The Bill introduces minimum benefits payable in future. These minimum benefits will reflect the reasonable expectation of members who exit the fund before retirement and pensioners in terms of pension increases.
Existing actuarial surplus is used first to top up the amounts paid to, or in respect of, former members and to top up current pensions, in both cases to the minimum levels established by the Bill.
Any residual actuarial surplus should then be equitably apportioned between the stakeholders, namely the employer, members (including pensioners) and former members, taking account of the financial history of the fund.
A process is put into place which incorporates checks and balances for the protection of the stakeholders.
2.1.THE AMOUNT OF SURPLUS.
Over the past twenty years, many South African defined benefit retirement funds accumulated significant amounts of actuarial surplus. The Chief Actuary to the Financial Services Board estimated the amount of actuarial surplus to be R80 billion as at the end of 1998.
2.2. THE LEGAL POSITION PRIOR TO THE BILL.
The Supreme Court of Appeal found in Tek Corporation Provident Fund v. Lorentz 1999 (4) SA 884 (SCA) (the Tek Appeal) that
- neither members nor the employer have any rights in law to actuarial surplus, and
- any rights would have to be conferred by the rules.
The provisions relating to the use of actuarial surplus which are commonly found in rules are the following:
- On liquidation, rules often provide that the assets of the fund should be distributed amongst the members and former members who left the fund within 12 months of the effective date of liquidation.
- The board has the right to improve benefits, subject to the consent of the employer whenever future service costs will be increased.
- Where the employer pays the balance of the cost of the benefits, if there is a surplus, the actuary may take account of this surplus in determining the employer contribution rate which will be sufficient to maintain a value of the assets equal to, or in excess of, the value of the liabilities. Such rate may be lower than the rate the employer would have to pay if there is no surplus, giving rise to a so-called “contribution holiday”.
- As members have a reasonable expectation that benefit improvements will be considered if there is actuarial surplus and any surplus utilised to improve benefits will reduce the amount available to support a contribution holiday, the employer’s reasonable expectation to be considered for a contribution holiday ranks equally with members’ reasonable expectations that surplus will be used to improve benefits.
The rules seldom, if ever, therefore, confer rights to surplus; they rather confer reasonable expectations. The rules would need to be amended to confer rights. The Supreme Court of Appeal suggested in the Tek case that, where the rules do not confer rights to surplus, the stakeholders should negotiate the disposition of the actuarial surplus and change the rules accordingly.
This Bill is designed to
- give effect to this recommendation of the Supreme Court of Appeal,
- determine which former members should be included and how much they should get, at least as a prior charge against surplus,
- guide the Registrar in determining how the negotiation should be conducted and who should be included, and
- provide a dispute resolution mechanism if the board of the fund cannot resolve the apportionment of surplus equitably and timeously.
2.3. DISCUSSIONS WHICH LEAD UP TO THE DRAFTING OF THE BILL.
A sub-committee of the Pensions Advisory Committee had investigated payment of surplus assets to employers following a decision of the Appeal Board established in terms of the Financial Services Board Act, 1990, in Lintas (South Africa) Pension Fund v. Registrar of Pension Funds, that it was possible to pay residual surplus to the employer on liquidation of a fund. The committee drafted a Bill which would have permitted payment of surplus to the employer after
- giving pensions increases at least equal to the change in the consumer price index after retirement,
- improving the resignation benefit to at least the present value of the benefits accrued in respect of prior service and
- gaining the consent of at least two thirds of members. The latter would only have been achieved if members had been given a share of the surplus.
The draft bill would therefore have resulted in the negotiated distribution of surplus. Following strong opposition from Labour, the draft bill was withdrawn in 1999.
Subsequent discussions were held with Labour to identify problem areas.
Business complained that they were excluded from these discussions. The matter was then taken into NEDLAC.
Labour and Business revealed very different positions on the matter. Various bilateral and trilateral discussions were held outside of NEDLAC in an attempt to resolve the differences. In summary the positions of the parties are as follows:
- Labour feel that assets are accumulated in retirement funds solely to provide benefits to members and their dependants. The employer has no right to any of these assets, but the employer may, if a fund is in surplus, reduce or suspend future contributions into the fund. With regard to past transfers, these did not satisfy members’ reasonable expectations: in particular many transfer values had not included the margin held within the defined benefit fund to protect the transferring members against a fall in the market value of the assets. The improper retention of this margin within the defined benefit fund artificially inflated surplus at the expense of the transferring members. It would be wrong to give employers any rights to such surplus. On the contrary, all funds should review these past transfers and retrenchments and should increase them to the fair value equivalent of the full accrued liability, even if this pushed funds into deficit.
