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The Actuary The magazine of the Institute & Faculty of Actuaries

Actuarial practice in South African and UK pensions

I must admit to having approached the Faculty pensions exam of 1993 with some anxiety, wondering whether the material I was studying would be of any use in the South African pensions market. A pleasantly surprising proportion was relevant, but by no means all. One of the clearest signs that many things were different came after a hard day getting to grips with the implications of trade union-driven pressure for companies to switch from defined benefit (DB) to defined contribution (DC); it was time to study the section in the reading material comparing the two. What I was not expecting to see, under advantages of DB funds, was that ‘trade unions prefer them’.
Five years later, in my first experience of what passes for summer in London, it seemed that all of the studies of UK pensions would be useful especially after I had refreshed my memory! This turned out to be mostly true, but there was a catch: most of the UK legislation had changed. I’m sure the experience of most people advising on pensions issues in the UK or South Africa or both is also one of continued rapid change. I hope this perspective on the interaction between these changes and actuarial practice will help to increase awareness of the similarities and differences between practice in the two countries, and to stimulate discussion in areas where one could easily take a given approach for granted.

Different worlds?
It is impossible to understand the forces driving pension arrangements without first considering the overall environment.

A blend of the developed and developing worlds
The South African economy has an unusual mix, ranging from subsistence agriculture through to cutting-edge technology. The UK is naturally a far more wealthy country, with world-class standards in most sectors, and the fourth-largest economy in the world (although one doesn’t hear this too often, because boasting just wouldn’t be British!). Financial services is one of the areas where South Africa is internationally competitive, for example, the South African banks had a single ATM network over ten years ago, and five years ago one could transfer money between a current account and a flexible mortgage using an ATM. So South Africa seems to be at least even and perhaps ahead on banking, but I’m afraid that difficult as it may be to believe at the moment the UK is ahead when it comes to the train system!

Robust debate
The social and political change in South Africa is the outcome not just of a few well-known events, but also a process of wide-ranging negotiations over a long period of time. Many people have worked through a range of issues, not just at government level, but also in mines, factories, offices, and pubs across the country. This has contributed to retirement funding issues becoming the subject of robust debate, ranging from the structure of pension arrangements through to investment strategy, governing structures, and ownership of surplus.
The work of actuaries has always affected a wide range of people, most of whom avoid coming anywhere near the slightest hint of actuarial jargon. But actuarial advice is increasingly the subject of broader interest, particularly concerning ownership of pension fund surpluses in South Africa. While much is being done to promote public awareness, I would suggest that actuaries need to do more to ensure that the issues, and the role of actuaries in addressing them, are understood by a wider audience.

Movement to DC
The trend towards DC started earlier in South Africa than in the UK, and has progressed further, to a point where it is the main method of retirement provision in the private sector. (Public sector funds are mainly DB, partly because underfunding makes it difficult to convert to DC.) While there are a number of common themes, there are also important differences.
– UK Changes to DC have been driven mainly by companies wishing to contain costs and avoid the ever-growing burden of compliance costs, combined with a greater awareness of the financial risks that have always been involved in sponsoring a DB fund. Memories of the problems caused by indiscriminate use of personal pensions in the late 1980s are sufficiently fresh to ensure some caution among employers, employees, and trade unions, to the extent that they are involved. However, many companies are moving to DC over time via the path of least resistance of offering only DC to new hires. DC is also the most frequently preferred option for companies needing to set up new arrangements after corporate transactions.
– South Africa In contrast, the move to DC that started in the early 1980s was initially driven by trade union pressure. Unions saw DC funds as a way of ensuring that investment returns were used to the benefit of members, rather than building up surpluses from which members might never benefit. Transfers to DC were generally accompanied by an improvement in withdrawal benefits combined with changing to a ‘provident fund’ structure, characterised by payment of retirement benefits in a lump sum. The choice of provident funds was largely with a view to giving better value to lower-paid workers with relatively short life expectancy, as well as avoiding the difficulties that many people retiring in rural areas experienced in receiving monthly pension payments. Actuaries have been involved from the start in advising trade unions on negotiating and establishing provident funds, and in assisting trustees in managing them.
After initially resisting changing to DC, South African companies have increasingly welcomed it, with company-initiated conversions being the order of the day in the mid 1990s. As in the UK, this has been driven by increased awareness of financial risk, including concerns about tax treatment becoming less favourable. This was accompanied by many companies becoming more willing to use surpluses to enhance transfer values, to encourage members to accept a change to DC.

Financing of DB funds
While there are a number of differences, both between the two markets and within them, the fundamental principles used to advise on the adequacy of funding of pension arrangements are the same in both countries. A key common area is that liabilities are generally assessed, for the purposes of accounting and for funding, as the discounted value of liabilities for benefits relating to past service, assessed allowing for expected future salary increases and pension increases. It is too easy to take for granted that the projected unit method and attained age method are the only ways that ongoing valuations are carried out. Involvement in international transactions has shown me that the range of methods used to assess pension liabilities is astonishing and it is not difficult to think of areas where greater actuarial involvement would be beneficial!

Asset valuation differences of approach
– UK The most dramatic change to valuations in the last few years must surely be the shift away from valuing assets on a discounted cashflow basis, to the use of market values. Over the last three years, the percentage of large funds having used market values for their most recent valuation has increased from 1% to 45%. This appears likely to increase further to around 70% when the current cycle of valuations has been completed (source: PwC Survey of Actuarial Assumptions 2000). Valuing assets based on the present value of future dividends is widely (although by no means universally) seen as having lost validity, given the increasing prominence of other ways of companies paying out to shareholders, such as buying back shares, which does not show through in the dividend yield on share indices.
– South Africa Actuaries tend to value assets at a discount to the market value, most commonly by explicit smoothing of market values, although the discounted dividend method is also common. This is done partly to ensure that assets and liabilities are valued in a consistent way, but in practice the main consideration especially from a trustee’s point of view is to have a margin against fluctuations in market values, especially given the considerable volatility in South African financial markets.

Minimum funding standards
– South Africa The standards for adequacy of funding are relatively simple, and their essential features have been the same since the Pension Funds Act 1956:
– past-service benefits should be at least 100% funded, allowing for future salary increases and pension increases;
– the allowance for pension increases should reflect ‘reasonable benefit expectations’, which broadly speaking requires taking into account historical discretionary benefits and the trustees’ and employers’ future intentions;
– if the funding level is less than 100%, a plan must be agreed to bring it up to 100% within three years if the deficit is as a result of unfavourable experience, or nine years if it is as a result of benefit improvements;
– the assumptions are at the discretion of the valuator (broadly similar to a scheme actuary in the UK).
– UK The minimum funding requirement (MFR) tests the adequacy of assets against the liability for the deferred pensions that would be payable on leaving service, ignoring discretionary pension increases and other discretionary benefits. It is currently subject to considerable debate, but perhaps it is worth noting the irony of the discounted dividend method of valuing assets having been hard-coded into the relevant legislation just before funding valuations started to swing towards using market values.

Recent research by the Faculty and Institute of Actuaries shows longevity of UK pensioners improving at a faster rate than previously expected. My observations of recent valuations by a number of firms indicate a move towards more cautious assumptions. While it is not obvious whether experience in South Africa will be the same, improving longevity in the UK gives a timely warning that South African actuaries should watch closely for signs of increasing life expectancy among pensioners. It seems quite possible that South Africa could experience longer life expectancy of pensioners at the same time as HIV infection increases mortality rates among younger employees.