IAG & NRMA SUPERANNUATION PLAN REPORT TO THE TRUSTEE ON THE ACTUARIAL INVESTIGATION AS AT 30 JUNE 2018

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1 STATEMENT OF ADVICE REPORT TO THE TRUSTEE ON THE ACTUARIAL INVESTIGATION AS AT 30 JUNE NOVEMBER 2018

2 CONTENTS 1. Key Results and Recommendations Financial Position as at 30 June Recommended Contribution Programs and Projections Other Findings and Recommendations for the Trustee Action Required Experience Contribution Requirements Funding Targets Financing Method Employers Future Service Cost Recommended Contribution Programs Projections Investment Policy and Key Risks Investment Policy Crediting Policy Key risks Impact of valuing pensions at market value Insurance Policy and Related Risks Assets Assets Operational risk reserves Actuarial Assumptions Economic assumptions Demographic assumptions Other assumptions The Regulator and Prudential Standards MERCER i

3 9.1. Review of Shortfall Limits Monitoring Process Requirements due to Unsatisfactory Financial Position Statements Required by SPS Actuarial Certification Purpose Background information of the Plan Additional information Actuary s certifications Appendix A: Membership Information A.1. Active defined benefit member age profile Appendix B: Glossary Appendix C: Plan Design Summary of benefits The Superannuation Guarantee (Administration) Act D.1. Note 1: Summary of Method of Attributing Benefits to Past Membership 51 D.2. Note 2: Summary of Assumptions MERCER ii

4 1 Key Results and Recommendations This report on the actuarial investigation of the Plan as at 30 June 2018 has been prepared to meet the requirements of the Plan s governing rules and SIS legislation. The previous triennial actuarial investigation of the Plan was as at 30 June 2015 with the results contained in a report dated 26 November The most recent actuarial assessment of the Plan was the Financial Condition Report as at 30 June 2017 with the results contained in a report dated 27 November This report should not be relied upon for any other purpose or by any party other than the Trustee of the Plan and the Employers who contribute to the Plan. Mercer is not responsible for the consequences of any other use. This report should be considered in its entirety and not distributed in parts Financial Position as at 30 June 2018 IAG Sub-Plan ($ 000s) NRMA Sub-Plan ($ 000s) Total Plan ($ 000s) Net Assets 1,861, ,763 2,104,862 Less: Accumulation Benefits 1 1,575, ,821 1,775,908 Less: Allocated Pension Accounts 108, ,818 Less: Capital Expenditure Provision 1, ,332 Less: SGIO DB Guarantee Provision Defined Benefit (DB) Assets 175,416 42, ,238 DB Vested Benefits (Lump sum only) 140,830 36, ,996 DB Vested Benefits (Lump sum or pension) 144,416 36, ,582 DB Present Value of Accrued Benefits 152,227 37, ,470 DB SG Minimum Benefits 122,163 34, ,689 1 Accumulation Benefits includes retained benefits, as well as the accumulation accounts of active defined benefit members and deferred pensioners The DB benefit totals above include the actuarial value of the current lifetime pension liability ($66,433,000) and deferred pension liability ($6,499,000) for the IAG Sub-Plan. These amounts are nil for the NRMA Sub-Plan Both sub-plans (and the Plan as a whole) were in satisfactory financial positions as at 30 June We expect this to continue to be the case as at the date of this report. The following tables show the coverage of vested benefits and actuarial liabilities by the Plan s assets as at 30 June For comparison, the equivalent funding indices at 30 June 2017 are shown in brackets. The shaded row relates to the Trustee s funding targets. MERCER 1

5 Whole of Plan (Defined Benefit and Accumulation Benefits) IAG Sub-Plan NRMA Sub-Plan Total Plan Vested Benefits 102% (102%) 103% (103%) 102% (102%) Vested Benefits (lump sum or pension) 102% (102%) 103% (103%) 102% (102%) Present Value of Accrued Benefits 101% (101%) 102% (103%) 101% (101%) SG Minimum Benefits 103% (103%) 104% (104%) 103% (103%) Defined Benefits Only IAG Sub-Plan NRMA Sub-Plan Total Plan DB Vested Benefits 125% (122%) 118% (118%) 123% (121%) DB Vested Benefits (lump sum or pension) 121% (120%) 118% (118%) 121% (120%) DB Present Value of Accrued Benefits 115% (115%) 115% (116%) 115% (115%) DB SG Minimum Benefits 144% (145%) 124% (123%) 139% (140%) Coverage of Defined Benefit Vested Benefits (lump sum or pension) for the IAG Sub-Plan was above the top of the funding target range of 115% to 120%. Coverage of Defined Benefit Vested Benefits for the NRMA Sub-Plan was within the funding target range of 115% to120%. The assets of each sub-plan at 30 June 2018 were also greater than SG Minimum Benefits and hence each sub-plan (and the Plan as a whole) was considered to be solvent under SIS legislation Recommended Contribution Programs and Projections IAG Sub-Plan In respect of the IAG Sub-Plan, I recommend the following Company contribution program: Accumulation members: Defined Benefit members: 13.0% of salary (or such other rate applicable to a member s category). 17.5% of salary. In addition, the Company should contribute to the Sub-Plan: any additional amounts required (of an accumulation nature) in order to meet the minimum SG requirement of Ordinary Time Earnings; and the full amount of member salary sacrifice contributions. The only change from the current contribution program is to discontinue the additional contributions in respect of Plan operating costs. Based on a projection using the recommended contribution program (refer Section 4), the financial position of the IAG Sub-Plan is expected to remain above the top of the target funding range (i.e. above 120%) for the whole of the projection period to 30 June MERCER 2

