NATIONAL TREASURY

Presentation to the Portfolio Committee of Finance

on thePension Funds Second Amendment BillAugust 21, 2001

Structure of presentation

• Broad principles

• Technical issues

Broad principles

Objectives of the Bill

• Achieve minimum benefits in future

• Top up past transfers, conversions and retrenchments (based on same principle)

• Apportion residual surplus

Government’s plan for negotiation process

• To seek consensus, guided by a set of principles

• To complete negotiations within 6 weeks

• Due to the complexity of issues and extent of entrenched views it took longer – Formal NEDLAC process (March 2000-01)– Preceded by bilateral consultations

Risk of protracted process

• Negative market impact

• Continuing applications to repatriate with FSB

• Extended negative effect on equity

How complexity of issue was addressed

• Four parallel processes– Broad plenary engagements– Small technical committee of experts

(Dirty dozen)– Bilaterals– Meeting of principals

History of negotiations

• In 1998, draft Bill was brought to Parliament• Organised labour objected on inadequacy-

withdrawn• Subsequent discussions

– Organised labour

– NEDLAC

> GOVERNMENT WANTED A SOLUTION BY CONSENSUS

Problem

• R80 billion of actuarial surplus– 12/1998: R410 billion of assets in private and

underwritten funds– 20% surplus based on fair value of assets

Problem (cont.)

• Are we still talking about R80 bn?

• The answer to this has different implications, depending on which side of the figure it lies

> Assets in 12/1999: R445 billion?

Problem (cont.)

• R80 billion of actuarial surplus

• concentrated in funds with few members

• current legal position: – Supreme Court of Appeal:

• no party has a right to it, in law• stakeholders should negotiate• legislation preferred

– Appeal Board: • pay residual surplus to employer on liquidation

Status quo

• Surplus is concentrated in funds with few members– surplus sterilised – no economic use– ripe for liquidation

• If liquidated, surplus goes to employer

DENYING ANY SHARE TO FORMER MEMBERS

4 major causes of surplus

• Transfers / retrenchments

• Low pension increases and return to members

• High real returns

• Conservative approach to funding

Low pension increases and interest rates

• If pensioner assets earn 2% more than is used for pension increases, surplus grows: + 9% after 5 years+ 19% after 10 years+ 30% after 15 years

• Many funds gave interest of 4% per annum compound or less while earning 15% or more

Effective real return - pa; quarters ending on date shown Universe compared to CPI

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Quarter ending

%

5 years

10 years

Lack of representivity and disclosure

• Most trustees appointed by employer

• Right to elect at least 50% of board of trustees by members, only effective after 15 December 1998

• Little differentiation between employer and fund

• Insufficient disclosure to members in transfer situation (Lack of knowledge?)

Government view: Members, former members and the employer should participate

in any use of surplus

Rationale: They all contributed

Government Principles • Equity• Risk sharing

– No obligation to fund deficit• Savings • Separate past from future

– Address risk sharing issue– Puts obligation on employer to fully fund– Gives right to surplus in future

• Preserve stability of sector– Safeguard savings health of economy– Do not turn surplus funds into deficit– Manage expectations

Labour’s views

• Recognise need for legislative change

• Purpose is to provide benefits to members and dependants

• Employer may not benefit in cash, but

• Employer may reduce contributions, by taking contribution holidays

Labour’s views

• 1999:– Past transfers inequitable;

transfer value = asset share

– Inflation proof pensions & improve minima

– Top up former members

– No payment to employer

– Distribute balance of surplus to members on exit

• 2001– Past transfers inequitable;

transfer value

= AL x FV / AV of assets

– Inflation proof pensions

– Top up former members

– No payment to employer

Business’ views

• Recognise need for legislative change

• Actuarial conservatism caused over-contribution by employer

• Contribution holiday is a right

EMPLOYER “OWNS” THE SURPLUS

• Past transfers and retrenchments negotiated at arms length –no justification for review

• Unfair burden on Trustees to undertake reparation of past inequities

Business’ views

• 1999– No retrospectivity– Contribution holiday is a

right– Duty to fund deficit =

employer owns surplus– State to use tax on

surplus paid to employer for social objectives

– Limit going back in time

• 2001– No retrospectivity– Contribution holiday is a

right– Duty to fund deficit =

employer owns surplus– State to use tax on

surplus paid to employer for social objectives

– Limit going back in time

Areas of potential compromise

• Minimum benefits in future (in order to satisfy members’ reasonable expectations)

• Top up past transfer, conversion and retrenchment values, and current levels of pensions

(redress past inequities)

Once problem of past inequity addressed

• Allow the members and employer to participate in apportionmentMembers: benefit improvement or credit surplus

accountEmployer: credit surplus account

Principles embodied in Bill and Regulation: Future

• Fair minimum benefits

• Apportion surplus in rules or by trustee decision

• Time to renegotiate benefit levels if minimum will cost too much

• Make the employer responsible for funding any deficit

Principles embodied in Bill and Regulation: Past

• Review financial history: – significant transfers, conversions, retrenchments –

members affected and terms offered

– source of surplus

• Increase benefits as prior charge on surplus: – significant transfers, conversions and retrenchments

– pensions and deferred pensions

• Apportion remaining surplus equitably between the members, former members and the employer

Retrospectivity limited

• Existing surplus

Plus• Surplus used improperly

– Higher benefits for executives

– Pensions in lieu of post retirement medical subsidy

– Past service benefits to transfers into fund

> No impact on past contribution holidays

Retrospectivity limited (2)

• Within realistic and credible limits– Consider significant transfers

– Reasonability in identifying beneficiaries

– Consideration of availability of records

> 20 years

Member and employer surplus accounts

• Member• Benefit improvements • Subsidy of expenses / contributions

• Employer: • contribution holidays, • selective benefit improvement including post retirement

medical subsidies, • transfer between funds, • payment in cash on liquidation or to avoid retrenchments

following negotiation in terms of section 189 of LRA

What will this achieve?

