Submitted to the Finance Portfolio Committee
August 2001

1. Introduction and summary of concerns

The issue of the pension "surplus" is one of fundamental importance for FEDUSA. This issue affects many previous and current employees at all levels. At stake are huge resources to which the rightful beneficiaries have been denied their equitable share of pensions by certain unscrupulous employers.

As a Trade Unionist I find myself in a very difficult position having to talk about these Pension Fund Amendments as one can support the changes, which are being requested, but there has to be reality in making these changes. Emotions must be taken out of this debate and cool heads must be kept with careful consideration to ensure that, what should be an attempt to redress the past inequities, does not end up in a total collapse of the Pension Fund Industry as it is known today.

It is also important for me to point out that there are various types of funds and I will set these out as follows:

Defined Benefit Fund: Where a formula is used, multiplied by the years of service and the last three years average pay. This type of fund can determine each year what its liabilities are going to be. As at the end of a year the employer normally knows who will retire during the course of the following year and can make provision therefore. It is this type of fund that normally has large surpluses that is being targeted. However, the employer has to take the responsibility for keeping this fund financially sound and actuarially correct and therefore if there is a shortfall in this type of fund, the employer has to make good, whatever the shortfall.

These funds are normally employer funds and there are still quite a few of them around.

Defined Contribution Funds/Provident Funds: Both these funds are an accumulation of the employer and member contributions plus interest compounded and at the end of this period, the member gets his full share. i.e. employer contributions, member contributions and all accumulated interest of which the member can take one third in cash and with the remaining two thirds a pension must be purchased with.

A Provident Fund on the other hand is a fund that accumulates its wealth exactly like a Defined Contribution Pension Fund, with the difference being, at the end of the period, the member takes his full amount (fund credit less tax) and either invests or buys a pension. But he has full control on what he wishes to do with that money.

The structure of both the Defined Contribution Pension and Provident Fund is of such a nature that they do not carry surpluses. These surpluses are paid out to the members each year when a declaration is made on the interest earnings, which are based on the investment performance of the funds’ assets. Most of these funds have to carry a small investment reserve account to cover things such as administration, tax and in some cases even, to insure the death and disability benefit, which will be becoming a factor due to the HIV/AIDS. This is fast becoming a serious problem for the Pension Fund Industry, as large amounts have to be paid out of these funds and as the funds do not make provision for this, they have to take out outside insurance to cover this benefit, which has become excessively expensive.

The Defined Contribution funds, as well as the Provident Funds, are controlled by a mixture of employers and unions with outside consultants giving advice on how these funds should be run. There is a tendency at present, where employers are moving away from Defined Benefit Funds to Defined Contribution Funds, which has two effects for themselves.

i.e. they are moving the risk of the funds away from themselves as employers and placing it on members; and
to avoid legislation, which is going to compel them to distribute any surpluses.

The unions on the other hand, have also been practicing the same procedure, as all of their funds are Defined Contribution Funds, but for different reasons. They believe that the amount of money, which stands to the credit of the member in a Defined Contribution Fund, as well as a Provident Fund, is visible, whereas a Defined Benefit Fund is something that a person would get at the end of his/her working life. They have a strategy of either guaranteed investments with little or no reserves and only a reserve fund, which must cover costs of administration tax.

The transparency of a Defined Contribution Fund and a Provident Fund appeals to members.

FEDUSA appreciates the opportunity to comment on the Pension Fund Second Amendment Bill and Parliament now has the opportunity to address the situation by passing legislation which clarifies and protects members’ existing rights and ensures that:

· restitution of "surplus" assets takes place by allocating these assets to former members and pensioners who were deprived of there reasonable benefits in the past; and this can only be done if funds can afford to do so without affecting present members expectations or reducing benefits.

· members are not deprived of their reasonable benefits in the future;

· When making changes to legislation to affect these provisions, current members’ benefit expectations are not in any way to be affected.

It is important to know that surpluses have arisen as a result of members leaving Defined Benefit Retirement Funds without their full benefits, as their equitable value was not established.