6 NRMA Sub-Plan In respect of the NRMA Sub-Plan, I recommend the following Company contribution program (which represents no change from the current contribution program): Accumulation members: Defined Benefit members: 13.0% or the minimum SG requirement of salary as applicable to the member. 13.0% of salary. In addition, the Company should contribute to the Plan: any additional amounts required (of an accumulation nature) in order to meet the minimum SG requirement of Ordinary Time Earnings; and the full amount of member salary sacrifice contributions. Based on a projection using the recommended contribution program (refer Section 4), the financial position of the NRMA Sub-Plan is expected to reach 120% coverage by 30 September 2018 and then continue to improve over the whole of the projection period to 30 June This strong financial position of the NRMA Sub-Plan means that there is scope for contributions to be reduced in the short term, and this might be explored further with NRMA, as there are a number of possible options Other Findings and Recommendations for the Trustee In our opinion: the investment policy for the defined benefit section of the Plan is suitable. the crediting rate policy for the defined benefit section of the Plan is suitable. the insurance arrangements for the defined benefit section of the Plan are suitable. the Shortfall Limits (for the purposes of SPS 160) are suitable. the Trustee s monitoring process of the Plan s financial position is suitable Action Required The Trustee should consider this report and confirm its agreement (or otherwise) to the contribution and other recommendations. The Trustee should seek formal agreement from the Employers to contribute in line with the recommendations. MERCER 3

7 2 Experience 2.1. Investment Returns and Net Earning Rates The table below shows the rates of investment earnings (after tax, investment fees and asset based administration fees) for assets supporting defined benefits based on the movements in unit prices, and the Net Earning Rate over the period since the previous triennial investigation. Year Ending Investment Return (pa) Net Earning Rate (pa) 30 June % 8.2% 30 June % 7.2% 30 June % 6.5% Compound Average 6.5% 7.3% The average investment return for the three year period to 30 June 2018 was 6.5% p.a. The actual return for the year ending 30 June 2018 of 7.1% was consistent with the assumed return of 7.2% in the last financial condition report. The Net Earning Rate exceeded the actual investment return over the 3 year period, mostly in respect of This is a function of the three year averaging in the calculation of the Net Earning Rate Salary Increases Salaries for current defined benefit members increased by 2.5% over the year to 30 June 2018 (3.1% for IAG and 0.6% for NRMA) compared to our assumption at the 2017 Financial Condition Report of 3.5% p.a. plus promotional increases. Salary increase experience over the last 3 years is summarised below. Year Ending IAG Sub-Plan NRMA Sub-Plan Total Plan 30 June % 2.6% 2.2% 30 June % 2.8% 2.9% 30 June % 0.6% 2.5% Average 2.7% 2.0% 2.5% For the IAG Sub-Plan, the lower than expected salary increases had a small beneficial impact on the financial position. Given a significant proportion of the liabilities of the NRMA Sub-Plan are linked to the Net Earning Rate (and so a small proportion of the liabilities are of a defined benefit or salarylinked nature), this has had only a minor positive impact on the financial position. MERCER 4

8 2.3. Pension Take-Up Rate The rate at which members elect to take a pension benefit on retirement is only relevant to the IAG Sub-Plan. The average pension take-up rates have been as follows: Category Assumption Actual Impact Ex-SGIC 100% 100% Ex-CGU 30% 33% Ex-RACV 30% 0% Nil. Entirely consistent with assumption. Negligible. Consistent with assumption Positive, although there were only 2 members eligible to take a pension in the period Pension Indexation It was assumed that eligible pensions would be indexed at 2.5% p.a. The average actual rate of indexation over the three years to 30 June 2018 was 1.6% p.a. as set out below. Year Ending Total Plan 30 June % 30 June % 30 June % Average 1.6% The rate of indexation was lower than expected which means that pension liabilities grew less rapidly than expected. This had a positive impact on the Plan s financial position Employer Contributions The employer sponsors are currently contributing to the Plan in accordance with the program recommend in the Financial Condition Report as at 30 June MERCER 5

