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The Actuary The magazine of the Institute & Faculty of Actuaries

What to do with surpluses

The hottest actuarial topic of the South African moment is probably the use of pension fund surpluses. This might be surprising in the light of five years of flat equity yields, but a number of funds have considerable surpluses when expressed as a proportion of their liabilities.
These have frequently arisen after most of the active members have transferred to money purchase provident funds with less than their share of the fund. In some instances, pensioners have also been shifted out by lump sum offers of varying generosity, which have also been less than share of fund. That there are fewer formal sector jobs than there were a decade ago suggests that there have also been numerous retrenchments. Benefits on retrenchment have recently improved and are normally less miserly than voluntary severance payments, but seldom more than a reasonable actuarial reserve.
In retrospect, it might appear that much of the 90s was spent creating these refundable surpluses. This suspicion has certainly been aired in the media, and the actuarial profession has not escaped being associated with the possibility. The most public criticism has come from the pensions adjudicator. This relatively new post has attracted an avalanche of complaints which he has manfully attacked with energy and legal rigour. The courts recently came under the public attack of the new justice minister for their inefficiency. The same accusation cannot, however, be levelled at the adjudicator, who appears to issue substantial rulings on a weekly basis. His dedication is an inspiration.
His criticism of the profession has found public form, both in his rulings and in a paper delivered last year to the Pensions’ Lawyers Association. He appears to be uncomfortable with the discretionary powers exercised by actuaries in retirement funds, and especially that the discretion does not appear to be sufficiently constrained by generally accepted principles.
His recent ruling on Basil Kransdorff v Sentrachem is a case in point. Although not professionally active in the industry, the complainant has made it something of a personal crusade to bombard everyone from the minister of finance down with a series of vigorous polemics against poor withdrawal benefits. It is ironic that he should fall victim to retrenchment himself, and suffer losses as a result of his retirement payout.
His principal complaints were that his retrenchment payout was based on a reduced actuarial reserve. First, it did not include the investment reserve (being the difference between the actuarial and market value of assets) and, second, had been reduced because no allowance had been made for death benefits before retirement as the benefits were all insured. These practices are common, although in my opinion, for what it is worth the reasoning that defends them belongs to the category of propaganda: believed only for its frequent repetition.
Where actuarial values differ from that of the market, they cannot be traded for cash; if the investment reserve is required to stabilise the contributions of the employer, it is similarly necessary to preserve the reasonable benefit expectations of the members (these are written into our Pensions Act). Payment of actuarial reserves should, therefore, be at market value.
The practice of insuring the whole death benefit has clear advantages for fund advisers, as it increases insurance premiums and the commissions based on them. It seems that the concomitant disadvantages to the funds concerned are aggravated by its doubtful legality. The funds cannot have an insurable interest in their members’ reserves which fall into surplus on death.
As it happens, the adjudicator acknowledged the unfairness of the benefit received by Kransdorff, but declined to rule in his favour because of uncertainty about the effects of his ruling on pension fund solvency. He also felt unable, for technical reasons, to rule on the additional benefits given to senior managers of Sentrachem. Press reports suggest that the CEO walked away with over 20m rand, most of which is alleged to have arisen from additional bonuses funded by artificially manufactured surpluses. Court cases are apparently pending, so we may soon hear more.
The adjudicator has, however, called for legislation to remedy the position. As too has the Appeal Court in its long-awaited ruling on the TEK judgment, which overturned a High Court judgment that appeared to require trustees to apply part of their fund’s surplus to increase members’ benefits. The judgment that the employer had no prior right to the surplus was, however, upheld, which leaves the position unresolved. Neither members nor employers have any rights to the distributable surplus, and the trustees risk legislation if they attempt to allocate it. This does not stop employers accessing the surplus by contribution holidays, or diluting it by restructuring funds. Some of these arrangements are questionable. Another recent ruling by the adjudicator will lead to a revision of one restructuring because the members were not informed accurately as to the size of the surplus.
It is not that the law has not been tried. The Financial Services Board submitted a bill allowing for the refunds of surplus to employers in 1997. It seemed to me to represent a big step forward as it required full inflation indexation of pensions, and withdrawal benefits no lower than actuarial reserves, before refunds could be given. It did not, however, cover the question of contribution holidays that might be funded by artificially manufactured surpluses. Thus, after lengthy discussions with the trade unions, they objected to the parliamentary committee and the legislation was shelved.
It needs to be explained that nationwide strikes in 1981 over a proposed law to prohibit cash withdrawals from pension funds marked the first real assertion of black political power since the defiance campaign of the 1950s. Union members feel pension issues keenly and have damaged government previously over related questions. This year should see some interesting developments.