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
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.
· better resignation and retrenchment benefits;
· a funding structure which they found easier to
understand (which was important in an environment of relative
· 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
· (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
Union-sponsored retirement funds were major beneficiaries of this
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
The actuary's role in communicating the numbers involved is now being
questioned. Was the actuary to the employer-sponsored fund concealing
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.
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
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
· 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
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
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
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
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
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.
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
Rights are not defined in law, or in the rules, on transfer,
conversion, or retrenchment, but may be defined in the rules on
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
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.
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