9 3 Contribution Requirements 3.1. Funding Targets The Trustee has agreed certain funding targets with the employer sponsors of each subplan. In respect of the IAG Sub-Plan, the target level for the coverage of defined benefit vested benefits (Lump sum or pension) is between 115% and 120% to ensure that, with a reasonable probability, the coverage will remain above 100%. The current coverage is 121% which is above the top of the target range. In respect of the NRMA Sub-Plan, the target level for the coverage of defined benefit vested benefits is also between 115% and 120% to ensure that, with a reasonable probability, the coverage will remain above 100%. The current coverage is 118% which is within the target range. Based on the projection in this report (refer Section 4) the financial position of the NRMA Sub-Plan is expected to reach 120% coverage (ie the top of the range) by 30 September 2018 and then to continue to increase significantly over time. Based on the assumptions adopted for this investigation, achieving the target level for the coverage of defined benefit vested benefit (Lump sum or pension) between 115% and 120% would also result in at least 100% coverage of the Actuarial Value of Accrued Benefits and a satisfactory margin of coverage over 100% of SG Minimum Benefits. Hence it is not considered necessary to adopt specific financing objectives in relation to these benefit liability measures Professional Requirements Under Professional Standard 400 issued by the Actuaries Institute, the funding method selected by the actuary must aim to provide that: (a) members' benefit entitlements (including any pension increases provided by the Trust Deed or in accordance with either precedent or the intentions of the Trustee and/or Fund Sponsor) are fully funded before the members retire; and (b) the assets of the Fund from time to time, after making full provision for the entitlements of any beneficiaries or members who have ceased to be employed, exceed the aggregate of benefits which employed members would reasonably expect to be payable to them on termination of membership, including the expenses of paying those benefits, and having regard to the provisions of the Trust Deed and the likely exercise of any Options or Discretions. (Paragraph of PS400). MERCER 6

10 Accordingly the actuary needs to be satisfied that any funding program is expected to provide a level of assets which meets or exceeds immediate benefit entitlements based on members reasonable expectations. Should assets fall below that level, the funding program needs to aim to lift assets to at least the required level over a reasonable time period and to maintain assets at or above the required level thereafter. The funding targets have been set on the basis that members reasonable expectations on termination would be to receive their vested benefit entitlement (including the lump sum value of their pension, on the actuarial assumptions adopted for this investigation, in the case of current pensioners) Provisions of the Trust Deed Rule of the Plan s Trust Deed requires a triennial actuarial review to be carried out, and Rule requires an actuarial report on the financial condition of the plan to be prepared at least annually. Rule 4.03 of the Trust Deed provides that IAG and NRMA agree to contribute each year the amount certified by the Actuary as necessary for the respective Sub-Plan to carry out the objects and purposes of the Plan in respect of Beneficiaries registered in the respective Sub- Plan and meet all expenses and other costs of the Sub-Plan other than those deducted from member accounts. Rule also provides that in the event of the Actuary s report showing a deficiency in a Sub-Plan, the Trustee shall take the necessary steps to obtain payment from the employer sponsor of a sum sufficient to restore the solvency of the Sub-Plan. Such payment can be spread over a period of up to 15 years (or such lesser period required by law) Financing Method There are various financing methods that could be followed in setting the Company contribution level. In this investigation we have projected the likely future experience of each sub-plan using the assumptions set out in this report, and then examined the expected relationship between the assets and liabilities of the sub-plan. The same method was used at previous investigations. Under this method of financing, Employer contribution programs may vary from time to time to ensure that the Plan remains on course towards its funding targets. I consider that the financing method is suitable in the Plan s current circumstances as it allows the recommended contribution programs to be determined specifically to meet the funding targets for each Sub-Plan. MERCER 7

11 3.3. Employers Future Service Cost Based on the assumptions adopted, and ignoring any adjustment for surplus or deficiency and any additional contribution towards Plan expenses, we have determined that the following Company contributions rates (expressed as a percentage of defined benefit members superannuation salaries) are expected to be sufficient to provide for the future service benefits of defined benefit members over their expected remaining working life: Defined Benefit Membership Group Employer long-term cost (of future benefit accrual) (% of Salary) IAG 19.5% NRMA 12.7% The rate for the IAG Sub-Plan is lower than that calculated at the previous actuarial valuation as at 30 June 2015 (19.9%) primarily as a result of changes in the membership profile. We have maintained the basic employer contribution recommendation at 17.5% of defined benefit members salaries given that the projections show that this is expected to be sufficient for the funding target to be met over the projection period. The rate for the NRMA Sub-Plan has not changed materially from the previous valuation Recommended Contribution Programs I recommend the following contribution programs in respect of each sub-plan. IAG Sub-Plan In respect of the IAG Sub-Plan, I recommend the following Company contribution program: Accumulation members: Defined Benefit members: 13.0% of salary (or such other rate applicable to a member s category). 17.5% of salary. In addition, the Company should contribute to the Sub-Plan: any additional amounts required (of an accumulation nature) in order to meet the minimum SG requirement of Ordinary Time Earnings; and the full amount of member salary sacrifice contributions. The only change from the current contribution program is to discontinue the additional contributions in respect of Plan operating costs, as this is not expected to be necessary to maintain the Plan s financial position above the target range. Based on a projection using the recommended contribution program, the financial position of the IAG Sub-Plan is expected to remain above the top of the target funding range (i.e. above 120%) for the whole of the projection period to 30 June MERCER 8

12 NRMA Sub-Plan In respect of the NRMA Sub-Plan, I recommend the following Company contribution program (which represents no change from the current contribution program): Accumulation members: Defined Benefit members: 13.0% or the minimum SG requirement of salary as applicable to the member. 13.0% of salary. In addition, the Company should contribute to the Plan: any additional amounts required (of an accumulation nature) in order to meet the minimum SG requirement of Ordinary Time Earnings; and the full amount of member salary sacrifice contributions. Based on a projection using the recommended contribution program (refer Section 4), the financial position of the NRMA Sub-Plan is expected to reach 120% coverage by 30 September 2018 and then continue to improve over the whole of the projection period to 30 June This strong financial position of the NRMA Sub-Plan means that there is scope for contributions to be reduced in the short term, and this might be explored further with NRMA, as there are a number of possible options. MERCER 9

