As discussed in the ActEd notes, sponsored benefit schemes can “wind-up” not due to the insolvency of the sponsor but rather because the sponsor decides to stop financing benefit provision. This was the case for South African DB fund sponsors around the 1980s and 1990s.
Prior to this period, most pension funds were DB funds set up by employers for their employees and the problems that existed with these funds was as follows:
1) From the Employer’s perspective:
The employer is the sponsor of the fund in that its contributions are based on the ‘balance of the cost’ needed to maintain solvency. This means that the employer assumes the risk of increasing future costs due to poor investment returns or high salary increases. In order to remove this risk employers opted to convert to DC funds, by offering members the option of transferring their DB benefits to DC benefits. Because this conversion had to be voluntary employers had to offer members “sweeteners” to move –which typically consisted of a share of the surplus that existed in the DB fund. As not all active members opted to move, and no pensioners were moved to DC funds, the DB fund had to stay open to accommodate them, even though they became closed to new membership. This means that DB funds will be around for a long time still, eg a 35 year old member who decided to remain could retire and die as a pensioner 50 years later.
The dominant retirement fund consultants in the market at the time, Alexander Forbes, were the main drivers in the market for this conversion from DB to DC and benefited a lot from the move.
2) From the Members’ perspective:
DB funds relied on cross-subsidies, from early leavers to long serving members, in order to keep the cost of funding down. Therefore they were not good for early leavers (typically members leaving before 7 years did not get their own contributions plus the employer contributions plus investment returns back) but were very good for long serving members.
Legislation was later changed to provide for minimum benefits for early leavers but this just made DB funds even more expensive as the cross-subsidies were removed. Also, at the time there was no regulation stating that members could elect trustees and so there was very little transparency as well as a belief that these funds were not there to help the members.
In the process of conversion, most funds simply gave members their actuarial reserve values (ARVS) plus an agreed share of the surplus. The share of surplus that was offered depended on how much the employers wanted members to move to the new DC funds and was an issue of contention. An additional issue was that a lot of funds operated investment reserves – equal to the difference between the market value of assets and the actuarial value of assets used in the valuation. These reserves were normally not transferred across to the DC funds, resulting in a big bonus for the members remaining in the DB fund and for the employer.
This paper provides more information on the process and views of the different parties involved and ultimately concludes that the conversion to DC funds has not been unfair towards members. However, because the calculations of conversion weren’t communicated properly and initial calculations were probably inaccurate, there were complaints by various parties involved that lead to a call for legislation. The author goes on to state that the reputation of the actuarial profession has been damaged to a certain extent due to all the negative publicity involved, and going forward actuaries need to put more thought into issues surrounding fairness before giving advice to trustees.