Pension Transfers

South Africa

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Letter by Jeremy Andrew, Chief Actuary of the Financial Services Board in 2000

Extract of salient points made by Jeremy Andrew in a letter to the Actuarial Society in the United Kingdom:

Jeremy Andrew, Chief actuary, Financial Services Board, 7 December 2000 ......

"With the benefit of hindsight, we should have given transferring or retrenched members at least an amount which, if invested prudently until retirement age, could reasonably be expected to replace the benefit lost in respect of service prior to date of exit."

"Seldom were members given the benefit of any provision held within the fund to protect the fund against a fall in the stockmarket, or of any actuarial surplus."

"There was a lack of understanding on the part of the members and their trade unions of how defined benefit funds were financed. In particular, the union negotiators may not have appreciated that a provision against the possibility of a fall in the stockmarket may have existed on top of the declared actuarial surplus."

(Note by Roger Wellsted– The Investment Reserve was not "on top of the declared surplus" – this reserve/provision forms part of the Actuarial Reserve value as defined by Regulation 15 of the Act)

"While we may be able to reach agreement with all stakeholders on the way forward, redressing inequities of the past is fraught with difficulty and opposition."

"The transfers left both the actuarial surplus and any difference between the fair value of the assets and the actuarial value of the assets behind in the defined benefit fund. When the fund was next valued, a significant part of any excess of fair value over actuarial value of assets in respect of the members who had transferred out of the fund with only their accrued liability would be released into surplus. This has resulted in a concentration of surplus within residual defined benefit funds."

"While I do not agree with Mr Wellsted on all the issues that he has written about, we get complaints from pensioners that pension increase are sometimes lower than what could have been afforded by the fund, with an apparent intention of creating surplus which will be used for the benefit of the employer or members who have not yet retired."

"Was it fair for members to have received only the accrued liability?"

"Conclusion

I hope this will reassure your readers that, while we may have been slower in South Africa than we should have been to react to the trend that was emerging around us, we are aware of the problems and are seeking to address them."

Jeremy Andrew -Chief Actuary - Financial Services Board

Copy of letter published on The Actuary website in January 2001

THE SOUTH AFRICAN REGULATORY RESPONSE TO PROBLEMS WITH TRANSFER AND RETRENCHMENT VALUES AND SURPLUS DISPOSITION

After reading Roger Wellsted's article in the November issue of The Actuary, entitled 'Employers' surpluses or members' reserves?', many readers will question what the regulators are doing in South Africa. I would like to set out what the Financial Services Board has been striving to achieve, and why we feel that legislation is the appropriate solution to the problem.

It is impossible to discuss the matter without some background to what has been happening in South African retirement funds over the course of the last 20 years.

The trend to defined contribution

At the end of the 1970s most large employers in South Africa sponsored defined benefit pension funds.

During the 1980s and 1990s most employees working in the private sector moved from defined benefit to defined contribution funds. Many of the latter pay lump sums on retirement, rather than incomes, and are described as provident funds in South African retirement fund jargon. The only major defined benefit funds left in South Africa lie in the public or parastatal sectors. Even here there is talk of conversion.

This shift seemed to suit both members and employers.

Members got:

· better resignation and retrenchment benefits;

· a funding structure which they found easier to understand (which was important in an environment of relative low education);

· the possibility of managing contributions more flexibly within a package approach to remuneration;

· a share in the management of the funds (which only became mandatory from 15 December 1998);

· the reward of high real returns which were being earned in our economy (where 'real return' is the degree to which investment returns earned exceeded salary and price inflation); and

· (if the transfer was from a pension fund to a provident fund) a lump sum on retirement which eased lower paid workers' fears of dying soon after retirement and losing the value of a pension, and which could be invested in such a way that the member could circumvent the means test applicable to the state pension paid after retirement age.

The employer achieved:

· a transfer of the investment and expense risks from the employer to members; and

· capping of employee benefit costs.

The capping of employer costs and the transfer of risk to members was particularly important in an environment in which HIV/AIDS was expected to result in significant increases in death and disability insurance premiums, and in which there was considerable uncertainty over the future management of the economy by a democratically elected government which was likely to have a different relationship with business than its predecessor.