· These past payment practices were inequitable;
· It is necessary for legislation to provide that former members who did not receive the investment reserves on their assets, be paid out these moneys; if the fund from which they exited can afford to pay.
· It is necessary for legislation to provide for the minimum pension increases and minimum benefits to be paid to members when leaving a fund or on conversion of a fund in future.
· When calculating or considering legislation, it must be borne in mind that a number of funds do not have investment reserves and legislation should be carefully worded if it is going to take this route as many funds do not have investment reserves and would not be able to meet the requirement of the Act.

Employers are not and should not be beneficiaries of these funds. This position is supported in South African Law.

This submission begins by providing a brief history of the origins of the "surplus" and discusses the current legal position in terms of the ownership of retirement funds and of the "surplus" itself. It goes on to outline the process of developing legislation intended to address this problem up to this point. We also highlight some of the adverse effects on members arising from the absence of legislation, and the schemes used by employers to loot pension "surpluses". This is followed by a section setting out the core principles which FEDUSA believes should inform the Bill and identifying how the current version of the Bill departs from these.

There are five main principles of concern to FEDUSA, which we believe should inform the way in which the Bill resolves the issue of the pension "surplus". However, the Bill as it stands is not fully compliant with any of these core principles, and substantial amendments would be required to ensure that past, current, and future members of retirement funds are indeed adequately protected. These principles are as follows:
1. A pension fund belongs to its members and no third party should have a legal or equitable stake in the fund.
2. Every pensioner is entitled to inflation related benefits.
3. Every member is entitled to a proportional share of what he or she would have been entitled to as a pensioner in the fund.
4. Any ordinary surplus remaining after satisfying the entitlements of pensioners and early leavers should be apportioned to pensioners and early leavers in equal shares.
5. Any deficit must be made good by the employer over time.

2. Background to the Bill
2.1 The Origins of the "Surplus"

An understanding of how "surpluses" have arisen in retirement funds is critical to answering the question as to who should be entitled to benefit from these "surpluses" and in assessing whether the Bill will effect the appropriate and necessary amendments to the Pension Funds Act.

What is commonly referred to as "surpluses" that currently exist in funds are in fact not surpluses at all, but represent assets that defined benefit funds originally set aside to provide sound investment to meet members’ reasonable benefits expectations. Over the past 20 years a practice developed whereby these assets were not given to members when they left funds as a result of resignation, retrenchment, retirement and outsourcing of pensions. This was in terms of the rules of the Pension Funds which have approved by the Registrar of Pension Funds. It will be impossible for a fund to correct wrong practices retrospect for 20 years and a shorter period would be more workable.

Without any basis in law or equity, the industry has driven the practice of treating actuarial values as market values, even though the former is about a third less than the latter. Members have therefore left their investment reserves in their previous funds and the profit generated by retaining the reserves is then referred to in the industry as "surplus". These profits or "surpluses" have been considerable and have severely disadvantaged many former members of retirement funds, who as a result will have inadequate private provision for retirement.

When employees transfer from a defined benefit fund to a defined contribution fund, employer and employee contributions usually remain unchanged from the levels of contribution in the defined benefit fund. The two funds, pension and provident, therefore run in tandem with the same contribution rates. The same investment process and the same accumulation of assets process take place. However, in the defined contribution fund the members receive full benefit from the investment process. In the defined benefit fund they do not, because of the need to stabilise asset values and meet guarantees.

However, once the guarantee is released, as happens at retrenchment, retirement, transfer, outsourcing of pensioners, there is suddenly and somewhat mysteriously to most observers, a "surplus" or profit in the defined benefit fund. In such instances, the risk has been transferred, but one of the most important means to manage that risk has been left behind, namely, the "investment reserve".

The benefits of members who exited from defined benefit funds were thus calculated in such a way that they left behind a significant portion of the assets that had in fact been paid into the funds to secure their retirement benefits. Employers and trustees convinced members that they were being paid the benefits they were entitled to in terms of the rules of the funds. Members did not have sufficient knowledge of how defined benefits funds worked or access to proper information to realise that they were effectively being robbed of their benefits. When a defined benefit fund is converted to a defined contribution fund, the surpluses are apportioned to members to give an opening balance.