- Business feel that the conservatism of actuaries has caused employers to contribute much more than has been required to meet the obligations of the funds towards the members. Surplus therefore represents over-contribution by the employer. Most rules give the employers the right to take any surplus into account when determining how much they will contribute to funds. They therefore consider that the employer has a right to use any surplus. They favour payment of any surplus in cash to the employer, to be taxed as ordinary income in the year of receipt. With regard to the past transfers, they feel that amounts had been negotiated by employers and trade unions in arms-length transactions, and there is no good reason to review the amounts transferred during the conversion from defined benefit to defined contribution.
One of the few areas of agreement between Business and Labour was that Government should introduce legislation.
The positions of Labour and Business did not change significantly over the 18 months of discussion inside and outside of NEDLAC. By the end of August 2000, Labour and Business demanded that Government decide what it would propose to Parliament.
2.4. THE GOVERNMENT VIEW
The Government team concluded that the views of Business and Labour reflected three significant reasons for the build-up of actuarial surplus:
- More members left the funds than the actuary had expected to leave prior to retirement, taking out, through benefit payments or transfer values, less than the fund was holding to meet their eventual benefit payments. The Financial Services Board has estimated that as much as 80% of members employed in the private sector moved from defined benefit funds to defined contribution funds over the last twenty years. In addition some industries had contracted significantly in terms of numbers employed, resulting in widespread retrenchments. Most of these members exited on terms which released into surplus some of the difference between the fair (or market) value of the assets and the value that the actuary placed on benefits that had accrued to the members in respect of their prior service.
- Pension increases and the interest rate used to accumulate member contributions were often lower than members could reasonably have expected based on the investment performance of the fund. This contributed to the growth of surplus but was acknowledged not to be fair to the members concerned.
- Investment returns earned by the funds exceeded salary and pension increases by more than the actuary had anticipated when advising boards on the financial position of the funds and on the contribution rate required from the employer to meet the balance of the cost of the benefits. Whereas most actuaries were assuming investment return would exceed salary increases by between 1,5% and 3%, rates of 4,5% to 6% were experienced. If the latter had been anticipated, the contribution rates required to fund benefits would have been much lower.
The Government team concluded that there is a need to establish a minimum benefit regime to apply in future, covering benefits on transfer, conversion or retrenchment, pension increases and the interest rate used to accumulate member contributions. This will ensure that members are treated fairly in future, and that future surplus is not generated by the payment of benefits that are lower than members’ reasonable expectations.
Past transfers, conversions and retrenchments should be topped up where the amounts paid were less than such minimum. Current pensions should be increased to the minimum. Interest rates used to accumulate member contributions should be raised to a minimum. This should be a prior charge against existing surplus and should minimise the chance that existing surplus has been inflated by paying members less than they should reasonably have been able to expect.
There would then be a good chance that stakeholders would accept an equitable apportionment of any remaining surplus between the employer, members and former members, taking account of the financial history of the fund. Such financial history would include an analysis of the source of the surplus, including amounts paid when members transferred out of the fund, were converted or were retrenched.
It would be appropriate to include in the distribution the following parties:
- The employer should participate because the employer may have over-contributed, either directly in the sense of having paid more than the actuary recommended, or indirectly because the actuary set the assumptions conservatively resulting in a higher employer contribution rate than would have been necessary if the actuary had achieved an exact match between expectation and reality. Such participation must include a right to take a full or partial contribution holiday in future funded out of the amount allocated to the employer.
- Active members should participate, particularly where they have contributed, because they can reasonably expect to benefit from excess investment returns earned on their own contributions, and because, if a surplus develops, they have a reasonable expectation of participating in its use. Account must be taken of any benefit improvements that they have enjoyed in the past.
- Pensioners and deferred pensioners should participate because their pension increases could have been held back to less than the fund could have afforded. (Most funds establish a funding plan which aims to have funded a pensioner’s benefits prior to the retirement of the member. Subsequent investment return in excess of the rate expected is available to fund pension increases.) Account must be taken of benefit improvements that they have enjoyed in the past.