Union-sponsored retirement funds were major beneficiaries of this conversion.

Trade unions had flourished as a major force opposing the apartheid regime. Transfers into union-sponsored funds placed very considerable financial resources at the disposition of investment managers, over which the union would have some influence. Control of significant retirement fund investments was an objective of the union movement, and was largely achieved through this process.

Many of these transfers to union-sponsored funds were a result of tough bargaining between the unions and the employers concerned.

The negotiating parties would have had access to at least the information that is publicly available. This comprises the rules, annual financial statements and triennial actuarial valuations which must be lodged with the Financial Services Board. These actuarial valuations reveal both the market and actuarial value of the assets, and the value placed on the accrued liabilities.

Despite this information being available, perhaps as a result of tough bargaining, in the early transfers members often moved with only their cash resignation benefits, usually a refund of their own contributions accumulated with a modest rate of interest. They left behind excess investment earnings and the employer contributions. Later they moved with their accrued liability, representing the present value of benefits expected to be paid in future as a result of service prior to the date of transfer.

Seldom were members given the benefit of any provision held within the fund to protect the fund against a fall in the stockmarket, or of any actuarial surplus.

There was a lack of understanding on the part of the members and their trade unions of how defined benefit funds were financed. In particular, the union negotiators may not have appreciated that a provision against the possibility of a fall in the stockmarket may have existed on top of the declared actuarial surplus.

The transfers left both the actuarial surplus and any difference between the fair value of the assets and the actuarial value of the assets behind in the defined benefit fund. When the fund was next valued, a significant part of any excess of fair value over actuarial value of assets in respect of the members who had transferred out of the fund with only their accrued liability would be released into surplus. This has resulted in a concentration of surplus within residual defined benefit funds.

The actuary's role in communicating the numbers involved is now being questioned. Was the actuary to the employer-sponsored fund concealing information?

Where the transfer was voluntary, particularly in the restructuring of company sponsored funds, it became commonplace to offer some form of 'sweetener'. This was either an across-the-board addition to the accrued liability, or some more targeted number, such as the present value of the future service benefits less the present value of future contributions expected to be invested towards the retirement benefit in the receiving defined contribution fund. The member would then usually have been given a comparative benefit statement showing the expected retirement and resignation benefits on the old and the new benefit structure before being asked to exercise his or her choice.

Downsizing

At the same time, many industries experienced considerable contraction of their workforce, resulting in, for the first time in our economy, significant retrenchments. Initially retrenchment benefits were not defined as a separate class of benefit: members received only the resignation benefit, which may have been considerably lower than the accrued liability, because of a practice to penalise early leavers. Gradually, practice changed until it became commonplace for the accrued liability to be paid. Still, members were seldom considered for any share of the provision against a fall in the stockmarket or of any actuarial surplus. Indeed, most members did not understand that they might have a claim in respect of more than their accrued liability.

This aggravated the concentration of surplus in the residual defined benefit funds.

Was it fair for members to have received only the accrued liability?

With the benefit of hindsight, we should have given transferring or retrenched members at least an amount which, if invested prudently until retirement age, could reasonably be expected to replace the benefit lost in respect of service prior to date of exit.

This could be very different to the accrued liability calculated on an ongoing fund basis.

This is not to say that:

· the benefit they received, if appropriately invested, may not have been able to grow to replace the benefit lost on retirement;

· the benefit they received plus investment of the contribution rate in the receiving fund may not have been able to match the benefit they would have expected in the former fund by the time they retired;

· it would have been fairer to have given them the accrued liability multiplied by the ratio of the market value to the actuarial value of the assets as determined in the last statutory actuarial valuation, where the actuary was setting his valuation assumptions in order to manage the contribution rates in ignorance of any requirement to use such ratio to adjust the benefit payable on transfer or retrenchment. (The actuary, in consultation with the trustees and the employer, may have made quite different assumptions if he or she had known that such ratio would be applied to any transfers.)

Only a case-by-case analysis could be used to establish fairness. It might depend, for example, on the age of the member.

How do we correct the problem, if there is one?

