The beneficiaries of pension fund surpluses have entered the home stretch, but there are still legal obstacles that have to be cleared before they get their hands on the money.
The Financial Services Board (FSB) has published the last outstanding regulations which had been delaying the implementation of the distribution of pension fund surpluses. This comes 18 months after the enactment of enabling legislation for the surplus distribution.
Retirement funds can now go ahead with surplus distributions.
Two of the country's top experts on surplus distribution, Howard Buck, an actuary from actuarial consulting company Fifth Quadrant, and Rosemary Hunter, a pension lawyer at Edward Nathan & Friedland, warned that there could still be many problems in the interpretation of the legislation and the latest regulations and in deciding who gets what.
The latest regulations and notices from the FSB sets down how minimum benefits should be calculated, both for existing members of funds and for previous members of funds who qualify for any surplus a fund may hold. In terms of the surplus legislation, the first step in the distribution of any surplus is that legally prescribed minimum benefits must be provided to existing and qualifying former members before any remaining surplus can be distributed to members or employers.
Hunter says that although some of the FSB notices relating to the surplus legislation are effective in providing clarity, there are now contradictions between FSB notices and the legislation. It would have been better for the legislation to have been amended by Parliament.
Hunter says it may not be easy for funds to implement the guidelines contained in the latest round of regulations and notices from the FSB.
Buck says the delay in the publication of the regulations and notices "has frustrated those people who believe they are entitled to a portion of the surplus".
Buck says: "Given the fact that the legislation still contains a number of technical problems and is also open to interpretation in a number of places, we expect that these issues may only be resolved by trustees taking legal action to determine how they may proceed.
"Given the competing interests of stakeholder groups, this may also lead to litigation. Unfortunately, any such legal action will result in delays in the finalisation of the surplus distribution process and the payment of benefits to stakeholders."
Buck also warns that the negative investment returns earned by most funds over the past 12 months will have "significantly reduced" the surpluses. The average investment manager delivered a return of minus 11.1 percent (before investment manager fees and retirement fund tax) for the year ended March 31, 2003.
Buck says the main elements of the regulations and notices are:
Balancing competing interests of members
A key issue for retirement fund trustees in determining the amount of surplus available for distribution is the need to balance the requirement to secure the long-term solvency of their fund (and thereby protect the benefits and reasonable benefit expectations of current members and pensioners) with the interests of former members in a surplus.
Buck says the regulator appears concerned that trustees may attempt to "hide" surpluses by adopting unduly conservative methods in setting up reserves to ensure the long-term solvency of a fund. As a result, the basis for each contingency reserve adopted by trustees must be fully motivated by the actuary to a fund, and the Registrar of Pension Funds has the right to reject this motivation if it is considered unreasonable.
Buck says it is essential that the Actuarial Society of South Africa draws up a practice note for actuaries with regard to what contingency reserves are required by funds and the reasonable level of such reserves to facilitate a consistent approach.
Tracing former members
Part of the surplus of a fund may land in government coffers instead off in the hands of fund members. In terms of the regulations, where a fund has sufficient information to calculate the enhancement in benefits due to a former member, but is unable to trace this member, the enhancement must be allocated to a contingency reserve.
This amount may not be released unless the member is traced, or a payment is made to the Guardian's Fund, or some other fund established by law for unclaimed benefits.
Buck says this will have the effect of reducing the surplus available for distribution among former members who are traced.
"Our sense is that for funds that have experienced a high level of staff turnover, a large number of former members may be untraced, even after a period of, say, five years.
"If, say, only two-thirds of the former members can be found after a genuine and rigorous attempt to find all former members, the regulations require that the unclaimed amount be paid to a central unclaimed benefits fund (or held by the fund until an unclaimed benefits fund can be established)," Buck says.
"Previous expectations had been that the money in respect of untraced former members could be used for the remaining former members, or otherwise distributed as part of the surplus distribution exercise."
Audit-exempt funds
"Actuarial-exempt" and "audit-exempt" retirement funds (mainly funds which are managed under a life assurance policy, such as umbrella retirement funds), will now also be forced to undertake a surplus distribution exercise.
Multi-employer umbrella funds (as opposed to union or industry funds) can treat the actuarial surplus of each participating employer separately. This deals with the problem in the legislation where a surplus in respect of one participating employer may have been required to be paid out to the members and former members of another, totally unrelated, participating employer.
Contradictory legislation
The actuarial assumptions to be used to calculate the minimum individual reserve of each member or former member of a defined benefit fund are detailed in another FSB notice.
Buck says the notice "is somewhat contrary to our understanding of the intention of the surplus legislation, which is to provide pensioners with pension increases that match inflation, subject to affordability by their retirement fund".
The notice prescribes the net investment return that should be used before retirement, but adopts the actuary's valuation basis for the value of the pension after retirement.
But the valuation basis of some funds makes very little provision for pension increases after retirement which will then get carried through into the calculation of minimum individual reserves. In effect, the notice allows a continuation of this approach leaving such funds little protection against the effects of inflation after retirement.
Complex surplus calculations
It will be extremely difficult for most fund members to understand the surplus calculations, which are complex, and be satisfied that they have received the correct benefits due to them.
Equally, the prescribed method of calculation may result in significantly different additional benefits allocated to former members who happened to leave their fund a few months apart.
Prescribed minimum benefits
Another FSB notice sets out methods of apportionment that the registrar will automatically deem equitable and reasonable if they are followed.
In essence, the surplus must first be applied to provide an enhancement to all former members to bring their exit benefit up to a prescribed minimum amount (known as a minimum individual reserve) and restore the purchasing power of the pensions of all pensioners to that which it was at the date of their retirement.
Buck says within the guidelines, trustees will need to develop an apportionment scheme that is equitable given the financial history and the unique circumstances of their fund. They will need to ensure that their apportionment scheme is properly thought-out and documented and that they can successfully defend their allocation if it is challenged.
Buck says the practical application of the surplus legislation is extremely complex, and the long-term consequences of any decision made by the trustees need to be fully understood.
Trustees must balance the needs of the existing members and pensioners in terms of their reasonable benefit expectations with that of the former members.
As much as the trustees should not deliberately hide the surplus, they should not release too much surplus, because this may have a long-term consequence for reasonable benefit expectations.
What you should know
As a member of a retirement fund, you should know that:
- Not all funds have a surplus. Check with your trustees or your fund's principal officer whether your fund is in surplus;
- A defined benefit fund is more likely to have a surplus than a defined contribution fund (pension or provident);
- Actuarial valuations, legal arguments and claims by various stakeholders may delay surplus payouts; and
- Surplus payouts will not be in cash lump sums, but will be added to benefits.