13 4 Projections I have prepared the following projections of the assets supporting defined benefits and vested benefits (including lifetime pensioners) for each sub-plan based on: the assumptions adopted for this investigation; but allowing for actual investment returns from 30 June 2018 to 7 November 2018 of -0.6%; and assuming that the Employers contribute in accordance with the recommended contribution program. It should be noted that the first charts for each sub-plan are projections based on the assumptions adopted (and allowing for year to date investment returns), which represent a single scenario from the range of possibilities. The future is uncertain and the Plan s actual experience will differ from those assumptions; these differences may be minor in their overall effect, or they may be significant and material. In addition, different sets of assumptions or scenarios may also be within the reasonable range and results based on those alternative assumptions would be different. To illustrate this, we have included a second chart which shows the variability in investment returns over time under and low investment return scenarios. There is approximately a 10% chance of the Plan s cumulative investment return being less than the low return scenario. Similarly, there is approximately only a 10% chance of the Plan s cumulative investment return being greater than the high return scenario. We have not prepared projections of the coverage of assets compared with the Actuarial Value of Accrued Benefits for either Sub-Plan. However, given the margin of vested benefits over the Actuarial Value of Accrued Benefits at the investigation date and the projected level of asset coverage, I am of the opinion that the recommended contribution programs are expected to result in asset coverage of more than 100% of the Actuarial Value of Accrued Benefits. MERCER 10

14 IAG Sub-Plan The IAG Sub-Plan s financial positon is expected to remain above the top of the funding objective range of 115% to 120% for the entire projection period. The following chart shows the impact of investment volatility on the IAG Sub-Plan s financial position over the next few years using the high return and a low return scenarios. 170% 160% 150% 140% 130% 120% 110% 100% 90% IAG Sub-Plan Projected Coverage of Vested Benefits (Defined Benefit Liabilities Only) 80% Median Return Scenario Low Return Scenario High Return Scenario Funding Target 30 June MERCER 11

15 Based on fluctuations in investment returns only, and assuming other experience is in line with the assumptions adopted for this investigation, there is approximately an 80% chance that the coverage of assets of Vested Benefits at 30 June 2021 will fall in the range from 99% to 153%. Please note that the Low Return Scenario and the High Return Scenario shown are illustrations only, and show what may occur under assumed future experiences which differ from our baseline assumptions. These scenarios do not constitute upper or lower bounds and the actual future coverage of Vested Benefits may differ significantly from the range shown, depending on actual future experience. In my view, the Trustee should be satisfied with the expected level of security over the next few years if the Employer contributes in accordance with the recommended contribution programs. NRMA Sub-Plan The NRMA Sub-Plan s funding level is expected reach 120% (the top of the target funding range) by 30 September 2018 and then continues to increase over the entire projection period. MERCER 12

16 The following chart shows the impact of investment volatility on the NRMA Sub-Plan s financial position over the next few years using the high return and a low return scenarios. 160% 150% 140% 130% 120% 110% NRMA Sub-Plan Projected Coverage of Vested Benefits (Defined Benefit Liabilities Only) 100% Median Return Scenario Low Return Scenario High Return Scenario Funding Target 30 June The smaller degree of variation from the median return scenario reflects that the majority of vested benefits are linked to the investment return. The movements in the short term arise because of the three year averaging in the Net Earning Rate. Based on fluctuations in investment returns only, and assuming other experience is in line with the assumptions adopted for this investigation, there is approximately an 80% chance that the coverage of assets over Vested Benefits at 30 June 2021 will fall in the range from 126% to 136%. MERCER 13

17 5 Investment Policy and Key Risks 5.1. Investment Policy Assets backing accumulation benefit liabilities The Plan provides members with a range of investment options for their accumulation benefits (including the additional account balances of defined benefit members). The assets supporting the Plan s accumulation benefit liabilities are invested according to members selected investment options and the actual returns on those investments (whether positive or negative) are passed on to members via changes in the unit prices by which member account balances are determined. Thus the Plan s accumulation liabilities and related assets are matched. The Plan s investments are expected to provide a high level of liquidity in normal circumstances. I consider that the Plan s investment policy for assets relating to accumulation liabilities is suitable, having regard to the nature and term of these liabilities. Assets backing defined benefit liabilities The Plan s investment strategy for assets supporting defined benefit liabilities (including pensioner liabilities) currently involves a benchmark 70% exposure to growth assets such as shares and property and a benchmark 30% exposure to defensive assets such as cash and fixed interest (refer to the table below for the actual and benchmark investment allocations of these assets as at the investigation date). Growth assets are expected to earn higher returns over the long term compared to defensive assets, but at the same time to exhibit more variation in returns from year to year. 30 June 2018 Benchmark Allocation Actual Allocation Australian Shares 25% 26.0% Overseas Shares 25% 24.5% Growth Alternatives 10% 5.6% Property/Infrastructure 10% 12.7% Fixed Interest 15% 15.1% Defensive Alternative 10% 10.4% Cash 5% 5.7% Total 100% 100% We note that more than 80% of liabilities of the NRMA Sub-Plan are linked to the Net Earning Rate (and so only a small proportion is of a defined benefit or salary linked nature). For the IAG Sub-Plan 14% of liabilities are linked to the Net Earning Rate. MERCER 14