The practice in South Africa is therefore, that while the parallel pension and provident arrangements in almost all companies have the same contribution rates, employers and company shareholders in retirement funds ultimately enjoy the windfall benefit from the release of investment reserves.

The effect of these inequitable practices was to produce "surplus" over and above what existed in funds prior to these events.

FEDUSA recognises that, in a defined benefit fund, after members and pensioners receive their fair share of the fund, the fund's assets may still exceed its liabilities. In such a situation it would be correct to say that a surplus existed in the fund. We will refer to this situation as a surplus. In the normal course of events, the surplus would be a relatively small proportion of a fund. The reason for this is that pension funds are non-profit organisations and that employers would normally avoid building ordinary surplus beyond prudent minimum requirements.

The Financial Services Board (FSB) estimates that these two categories of "surplus" together amount to at least R80 billion in current terms. Most of the R80 billion can be categorised as surplus. When making statements like this there must be elements of truth in this statements but it may only be certain funds. These monies must be returned to their rightful owners – the members and former members of funds. The legislation therefore needs to provide for restitution of members’ retirement benefits. The fact that millions of members of retirement funds do not have sufficient savings in their funds to survive after retirement or retrenchment.

From the late 1980’s up to now many employers stopped paying contributions to the defined benefit funds on a massive scale and used the surplus to fund the contributions for which they were liable in the ordinary course of events. This is referred to as so-called "contribution holidays". The surplus was also allocated to employer reserve accounts.

A particularly disturbing and highly irregular practice that has developed in the South African retirement fund industry is that, when profits or "surpluses" are generated in defined benefit funds, these are frequently transferred to employer reserve accounts in the defined contribution funds. The employer contributions are then paid from the employer reserve accounts. Employers are therefore obtaining a direct financial advantage from the members’ investment reserves. FEDUSA does not condone these practices.

On the one hand it may be argued that the regulatory authorities turned a blind eye to many of these practices. On the other hand, many of the schemes were cleverly structured and designed to ensure that it was not possible to detect from the documents submitted to the authorities what the real purpose of the transaction and rule amendments were.

These schemes saved employers many millions of Rands on an annual basis. However, the assets left behind by members were so extensive that many employers could not use all the assets through their various schemes. Employers got greedier – they decided that they wanted to be able to take all forms of "surplus" money out of retirement funds to use for whatever purpose they deemed fit.

2.2 Ownership of retirement funds and of "surplus"

The object of a retirement fund is therefore to provide retirement benefits to its members and death benefits to its members’ dependants. Employers set up and contribute to retirement funds as a form of delayed remuneration (or deferred wages) to employees. If, with the benefit of hindsight, it becomes apparent that the employer contributed at a rate higher than was actually necessary to fund the benefits of the retirement fund, this does not change the fact that the contributions became part of the assets of the fund. There is no basis in law to argue that an employer is entitled, for reasons of equity or otherwise, to claim back assets which were properly paid in the contemplation of a pattern of investment, withdrawals or whatever, that subsequently proves to be unduly conservative or pessimistic. If a "surplus" arises, it is not distinct from the fund, it remains part of the fund’s assets.

Under the rules, the amount that an employer must contribute is decided by the actuary (who is appointed by the board of trustees). Calculations performed by the actuary depend on a number of assumptions, including the future performance of the investment market. In making these assumptions, actuaries tend to be cautious, and as a result one can, particularly in investment market booms, achieve a significant level of ‘over-funding’. The "surplus", it should be clear, is an actuarial conception. The underlying asset it represents remains the property of the fund, and the fund only.

In South Africa, there is no common law principle or statutory provision that allows a "surplus" in a retirement fund to be distributed to the employer. At common law, trustees are obliged to act in the best interests of the fund. This precludes them from exercising their discretion in order to promote their own interests or the interests of third parties (such as the contributing employer).

