nottheaverageactuary

Actuarial news and views from Cape Town and beyond

Discontinuance of DB funds in South Africa

5 Comments

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.

Advertisements

5 thoughts on “Discontinuance of DB funds in South Africa

  1. Alexander Forbes possibly had a lot to gain from the change in scheme type: most DB funds would have probably been run in-house, with external assistance from actuaries and/or insurance companies. By shifting to DC funds, Alexander Forbes would have gained customers (they would invest funds on behalf of the employees in exchange for a fee). Alternatively Alexander Forbes could have been emphasising the move in order to be perceived as a market leader in such funds, i.e. to enhance their reputation.

  2. The actuarial reserve involved in calculating transfer amounts would probably be akin to an asset share; that is to say the accumulated contributions less expenses of running the fund less the “cost of cover” (probably related to the current pensioners’ pay-out).

  3. How have actuaries changed their approach to giving advice to trustees after this incident?

    Given that DB funds are being phased out in favour of DC funds, the issue of surplus allocation is becoming less relevant. However, given that there are still DB funds that exist in South Africa, actuaries need to take care in dealing with the contentious issue of surplus allocation as there are many parties whose interests may conflict.

  4. With regards to how many DB funds are still around in SA: the exact number is unknown but there are at least a hundred left, which illustrates the point that just because these funds were discontinued, it will take a while to phase them out.

  5. I thought it might be interesting to consider what other countries do in terms of “winding up” a DB fund.

    The Pension Fund Regulator in the UK has a website with the relevant guidelines for the trustees of a defined benefit pension fund if the pension found is “wound up”.

    This is the link to the relevant website:
    http://www.thepensionsregulator.gov.uk/trustees/winding-up-your-db-scheme.aspx

    These guidelines cover key points such as: when “winding up” will occur, procedures to notify the regulator and the main activities that are involved in the process.

    This webpage also mentions a “Pension Protection Fund”. This appears to be a description of a section covered in our course notes. Our course notes mention that, in the case of insolvency of a defined benefit scheme, a non-insolvent sponsor may make additional assets available if the scheme is in deficit.

    The website of the “Pension Protection Fund” (http://www.pensionprotectionfund.org.uk/About-Us/Pages/About-Us.aspx) states that their main function is to provide compensation to members of defined benefit schemes if their employer is unable to do so due to insolvency and insufficient assets. This is funded through a compulsory annual levy on all eligible schemes.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s