18 Given that it is not known when members will take their benefit with certainty, the exact term of the Plan s liabilities is unknown. The duration is estimated to be 9 years for the IAG Sub- Plan and 4 years for the NRMA Sub-Plan. The projections carried out as part of this actuarial investigation indicate that it is expected that defined benefit assets will gradually wind down, more so for the NRMA Sub-Plan. For the IAG Sub-Plan, the expected term of the Plan s liabilities is still such that the Plan is expected to benefit from the higher returns expected from growth assets over the long term. While the investment time horizon for the NRMA Sub-Plan is significantly shorter, it is members who bear the majority of the risk and reward of the current investment strategy. In the case of short term investment risk, this is muted for members by the three year averaging in the calculation of the Net Earning Rate (refer below), as well as the requirement that the rate be non-negative. The Plan s investments are expected to provide a high level of liquidity in normal circumstances. I have reviewed the Plan s defined benefit investment policy taking into account the Plan s financial position and the nature and term of the Plan s defined benefit liabilities and I confirm that I consider that the policy adopted is a suitable investment policy. I note that the current policy has the potential for substantial variability in investment returns and that this variability may impact on the Employer contribution programs. I understand that the Employers recognise and accept the potential variability in returns and contribution requirements. Should the Employers risk tolerance change, it would be appropriate to review the current investment policy Crediting Policy Accumulation benefits The main features of the unit pricing and crediting rate policy in relation to accumulation member accounts and to the additional accumulation accounts of defined benefit members are summarised briefly below: Earnings credited are based on the actual investment return (i.e. earnings net of investment costs, asset-based administration fees and provisions for tax) of the members selected investment options. Net investment earnings are allocated via changes in unit prices. Unit prices are determined on a daily basis. Rules relating to the prices at which units are bought and sold are designed to prevent selection against the Plan by members. Termination of service does not result in any automatic change in a member s investment options. Member accounts remain invested in their selected investment options until paid. No investment reserves are held. Net investment earnings are fully passed on to member accounts via unit prices. MERCER 15

19 Defined benefits The main features of the crediting rate approach in relation to defined benefits as set out in the Trust Deed are summarised briefly below: Resignation benefits for certain categories, as well as the Superannuation Guarantee minimum benefit, are based on the accumulation of member and notional employer contributions with investment earnings at the Net Earning Rate. The resignation benefit in some cases also applies as a minimum on retirement. The Net Earning Rate is determined as the average of the annual earning rates (after allowance for tax and investment costs) of the defined benefit assets over the prior three years, subject to it being non-negative. The Net Earning Rate is declared annually for each year as at 30 June. For benefit payments, interim crediting rates apply for the period from the end of the previous year to the date of leaving service. The interim crediting rate is determined on a quarterly basis, taking into account known actual earnings for the year to date. No specific reserves are maintained to support the averaging process. However the valuation assumptions for future Net Earning Rates (and hence projected benefit liabilities) take into account the operation of the averaging formula. As can be seen from the table in section (and in particular 2016 for example), there can be significant differences between the actual earning rate and the Net Earning Rate in a single year, with the result that the liabilities linked to the Net Earning Rate often may not move in alignment with related defined benefit assets in the short term. Furthermore, the impact on benefit costs may not average out over time due to changes in the amount of liabilities linked to the Net Earning Rate, with the result that averaging may not be costneutral to the employer sponsor Key risks There are a number of risks relating to the operation of the Plan. The more significant financial risks relating to the defined benefits are: Investment risk the risk is that investment returns will be less than anticipated. For the IAG Sub-Plan this is predominantly borne by the employer. For the NRMA Sub-Plan the risk is predominantly borne by members, although in the short term the employer has significant exposure (due to 3 year averaging in the Net Earning Rate and the requirement that the Net Earning Rate be non-negative, as well as a salary linked underpin). Lower than anticipated investment returns will result in reduced coverage of members benefits and the prospect that the employers will need to increase contributions to compensate for this. Salary Growth risk borne by the employers. The risk is that salaries (on which future benefit amounts will be based) will rise more rapidly than anticipated, increasing future benefit payments and benefit liabilities. This is a much more significant risk for the IAG Sub-Plan. MERCER 16