South African law acknowledges that the members and beneficiaries of a fund may have benefit expectations in retirement funds that exceed their specific benefit entitlements under the rules. In many funds the rules provide that if there is a substantial "surplus" in the fund benefits may be improved and/or pensions increased. In these funds the members and beneficiaries have expectations that, if there is a substantial "surplus" in the fund and there are more than sufficient assets to allow benefit improvements and pension increases, the trustees will amend the rules to effect an improvement in benefits and will grant reasonable pension increases.

Therefore, legislative amendments which make provision for "surplus" assets to be used for the employers' benefit (other than by way of a reduction by the actuary of the contribution rate required by the employer) would have the effect of diminishing the members’ benefit expectations and would obviously not be in the best interests of the funds and their members.

If the assets of retirement funds had not been used for the benefit of employers, including by way of transfers the contribution holidays to defined contribution funds, the trustees of the fund would have had to exercise their discretion regarding how the assets could be applied for the benefit of the fund and its members. The members therefore had an expectation that their benefits would be improved by application of "surplus" assets in the fund. FEDUSA submits that the transfer or use of assets for the employer’s benefit is at the expense of the rights and reasonable benefit expectations of the members and beneficiaries of the retirement funds.

Notwithstanding the fact that the law currently prevents an employer from using the assets of a defined contribution fund to fund a contribution holiday, the Bill proposes that employers be allowed to do so.

The practical problems arise on how will ex – members claim their benefits. Funds do not have to keep financial information beyond five years. How will these be traced and the amounts confirmed? What will funds who do not have reserves or surpluses do?

In summary, the use of retirement assets for the benefit of the employer constitutes an unlawful alienation of trust money that improperly advantages the employer at the expense of the members and beneficiaries of the retirement fund.

2.3 The Bill and Process of Negotiation

As discussed in section 2.1 above, employers have attempted to devise schemes to extract all forms of "surplus" out of pension funds. However, based on the current statutory and common law provisions, the Financial Services Board (FSB) correctly refused to register rule amendments making provision for the "repatriation of surplus assets". Employers then pressurised for legislation to be introduced to legalise the final plunder of retirement fund assets through the amendment of the Pension Funds Act to make provision for the repatriation of "surpluses" to employers. In June 1998 a Pension Funds Amendment Bill was tabled in Parliament.

The Nedlac negotiations were seriously hampered by business’s unco-operative attitude and foot-dragging using various stratagems including not seeking appropriate mandates before the meetings. This made it extremely difficult to arrive at a consensus on the Bill. Due to business’s attitude Nedlac was unable to deal conclusively with the Bill and develop a comprehensive report that should be tabled before parliament. In other words, the parliamentary process almost has to restart from the beginning. FEDUSA therefore hopes that this process will now conclusively resolve the matter.
2.4 The Adverse Effects of the Absence of Legislation

Delays in finalising the legislation and the fact that no legislation is in place causes serious prejudice to members of funds because "surplus" assets, which are currently in funds, are being reduced on a daily basis.

The FSB are powerless to prevent these practices.

Further, there are social and economic consequences of depriving members of the assets set aside for their retirement. Whether in the manner proposed in the Bill or by repatriation, the use of retirement funds monies by the employers would lead to a number of adverse consequences.

Members, former members, and their dependants are exposed to a much large financial risk than they should be, with potentially dire consequences for workers in this country and resulting social implications. Among these consequences the burden to the state would increase substantially because former retirement funds members would be more reliant on the state social security system due to inadequate retirement benefits. Members that did not receive their full benefits have to deal with the cost of living and supporting their families on meagre pensions. The legislature must be careful to take into account funds that do not have surpluses or reserves and the investment risk is carried by the members, as there might be nothing to distribute.
3. FEDUSA’s core principles and concerns
3.1 A pension fund belongs to its members and no third party should have a legal stake or any claim on the fund

It is accepted in South African law that a pension fund's assets belong to the fund and that it must be preserved for the interests of members.

A central concern of ours is that the Bill elevates employers to the position of a "beneficiary" of the fund by requiring trustees to act in the interest of non-members. The Bill in its current form contains provisions that give the employer the same right as members to benefit from extraordinary and ordinary surplus arising in the past and in the future. This would adversely affect a fund's ability to meet members' reasonable benefit expectations.

