indexed to a faster growing index than the CPI.  Future governments may have to significantly increase their funding commitment to the Future Fund or admit that the Future Fund will not achieve its stated goal.