- Former members should participate because they might have enjoyed a share of surplus when they left, if the board of management and the employer had appreciated, at the time that they left, that neither the employers nor the members had a right to the surplus, in law, and distribution should have been negotiated. The Government team recognised also that many of the past transfers, conversions and retrenchment programmes had been negotiated between parties having very different knowledge of retirement funding and very different access to professional advice. To this extent, any consent given previously was suspect.
The principles that the Government team followed were:
- There should be a sharing of the reward that is commensurate with the risk that each stakeholder group experiences in the fund.
- If the employer is granted rights to surplus, there must be a commensurate duty to fund any deficit.
- The exercise should not cause a fund to go into deficit, except to the extent that the employer has derived inappropriate benefit from the surplus in the past. Such “inappropriate benefit” would include selective benefit improvement for executives to an extent not enjoyed by ordinary members, increases to pensions in lieu of the employer’s obligation to subsidise the medical costs of pensioners after retirement and the recognition of past service for new entrants and transfers without the receipt of sufficient funds to pay for the additional service.
- Funds should be permitted to retain contingency reserves before actuarial surplus is considered. There are two important uses for such reserves:
- The board can set aside moneys to protect the fund against a fall in the stock market, or to smooth investment returns, or to subsidise future expenses (such as increasing premium rates as a result of the HIV / AIDS epidemic). Only any residual surplus would be apportioned.
- Where the amount of surplus is small, and the board anticipates that the costs involved in a surplus apportionment exercise would be onerous relative to the benefits that would ensue, the board can reserve all of the surplus in such contingency reserves thereby avoiding a surplus apportionment.
- Minimum benefits should apply in future
- whenever membership ceases (and not just on retrenchment, conversion and retrenchment):
Members who leave a fund have a reasonable expectation that they should be able to invest the amounts received in a prudent mix of equities, property, fixed interest investments and cash and grow the amounts with the subsequent nett investment return to be sufficient to replace the benefits lost on the members’ retirement. A concept of “minimum individual reserve” was therefore established: “minimum individual reserve” means, in the case of a defined contribution fund, the accumulation of the member and employer contributions, nett of expenses, with a rate of interest that is reasonable in relation to the investment return earned by the fund; and in the case of a defined benefit fund it means the present value of the benefit the member would have expected on retirement, based on salary and service to date of exit, adjusted to an equivalent fair value depending on prevailing investment conditions. In the case of defined benefit funds the minimum individual reserve must not be less than an accumulation of the member’s own contributions with a reasonable rate of interest.
- on a three yearly basis, at the very least, when pensions are increased,
The fund should establish a policy, which is applied annually. Every three years, the fund must roll up the assets backing the pensioner liabilities, nett of pension payments and reasonable expenses, and determine what size increase the fund can afford. If this is higher than the change in the consumer price index, then the fund should pay the latter, otherwise the fund should pay as much as it can afford subject to this not exceeding the change in the consumer price index.
- The introduction of the minimum benefit regime might cause hardship. Some funds will only be able to afford the minimum if the employer contribution rate is increased. Employers should have reasonable time in which to evaluate the impact of the proposals and to renegotiate benefits if they cannot afford such an increase. Members should not be able to claim rights in respect of the minimum benefits until after this period. On the other hand, where a fund is liquidated or the retirement benefit is converted from defined benefit to defined contribution and there is sufficient surplus to pay the minimum benefits, the latter will then be applied.
- Historic benefits or transfer values paid when members left the fund at any time after 1 January 1980 and current pensions paid by the fund should be corrected to minimum benefit levels consistent with future policy as a prior charge against surplus, adjusted for any improper use of surplus in the past, meaning the extent that the employer or decision makers have been unduly benefited at the expense of members in general. The difference between the value of this improper use and the amount of surplus equitably apportioned to the employer will be the maximum amount which employers will have to pay into the fund, thereby preventing any undue strain on retirement fund finances.
- A person must represent the interests of former members and should be given unusual powers to be heard, so that the employer and the residual members do not conspire to the disadvantage of former members.