The Bill also gives employers unprecedented rights of access to assets in retirement funds for purposes that are contrary to the objects of pension funds.

Much of the abuse of fund assets over the last 20 years could have been avoided had the proper status of the employer as a debtor of a fund been recognised. This recognition would not reduce the bargaining power and influence of the employer, but would ensure that it is exercised in the appropriate forum, namely the workplace, and in the appropriate context, namely that of the employment relationship. This would establish a more consistent and sound approach to the true fiduciary nature of the relationship between trustee and fund and the duty of good faith owed by the employer to the fund.
3.2 Every pensioner is entitled to inflation related benefits

Members either stay on in a fund after retirement age as pensioners or leave the fund with a benefit payment. In either situation, it is necessary to prescribe the minimum inflation related benefits that members can reasonably expect. If members stay on as pensioners, they must be entitled to minimum pension increases.

All pensioners are entitled to inflation related increases. The Bill currently puts an inflation related ceiling on what pensioners will be entitled to. FEDUSA believes that the Bill should provide an inflation related minimum benefit for pensioners.

FEDUSA believes that pensioners are therefore entitled to the greater of the following two values:
· The defined pension increase policy of the fund, as defined in the rules of the fund; or
· What is affordable from time to time, i.e. the excess of the gross investment return over the funding interest rate.

In determining the defined pension increase policy, the fund must give due consideration to meeting pensioners' reasonable benefit expectation of full protection against the effects of inflation.

3.3 Every member is entitled to a proportional share of what he or she would have been entitled to as a pensioner in the fund

Defined benefit funds

If members leave the fund on or before retirement date, they must receive a minimum benefit. Early leavers, regardless of the cause of their exit or transfer, should equally receive the proportional share of the benefits that they would have been entitled to had they remained in the fund until retirement. Equivalent provision must be made to accord members similar protection against the effect of inflation on salaries and on pensions and against the movements of the investment markets.

The Bill only affords members their actuarial liability and does not contemplate members getting their proportional share of the fund. This means that members will not be afforded their share of ordinary surplus and may not receive protection against the economic variables. In addition, the Bill does not provide for a minimum benefit on resignation and dismissals. In terms of the Bill, the Registrar is empowered to regulate the basis for the determination of the minimum benefit. However, the Registrar is not required in terms of the Bill to take into account the way in which funds customarily protected its members against the economic variables.
FEDUSA therefore proposes that the minimum benefit of each member must be his or her proportional share of the fund. The member's proportion of the assets must be the same as the proportion that the member's actuarial liability bears to the total actuarial liabilities. This would mean that the member would receive all the assets in the fund that had been properly and objectively set aside to meet the member's rights and reasonable benefit expectations.

In the past, members have not received all these assets on transfers, conversions or other exits. Therefore, it has become necessary to prescribe what the basis must be for the calculation of the value of the assets and liabilities. FEDUSA acknowledges that it must be a "living" basis capable of responding to changing circumstances and that, to a certain extent, professional actuarial judgement must continue to be exercised. However this flexibility must not detract from the fund's ability to give full recognition to the rights and reasonable benefit expectations of all the members, taking into account the economic variables should it be affordable to the fund.

The definition of "minimum contribution accumulation" and minimum individual reserve in the Bill should be amended in order to give effect to the "share of fund" principle and to the proper recognition of the economic variables that customarily applied.

Defined contribution funds

The same principles should apply to defined contribution funds as in the case of defined benefit funds: early leavers should receive the proportional share of the benefits which they would have been entitled to had they remained in the fund until retirement. In defined contribution funds, the minimum benefit should include both the member's contributions as well as the employer contributions plus all accrued interest for retirement.

The Bill should therefore be amended to give effect to the principle contained in the memorandum that in a defined contribution scheme the members’ minimum benefits should include employer contributions (referred to as Full Fund Credit).

