Pension Transfers

South Africa

Home 2001 Submission Roger Wellsted Chief Actuary Case Study Who owns Surplus Regulation 15 Media Coverage Pension Fund Bill Reserve Value Defined Letter to Actuaries Liability

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Defined Pension Fund

versus

Money Purchase Pension Fund

 

 

 

 

 

 

Money-Purchase Pension - It is like a savings account attached to the share and property markets. All interest, dividends and capital growth on property and shares is added to a member's account holdings. Premiums for Ill-Health and Death Benefits are paid out of this account. On retirement, the member is handed the full value in the fund. After tax, the member can use the money to buy a pension or invest the money.

 

Defined Benefit - The Pension Benefit on Retirement is defined by the rules of the Fund.

In most Defined Benefit Pension Funds, the rules are along the following lines:

On date of retirement, the member will become entitled to a pension based on number of years service with the fund.

A formula to calculate the pension could be as follows:

 2% of final salary for each year of service

Example 2% per year of service for 25 years of service would give the pensioner a pension equal to 50% of his/her final salary.

Whilst the employee is still working, the actuary calculates how much money must be set aside to fund the employee's pension based on the employee's current age, salary and length of membership in the Fund,

Liability - As the Pension Fund will owe the member this pension, the value calculated by the actuary is called an "Actuarial Liability".

Assets - Money invested on behalf of a member is invested in a "spread" investment portfolio to fund the "Liability" - i.e cash, stocks, property, bonds, etc. Regulation 15 spells out how the actuary must report on how the money is invested. The actuary must place a realistic value on the stock market and property shares, as these fluctuate daily.

  • Note: If all the money was held in cash in a fixed deposit, the "assumed growth" would be lower than a spread investment portfolio. Therefore, more cash would be required to be set aside to fund the pension on retirement. So, the Actuarial Liability of a Cash-only investment would be higher than an Actuarial Liability for a Spread-investment portfolio.

So, in the case of the Assets to fund the Liability, the Assets will be described in two ways:

  1. "Actuarial Value of Assets" which is a theatrical value. This value must equal the "Liability".
  2. "Fair Value" or "Market Value of Assets" - This is the value of the portfolio at market rates. When share prices are higher than what the actuary considers realistic, the overall Market value of the Assets will be higher than the Actuarial value of Assets. When the stock market is in a slump, the market value of the portfolio could be lower than the actuarial value.

Assumptions

The actuary uses a number of assumptions to calculate both the Liability and the supporting Assets of the pension.

For example:

  • The actuary has to assume how long a member will live after retiring. The country's average "lifespan" for males and females is normally used for this assumption.
  • The actuary must also assume how much the investments will grow over-and-above inflation - this in normally around 4%
    • The actuary uses this percentage to "discount" the value needed to be set aside. If R100 000 is needed in five years time to fund the pension, only around R82 000 will need to be set aside now as it will be expected to grow at 4% faster than inflation.

Below is a chart that sets out the calculation process. The calculation for an entire pension fund is reported in one collective figure, but it is made up of individual calculations based on each member's age, salary and years of service.