We believe that the appropriate solution can only come through legislation, because:

· Once a member has been paid a benefit due in terms of the rules of a fund, the member loses any right to any further claim against the fund; looking at these past transfers or retrenchments, once the amount as negotiated had been paid by the funds, the former members had no rights in terms of the Pension Funds Act as it is currently written.

· Most of the transfers occurred more than three years ago. Even though members may now feel that they did not get what was promised in whatever agreement was signed between the parties who negotiated the transfer or retrenchment programme, the former members may be unsuccessful in claiming anything through the courts, because their claim would have prescribed.

We would have to give these former members special rights in legislation before their transfer values could be increased.

Non-receipt of benefits in terms of the negotiated transfer

It is relevant to distinguish between:

· the payment of a benefit that satisfies the contract between the parties but is not fair; and

· the payment of a benefit that does not satisfy the contract between the parties (whether fair or not).

The law is the appropriate place to resolve the former problem.

The courts are the appropriate place to resolve differences over the latter problem. For example, we expect unions who do not feel that their members got what was due to them in terms of their negotiated transfer to ask the courts to decide whether the terms of the negotiated settlement were honoured. Claims in this regard may have prescribed, because of the length of time that has passed since most of the transfers. The courts will then throw any claims out, regardless of their merit.

The legislative process

In early 1999 draft legislation aimed at giving employers the right to repatriate actuarial surplus after a negotiated distribution amongst stakeholders was withdrawn from Parliament at the request of the largest of the trade union federations. In the subsequent discussions aimed at resolving the differences between the federation and the Financial Services Board, we became aware that the fairness, or otherwise, of past transfer and retrenchment benefits lay at the core of the trade union movement's difficulties with the draft Bill. They felt that much of the surplus had arisen because of the transfer or retrenchment of their membership with unreasonable benefits.

In February 2000 we took these discussions into the formal negotiating chamber established for government, organised labour, and business. This gave business and labour an opportunity to hear each other, in the presence of a government team.

We have been striving for an approach which, taking account of the need to investigate the conditions behind past transfers and retrenchment on a fund-by-fund basis, will:

· ensure that members who transfer out of a fund, who are retrenched, or who convert from defined benefit to defined contribution, get a benefit which can be invested in current market conditions to grow to replace what they have lost in respect of past service;

· achieve redress where past transfers, retrenchments or conversions were done at less than a fair value;

We hope that such minimum benefits will be incorporated into legislation to be presented to our Parliament in its next sitting.

As many of your readers will know from the minimum funding requirement in the United Kingdom, the determination of such minimum benefits presents significant difficulties and can have unexpected consequences, such as imposing a constraint on the investment philosophy of the fund.

Practical difficulties and opposition from business

While we may be able to reach agreement with all stakeholders on the way forward, redressing inequities of the past is fraught with difficulty and opposition.

The difficulty is a practical one, namely the availability of the data from a decade or so back and the ability to trace beneficiaries, particularly where people have been retrenched and have moved away from the area in which they were employed.

The opposition centres around a reluctance to reopen what were often vigorously negotiated settlements. Employers felt that they had been forced to agree to the transfers as a result of industrial action, or a threat of industrial action, despite feeling that it would have been better for the employees to have remained within the employer-sponsored fund. To reopen the terms of a transfer which had been forced on them, to their financial disadvantage, is something that they will oppose.

If there is agreement that some form of redress is due, what happens if there is no surplus to fund the additional payments due? Who is to pay in the moneys that are required? What happens if the experience of the fund has been adverse after the transfers took place, removing the surplus? What happens if surviving members' benefits have been improved? Must they now surrender part of such improvements? What happens if the employer has taken a contribution holiday and used up the surplus? What happens if the employer has changed ownership?

This is not just an issue of actuarial practice: it was not the actuaries who, in the final event, decided the transfer or retrenchment terms Š it was trustees and employers and trade unions.

Significant social and legal issues complicate the draft legislation which we have been drafting for consideration by the Minister of Finance.

Minimum pension increases

Mr Wellsted mentions poor pension increases. He suggests that transfer of the difference between the market value and actuarial value of assets did not occur when pensions were outsourced to insurance companies. He feels that this is the primary reason why pensioners got poor increases after the crash in the Johannesburg stock market in August/September 1998.