Window period

The Bill currently provides for a phasing-in period for the provision of minimum benefits. FEDUSA acknowledges that in some cases there may be a need for phasing-in periods in the sense of allowing for the effective administration of the new benefit regime. However, the Bill should be amended to ensure that the rights to minimum benefits must vest or accrue from the date of the commencement of the Amendment Act, as opposed to the conclusion of any delayed phasing-in by funds.

FEDUSA is concerned that these window periods will result in prejudice to members and we would like to see greater protection for members in this regard. In addition to the amendment as discussed above to ensure that rights vest as from the commencement of the Act, the above provisions which potentially facilitate the evasion of employers’ minimum benefit obligations should be deleted.
3.4 Any ordinary surplus remaining after satisfying the entitlements of pensioners and early leavers should be apportioned to pensioners and early leavers in equal shares

The apportionment of any ordinary surplus that remains after paying members and pensioners what they are entitled to should be tightly regulated.

Any ordinary surplus remaining in the fund after both members and pensioners are paid their entitlements, should be distributed to members and pensioners in proportion to their actuarial liabilities.

The Bill should be amended to provide that, notwithstanding anything in the rules, ordinary surplus must be included within the scope of the minimum benefit to which each member is entitled. The effect of this would be that, in the ordinary course of events, there will be no surplus available and no employer or member reserve accounts which can be utilised.

· Members must be provided with all the necessary information, including regarding the effect that the allocation will have on their rights and reasonable benefits expectations, and the decision to approve the scheme must be a fully informed one.
· At least 75% of the members of the fund must approve the scheme in writing.

3.5 The same principles that will apply to future benefits should apply to the past and should benefit all former members and pensioners since 1980

The Bill makes provision on how any credit balance in the member surplus account must be used in Section 15D.

FEDUSA can agree with the principle, but an actuarial assessment needs to be done to ensure that current members’ future benefit expectations are not affected. Refer also to 15B.

Funds that currently hold an investment reserve account can easily adopt a guaranteed investment strategy. This places wealth into the investment managers’ hands, which is never disclosed, but used to smooth investment returns. Currently funds, which hold investment reserves, are transparent with their disclosure. It must depend on affordability whether a fund can distribute surpluses or not. It can become a piece of legislation, which is totally unworkable.

3.6 Any deficit must be made good by the employer over time

The Bill only provides for former members to be compensated for their loss of benefits if there are still sufficient funds remaining in the fund to do so. The memorandum suggests that only where distributable surpluses exist will funds be required to pay former members the benefits they should have received at the time of leaving the fund. This will result in a situation in which an employer who has already utilised the assets that were left behind by members and former members will not be required to pay former members their benefits. This also creates a perverse incentive for employers to attempt to deplete the funds in the interim. This, if applied to defined contribution funds under Union control, would not be practical, as all surpluses are paid over annually to members in the Fund Credit Declarations. This can also apply to employer funds.

Section 18 of the Pension Funds Act, which deals with funds that are not in a sound financial condition, applies to all deficits, regardless of the source of the deficit.

3.7 Dispute resolution regarding future minimum benefits and restitution of minimum benefits to past members should be dealt with on the basis of the same principles

The proposed dispute resolution procedure for disputes relating to "surplus" apportionment exacerbates the current problems with the resolution of retirement fund disputes. FEDUSA support an ad hoc specialist tribunal.

4. Conclusion

· A pension fund belongs to its members and no third party should have a legal or equitable stake in the fund.
· Every pensioner is entitled to inflation related benefits.
· Every member is entitled to a proportional share of what he or she would have been entitled to as a pensioner in the fund.
· Any ordinary surplus remaining after satisfying the entitlements of pensioners and early leavers should be apportioned to pensioners and early leavers in equal shares.
· Any deficit must be made good by the employer over time.
· Dispute resolution regarding future minimum benefits and restitution of minimum benefits to past members should be dealt with on the basis of the same principles.

We hope that the Portfolio Committee will accept these principles and effect the amendments to the Bill that flow from them. This would address the inequitable situation which currently exists, restore to members and former members what rightfully belongs to them, and ensure that the same situation does not arise in future.

FEDUSA's Submission on Pension Funds Second Amendment Bill Part 2: Proposed Amendments available from