20 Legislative risk borne by the Employers. The risk is that legislative changes could be made which increase the cost of providing the defined benefits for example an increase in the rate of tax on superannuation. Pension risks The risk is firstly that pensioner mortality will be better than expected, resulting in pensions being paid for a longer period. Secondly, that a greater proportion of eligible members will elect to take a pension benefit, which is generally more valuable than the corresponding lump sum benefit. This is only a significant risk for the IAG Sub- Plan. Inflation risk (on indexed pensions) The risk that inflation is higher than anticipated. This will result in increased pension payments, and that the employers will need to increase contributions to compensate for this. Again, this is only a risk for the IAG Sub- Plan. Expense risk borne by the Employers. The risk is that expenses incurred by the Plan may be higher than assumed, and decrease the amount of assets available to provide defined benefits. This may require increased contributions from the employer, or increased member fees. Net Earning Rates While over time the cumulative Net Earning Rate might be expected to broadly equal the cumulative actual investment return, the operation of the smoothing policy coupled with the requirement for a non-negative Net Earning Rate means that in the short term there can be a sizeable difference between what the Plan actually earns and what is credited to members. This exacerbates the movement in surplus and deficit. The Plan s Risk Management Strategy and Plan should identify a full range of risks faced by the Trustee. MERCER 17

21 5.4. Impact of valuing pensions at market value The basis used to value defined benefit pension entitlements for the purposes of this investigation is considered suitable taking into account the Plan s current circumstances, including the current investment policy and assuming the ongoing support of the Employer sponsors. As noted in Section 3.1, the funding target has been set on the basis that pensioners reasonable expectations on termination of the Plan would be to receive the lump sum value of their pension determined on the actuarial assumptions adopted for this investigation. If instead the pension liabilities were to be valued on a market value basis that is, the amount which would be required to be paid to a third party (for example, a life insurance company) to take on the liability a much higher pension liability value would be obtained. It is likely that a third party would base its pricing on a discount rate around the level of longterm Government bond rates. To provide an illustration of the order of magnitude of the potential impact, we have valued the pension liabilities using a discount rate of 2.3% pa (based on the 2 November year Commonwealth bond rate of 2.8% less 0.5% as a very broad allowance for expenses), but with other assumptions unchanged. This change in discount rate increases the value of the pensions by around 61% (around $40 million). We have also valued pensions using our best estimate of future mortality experience (based on white collar populations with allowance for mortality improvements). If a third party was to adopt more conservative mortality assumptions (as well as a lower discount rate), this could add another 5% - 10% (or more) to the value of the pension liabilities. To illustrate the potential impact on the funding indices set out above, if the value of the pension liabilities was increased by 70%, the coverage of DB Vested Benefits (lump sum or pension) of the IAG Sub-Plan above would reduce to 92%. If the accrued pension liabilities relating to active and deferred members were also valued on a market value basis then the increase in liability would be even higher again. MERCER 18

22 6 Insurance Policy and Related Risks The Plan is not permitted to self-insure. The Plan has appointed MLC Limited as insurer. The purpose of the insurance policy is to protect the Plan against unexpectedly large payouts on the death or disablement of members. For accumulation members, death and lump sum total and permanent disablement benefits (TPD) in excess of total account balances are fully insured, as are salary continuance benefits. The group life sum insured formula currently in use for the death and total and permanent disablement benefits of defined benefit members is: Sum Insured = Death Benefit Vested Benefit Ideally the total amount insured should be approximately equal to the excess of the death and disability benefits over the Plan s assets. Based on the above formula, the amount at risk as at 30 June 2018 for the Plan was as follows: IAG Sub-Plan $m NRMA Sub-Plan $m Death/Disablement Benefits less Sum Insured Uninsured portion of death & TPD benefits less Assets* Amount at Risk * Excluding assets supporting lifetime pensioners and defer pensioners The sum insured formula provides adequate protection for both sub-plans. There is a degree of over-insurance for each sub-plan but that is largely because the funding objective is to target a level of assets greater than vested benefits (i.e. the amount of over-insurance corresponds to the surplus over vested benefits). Accordingly I do not consider that a change to current insurance formula is necessary. The definition of TPD in the policy is either used to establish a member s eligibility for the benefit under the Plan s governing rules, or is broadly equivalent, thus minimising any definition mis-match risk. I confirm that the current group life sum insured formula for defined benefit members remains appropriate and provides adequate protection for the Plan. MERCER 19

23 7 Assets 7.1. Assets We have been provided with the audited financial statements of the Plan for the year ending 30 June 2018, showing the following net asset information. IAG Sub-Plan ($ 000s) NRMA Sub-Plan ($ 000s) Total Plan ($ 000s) Net Assets 1,861, ,763 2,104,862 The assets attributable to the defined benefit section of each sub-plan, are assumed to be as follows: IAG Sub-Plan ($ 000s) NRMA Sub-Plan ($ 000s) Total Plan ($ 000s) Net Assets 1,861, ,763 2,104,862 Less: Accumulation Benefits 1 1,575, ,821 1,775,908 Less: Allocated Pension Liability 108, ,818 Less: Capital Expenditure 2 Provision 1, ,332 Less: SGIO DB Guarantee Assets Attributable to Defined Benefit Section 175,416 42, ,238 1 Accumulation Benefits includes retained benefits, as well as the accumulation accounts of active defined benefit members and deferred pensioners. 2 As advised by Plan management. 3 This represents the difference in value between the vested benefit and the account balance for this category. We have re-stated Accumulation Benefits based on the hard close unit price Accumulation Benefits in the financial statements are based on soft close unit prices. This has involved an increase to Accumulation Benefits of $4.6m. In addition, we have also made allowance for the over-provision for tax of $1.4m in the unit pricing as advised in Sharyn Long s letter Review of Tax in Unit Pricing Quarter 30 June 2018 dated 22 October We have made these adjustments (total impact $6.0m) to better align the value for Accumulation Benefits with the underlying value of assets in the Plan s financial statements, particularly in the context of the assets attributable to the defined benefits (being the balance of Plan assets after allowing for Accumulation Benefits) being small in relative terms. Similar adjustments were made in prior actuarial assessments. The Assets attributable to the Defined Benefit Sections shown in the table above have been used for the purpose of this review. MERCER 20