Index-linked government stock was issued, in small quantities, for the first time in early 2000. Prior to this issue, and the product developments that resulted, annuity policies with a guarantee that increases would match inflation were not available. Most with-profit annuities sold incorporated increases that represented the difference between bonus rates declared and an underlying rate of interest assumed in the policy. Such annuity policies had delivered good increases in the past relative to inflation, and might again in future. Often pensioners were given choices during the outsourcing exercise, commonly between policies with guaranteed increases, with-profit annuities, and equity-linked annuities.

In the market crash, the value of equities fell by 40%. Interest rates rose. Most insurers dropped their bonus declarations. There was still some smoothing. If these pensioners had elected equity-linked annuities, their underlying capital would have borne the full brunt of the crash. As it was, with-profit annuitants received small increases.

Mr Wellsted argued that the margin between the market value and the actuarial value of assets would have been sufficient to enable reasonable pension increases in relation to inflation.

Many actuaries had assumed margins between the market value and the actuarial value of assets of 15% to 20%. These would not necessarily have enabled pensioners to get full inflationary increases after the crash.

If the fund had continued to pay pensions from the fund, and had bought smoothed bonus policies from insurers to back the pensioner liabilities, they would have experienced exactly the same effect as was experienced by the with profit annuities. If higher increases were to be awarded they would have had to draw upon other sources of finance (either surplus or additional contributions from the employer).

While I do not agree with Mr Wellsted on all the issues that he has written about, we get complaints from pensioners that pension increase are sometimes lower than what could have been afforded by the fund, with an apparent intention of creating surplus which will be used for the benefit of the employer or members who have not yet retired.

For this reason, we have suggested to government that the minimum benefit approach to be used for transfer, retrenchment, and conversion should be expanded to cover pension increases. This minimum approach will endeavour to ensure that funds give increases up to the full price inflation rate, if such increases can be afforded out of excess investment returns earned on the assets backing pensioner liabilities.

Surplus disposition

At the same time as we have been dealing with unions and business over transfer, retrenchment and conversion values, and pension increases, we have been discussing surplus disposition.

Our Pension Funds Act gives neither members nor the employer any rights to surplus. Most rules give rights to surplus only on liquidation of the fund.

The employer is able, currently, in terms of the rules of most defined benefit funds, to take a contribution holiday when there is surplus: if the rules oblige the employer to pay only the balance of the cost of the benefits in excess of the contribution paid by the members, and there is sufficient surplus to fund the accrual of benefits in terms of the rules, the actuary may certify that the employer contribution required is nil.

On the other hand, if there is surplus, the members have a right to expect the trustees to consider benefit improvements. If such benefit improvements are granted, they may use surplus which will leave less to fund a contribution holiday. It is for this reason that we feel that the members' right to have a benefit improvement considered ranks equally with the right of the employer to be considered for a contribution holiday.

Rights are not defined in law, or in the rules, on transfer, conversion, or retrenchment, but may be defined in the rules on liquidation.

The Supreme Court of Appeal, in a major decision handed down in September 1999, clarified the legal situation, and recommended that, in the absence of rights in law or in the rules, the stakeholders should negotiate the distribution of surplus. Business, labour, and government seem to be in agreement that it is desirable to bring in legislation, rather than leaving the matter to negotiation and the courts. We want to introduce a process which will protect stakeholders who have very unequal bargaining positions.

We advocate requiring trustees to equitably apportion surplus. The revised law will then give members and the employer rights in respect of such surplus allocated to them. All uses of surplus must be taken into account.

We have drafted legislation along these lines for consideration by the Minister of Finance. We hope that it will be submitted along with the minimum benefit legislation.

Conclusion

I hope this will reassure your readers that, while we may have been slower in South Africa than we should have been to react to the trend that was emerging around us, we are aware of the problems and are seeking to address them.

I hope also that I have created some awareness that the problems are complex and are best resolved through legislation.

We hope that we will be able to report the passage of such legislation through Parliament during 2001.

Jeremy Andrew, Chief actuary, Financial Services Board, 7 December 2000