- The resulting (modified) actuarial surplus should be equitably apportioned by the board between members, former members and the employer, with appropriate checks and balances to prevent abuse and to ensure than the unequal bargaining power between employer-appointed and member-elected members of the board is neutralised. There are several important checks and balances:
- At least 75% of the board, duly appointed in terms of section 7A must approve the scheme.
- Stakeholders must be informed, must have a right to object, and their objections must be considered.
- The Registrar has the right to request a report by an independent actuary when in doubt. Such independent actuary may be required to investigate the apportionment in the case of deadlock or doubt as to the valuator’s independence from the employer.
- The board must submit a scheme for the apportionment of surplus within a restricted time, failing which they will surrender the power to determine the apportionment to a specialist tribunal.
- The members of the independent tribunal may be selected from a panel approved by the Registrar.
- Once the specialist tribunal has made a decision, it will be binding on the stakeholders. The Registrar or the courts may only overturn it if the panel acted improperly.
- Members, former members and the employer must get rights to such surplus as is apportioned to them. These rights must include what happens on termination and transfer. Responsibilities if the fund is in deficit must also be clarified.
- The employer should be able to use surplus allocated to it to fund a contribution holiday, subsidise expenses, selectively improve benefits, transfer surplus between funds, and obtain cash payment on liquidation or on confirmation that negotiations in terms of section 189 of the Labour Relations Act have demonstrated that such a step is necessary to prevent significant job losses.
- Deficits in defined benefit funds should become debts of the employer.
- The Registrar must check that a board has gone through the required process in the apportionment. This process will include the checks and balances referred to.
- During the conversion from defined benefit to defined contribution, some of this actuarial surplus was transferred across to reserve accounts in the defined contribution funds into which most of the members transferred. Such reserve accounts are frequently defined in such a way that the employer is able to use the contents to subsidise the contribution rate. These funds must be included in the apportionment exercise.
PCOF incorporated the major issues of principle from the draft regulation into the Bill. The two major items of regulation that remain are:
- To amend Regulation 2 to require any fund which contains actuarial surplus to be actuarially valued;
- To set out the assumptions that will be used to determine the minimum individual reserve (past and future) for defined benefit funds. These will be developed in a representative committee and will be consulted on widely before being approved by the Minister of Finance.
A preliminary draft of the Bill was sent to various parties at the same time that the Bill was referred to NEDLAC in February 1999. Since February 1999 there has been extensive discussion within NEDLAC leading to the present Bill, which is very different from what was proposed then. The views expressed by parties outside of NEDLAC have for the most part also been expressed by parties within NEDLAC. The consultation process initiated in February 1999 was therefore not repeated outside of NEDLAC, except to the extent that interested parties were invited to make representations to PCOF. PCOF gave these parties an opportunity to express their views. In particular, the Association of Retired Persons and Pensioners and the Actuarial Society of South Africa gave both oral and written presentations. Some other bodies such as the Institute of Retirement Funds and the Life Offices Association were content to make written presentations only.
Where PCOF deemed it necessary, such comment has been taken into account in this version of the Bill.
The Bill has no direct financial implications for the State.
The costs of the specialist tribunal will be recovered from the surplus that they apportion.
The State Law Advisers, the Financial Services Board and the National Treasury are of the opinion that this Bill must be dealt with in accordance with the procedure established by section 75 of the Constitution since it contains no provision to which the procedure set out in section 74 or 76 of the Constitution applies.
“actuarial surplus”
When the value that the actuary places on the assets of a retirement fund exceeds the value that the actuary places on the liabilities (which reflect the obligation of the fund to pay benefits to members) together with the contingency reserve accounts, the excess is actuarial surplus.
“defined benefit fund”
A defined benefit fund promises members benefits in relation to salary and service such as a pension of 2% of the average pensionable remuneration earned over the two years prior to retirement for each year of pensionable service. Members contribute a fixed percentage of pensionable remuneration. The employer pays the balance of the cost of the benefits.
“defined contribution fund”
In a defined contribution fund, member and employer contributions less expenses are credited to an individual account for the member. Interest is added at a rate determined by the board of trustees. This interest rate usually relates to the investment return earned by the fund less retirement fund tax and costs related to the investments. It is sometimes smoothed to protect members against a fall in the stock market, in which case a portion is set aside in years of high return to subsidise the rate in years of poor return.