24 For the purposes of comparing total plan liabilities with total assets, we have excluded the Capital Expenditure Provision from the total net asset shown above Operational risk reserves The assets to meet the Operational Risk Financial Requirement (ORFR) are held directly by the Plan. The Net Assets shown above are after allowing for the ORFR (as per the financial statements). The scope of this Investigation does not include a review of the adequacy of assets held to meet the ORFR or the ORFR strategy. MERCER 21

25 8 Actuarial Assumptions The ultimate cost to the Employers of providing Plan benefits is: the amount of benefits paid out; plus the expenses of running the Plan, including tax; less members contributions; and the return on investments. The ultimate cost to the Employers will not depend on the actuarial investigation assumptions or methods used to determine the recommended Employer contribution programs, but on the actual experience of the Plan. The financing method and actuarial assumptions adopted will however affect the timing of the contribution requirements from the Employers. The actuarial process includes projections of possible future Plan assets and benefit liabilities on the basis of actuarial assumptions about future experience. These assumptions include investment returns, salary/wage increases, crediting rates, rates at which members cease service for different reasons, and various other factors affecting the financial position of the Plan. It is not expected that these assumptions will be precisely borne out in practice, but rather that in combination they will produce a model of possible future experience that is considered a suitable basis for setting the contribution program Economic assumptions The most significant assumption made in estimating the cost of defined benefits is the difference between: the assumed rate of investment earnings; and the rate of salary increases used in the projections of future benefit payments. The key long term economic assumptions adopted for this investigation are: Investment Return (after tax and investment fees) Pension Liabilities Investment Return (after tax and investment fees)# General Salary Increases Pension Indexation 5.4% per annum (previously 6.0%) 6.5% per annum (previously 7.0%) 3.5% p.a. plus age-based promotional scale Adult pensioners: 2.5% p.a. Child pensioners: Nil MERCER 22

26 Previous assumptions refer to those used for the Financial Condition Report as at 30 June The assumption for investment returns is based on the expected long-term investment return for the Plan s current benchmark investment mix, calculated using Mercer Investment Consulting s assumptions for the means and standard deviations of returns from the various underlying asset classes and the correlations of returns between those asset classes. For the purposes of the projections we have assumed a return of 2.8% for the year ended 30 June 2019 which allows for the actual return from 1 July 2018 to 7 November 2018 of -0.6% (as measured by the change in the MySuper (formerly Growth) unit price) and 5.4% p.a. for the balance of the year. Our calculations have assumed the following future Net Earning Rates, which take into account the current 3 year smoothing policy. For consistency, the Net Earning Rates for the projections include allowance for investment experience to 7 November Financial Year Net Earning Rates for Present Value of Accrued Benefits Projections % 6.9% % 5.1% % 4.5% 2022 onwards 5.4% 5.4% Defined Benefit Reserved members have had member investment choice since 1 May The investment earnings credited to such members is now the actual return for the investment option chosen. We have retained the general salary increase assumption which is based on long term economic forecasts for future increases in average weekly earnings (AWOTE). Specimen values of the assumed rates of promotional salary increases are shown below: Age Promotional Salary Increases % MERCER 23

27 8.2. Demographic assumptions I have maintained the same assumptions in relation to rates of resignation, retirement, death and total and permanent disablement (TPD) as were adopted at the 30 June 2017 Financial Condition Report. Retirement The rates at which members are assumed to leave the Plan due to retirement are set out below: Age Rates of Early Retirement 55 7% 56 15% 57 15% 58 15% 59 15% 60 20% 61 20% 62 20% 63 20% 64 20% % Resignation Specimen rates at which members are assumed to leave the Plan due to resignation are set out below. Age Resignation 40 5% 45 5% 50 7% 55 onwards - Retrenchment No specific allowance is made for the possibility of future retrenchments. MERCER 24

28 Death and Disablement in Service Examples of the assumed death and TPD rates for current employee members are set out below: Age Death Ill Health/TPD % 0.042% % 0.069% % 0.131% % 0.257% % 0.447% % 0.677% 8.3. Other assumptions New members The Plan s defined benefit section is closed to new entrants. No allowance has been made for new members. Expenses Expenses attributable to the defined benefit section of the Plan (being the balance of the Plan s total expenses less recovery by way of member fees) are assumed to be $900,000 per annum for the IAG Sub-Plan and $100,000 per annum for the NRMA Sub-Plan, indexed at 3.5% per annum. Tax All future Employer contributions are assumed to be subject to 15% contribution tax, after deduction of any insurance premiums and administration and management costs. All contribution recommendations quoted in this report are gross of contribution tax. No allowance has been made for: Excess contributions tax, as this is payable by the member; and Additional tax on contributions (including defined benefit notional contributions) for those with incomes higher than $250,000 (current threshold), which is also payable by the member. MERCER 25

29 Pension Options and Lump Sum Commutation Factors Where there is an option between an immediate lump sum and a pension benefit (or deferred pension benefit), we have assumed the percentage of members who will take a pension benefit as following: Category Assumption Former CGU 30% Former RACV 30% Ex-SGIC 100% For Former CGU Defined Benefit Members the factors used to commute retirement and resignation pensions are as follows: Former CGU Defined Benefit Members Lump Sum Received for Commuting $1 of Pension Age Males ($) Females ($) These commutation factors should be reviewed periodically, although it is assumed for the purposes of this valuation that they will remain unchanged. For Former CGU-VACC Defined Benefit Members the factor 11.5 has been used for all ages to commute retirement and resignation pensions, i.e. a lump sum of $11.5 is received for each $1 of pension commuted. Pensioner mortality Dependent Children Primary Pensioners Reversionary Pensioners Nil Mercer Retirement Pensioner Mortality with 25 year improvement factors from Australian Life Table Mercer Retirement Pensioner Mortality with 25 year improvement factors from Australian Life Table MERCER 26

30 9 The Regulator and Prudential Standards The regulator (APRA) has issued a number of Prudential Standards for the superannuation industry, including Prudential Standard (SPS 160) relating to the financial management and funding of defined benefit plans. We have commented below on a number of the requirements arising from SPS Review of Shortfall Limits The Trustee must determine a Shortfall Limit for each sub-plan, being the extent to which the sub-plan can be in an unsatisfactory financial position with the Trustee still being able to reasonably expect that, because of corrections to temporary negative market fluctuations in the value of the sub-plan s assets, the sub-plan can be restored to a satisfactory financial position within a year. The current Shortfall Limits are: Sub-Plan Shortfall Limit IAG 96.8% NRMA 98.3% The Shortfall Limit is expressed as a percentage coverage level of defined benefit vested benefits by defined benefit assets and it is appropriate to consider the following when determining if the shortfall limits remain appropriate: The guidance provided in the Actuaries Institute Information Note: Shortfall Limit in Prudential Standard 160, dated June 2013; The investment strategy for defined benefit assets, particularly the benchmark exposure of 70% to growth assets; The results of this investigation regarding the extent to which the current and projected defined benefit Vested Benefits are independent of the investment return on defined benefit assets (i.e. the extent to which benefits are salary-based and the current and projected relativity between Vested Benefits and Minimum Requisite Benefits. The results of this investigation indicate that the level of Minimum Requisite Benefits is not expected to be a constraint in determining the Shortfall Limit. Based on the above, we recommend maintaining the current shortfall limits We will reassess the suitability of the adopted Shortfall Limit as part of the next regular actuarial assessment. The Shortfall Limit should be reviewed earlier if there is a significant change to the investment strategy for defined benefit assets in particular a change to a more defensive strategy which has a benchmark allocation to growth assets of less than 65% - or if the Trustee otherwise considers it appropriate to do so. MERCER 27

31 9.2. Monitoring Process SPS 160 also requires the Trustee to determine and implement a process for monitoring the defined benefit Vested Benefits coverage against the Shortfall Limit for each sub-plan. If this monitoring process indicates that defined benefit vested benefits coverage has (or may have) fallen below the Shortfall Limit, then under SPS 160: An Interim Actuarial Investigation may be required (depending on the timing of the next regular actuarial investigation). A Restoration Plan is required to be put in place if an Interim Actuarial Investigation finds the plan has breached its Shortfall Limit. The Restoration Plan must be designed to return the plan to a satisfactory financial position, so that the Vested Benefits are fully covered, within a reasonable period that must not exceed 3 years and this must be submitted to APRA. Under the Plan s Trust Deed, an actuarial investigation is undertaken every three years, and a Financial Condition Report is obtained in each intervening year. The Trustee should also continue to monitor the Notifiable Events specified in the Plan s Funding and Solvency Certificate and advise the Actuary should any actual or potential Notifiable Events occur Requirements due to Unsatisfactory Financial Position Restoration Plan Under SPS 160, a Restoration Plan is also required to be put in place if the actuary finds in a regular Actuarial Investigation that a sub-plan: Is in an unsatisfactory financial position (whether or not the Shortfall Limit has been breached); or Is likely to fall into an unsatisfactory financial position. The Restoration Plan must be designed to return the plan to a satisfactory financial position, so that Vested Benefits are fully covered, within a reasonable period that must not exceed 3 years from the investigation date. An SPS 160 Restoration Plan is not required if the plan is technically insolvent (in which case the insolvency rules must be followed). If an SPS 160 Restoration Plan is already in place then any changes to the contribution program (including its period) must be made within the framework of that Restoration Plan. As indicated by the results in this report, we consider that: Neither sub-plan is in an unsatisfactory financial position; and Neither sub-plan is likely to fall into an unsatisfactory financial position. Hence the special requirements of SPS 160 relating to unsatisfactory financial positions do not apply at this investigation. MERCER 28