• Correct past “unfair” benefits

• Share surplus between stakeholders

• Give rights to apportioned surplus

• Avoids shock to national savings levels

• Achieves equity and risk sharing

Technical Issues

Features of the Bill and Regulation

• Definitions• Section 14A introduces minimum benefits

(determined in terms of section 15K) • Section 14 is amended to refer to the

minimum benefits• Sections 15A to 15J apportion surplus• Section 15L introduces a specialist tribunal

to apportion surplus

“Minimum individual reserve”

• DB: fair value equivalent of the present value of the member’s accrued deferred pension

• assumptions to be prescribed by Registrar• Technical committee• reasonable increases before retirement

• DC: member’s individual account value plus a proportionate share of reserves excluding employer surplus

“Minimum pension increase”

• Lower of – rate of increase supported by accumulated

pensioner reserve, taking account of board’s intention with regard to future increases

– Consumer Price Index from date of retirement

“Minimum contribution accumulation”

• own contributions

plus

• interest rate reasonable in relation to the nett investment return earned by the fund (allowing smoothing)

plus

• vested employer’s contributions

Changes to Section 14

• Service prior to the date of transfer

• Reference to minimum benefits

Section 14A

• “minimum individual reserve” if – retrenched, transferred, or converted after surplus

apportionment date + 12 months

– liquidated after commencement date

• “minimum pension increase” on surplus apportionment date and every 3 years thereafter

• “minimum contribution accumulation” from scheme anniversary after commencement date

Section 15A

• Surplus belongs to the fund

• Members and employer get rights after apportionment

• Employer can only use surplus apportioned to the employer surplus account– Contribution holiday between commencement

date and surplus apportionment date

15B: Surplus apportionment scheme

• Effective date = “surplus apportionment date” • 15 months thereafter to submit• Board of the fund determines

– who participates, – how much to retain in reserve, – amounts to go to the stakeholders and – how amounts to be used for members and former

members will be applied AFTER TAKING ACCOUNT OF THE FINANCIAL HISTORY OF THE FUND IN THE MANNER PRESCRIBED BY REGULATION

Surplus apportionment date

• Ongoing fund: – statutory actuarial valuation coincident with, or next

following, the commencement date• spreads exercise over three years + 15 months• minimise cost as valuation is required• advance date if board wants to apportion earlier

ALL FUNDS WITH SURPLUS WILL BE SUBJECT TO ACTUARIAL VALUATION (existing exemptions will be removed)

• Liquidation: – effective date of liquidation

Regulation: How far back?

• Significant transfers / conversions / retrenchments in last 20 years– 10% of members, minimum of 50

• Limit if data not available provided reasonable steps taken to obtain data

• May not exclude existing employees

Regulation: How much?

• Top up former members to lower of – minimum benefit– accrued liability x FV / AV of assets as a prior

charge

• Top up pensions to minimum

• Function of size and financial history– simple formula for small funds

Regulation: What if the fund is then in deficit?

• Add “surplus used improperly” to the existing surplus

• Deficit after top up = debt owed by employer

OTHERWISE ONLY APPORTION EXISTING SURPLUS

Why do this through regulation?

• Every fund has – different sources of surplus – different past uses of surplus – different amounts paid to past transfers, conversions and

retrenchments

• Data availability will differ • Methods may have to be adjusted if they prove

impracticable

REGULATION IS MORE FLEXIBLE

Recognise preference for legislation

BUT • UK forced to reconsider MFR

– Hard-coded– Insufficient ongoing consultation

• Circumstances will change – need flexibility

Process

• 75% of the board must approve• stakeholders cannot veto• valuator opinion • Stakeholders:

– informed / right to object / board to resolve

• Registrar – independent actuary– approve if reasonable and equitable– specialist tribunal

Apportionment of future surplus

• Board of the fund decides

or

• Rules of the fund determine

Utilisation for members and former members

• Improve benefits

• Reduce current contributions due

• Meet expenses which would otherwise reduce benefits for members

Utilisation for the employer

• Contribution holiday• Pay pensions in lieu of post retirement medical

subsidies• Pay expenses• Selective benefit improvement• Transfer to employer surplus account in another

fund• Pay in cash to employer on

– Liquidation– To avoid significant retrenchments

Existing employer reserve accounts

• Transfer to employer surplus account if Registrar is satisfied that contents were negotiated between stakeholders in a manner consistent with the principles behind sections 15B and 15C

• Treat any balance remaining as surplus to be apportioned

Rights to surplus accounts on exit

• Board of fund must consider whether members should share in member surplus account, investment reserve account and contingency reserve accounts on exit– proportionate share as default

• Members have no right to share in employer surplus account on exit

Funding of deficits

• Use surplus accounts proportionately to fund deficit

Liquidation

• Use reserve accounts and surplus accounts to satisfy members’ reasonable expectations as prior charge

• Distribute any remaining balance in member surplus account, investment reserve account and contingency reserve accounts amongst members

• Pay balance in employer surplus account to employer

Use of employer surplus to prevent job losses

• If negotiations in terms of section 189 of LRA have confirmed the need to retrench if additional capital is not obtained– Disclose to members– 2/3 of members must approve– Apply to Registrar

Objections

• Once apportioned, money will be spent • Resolve objections to scheme before

approval – Board– Registrar– Specialist tribunal = panel of experts– Appeal Board– Exclude Pension Funds Adjudicator

Specialist tribunal

• Replaces board

• Panel: lawyer, actuary + another

• Access information

• Hear parties

• Make a determination

• Record to be retained and to be available to public

30(3): Deficit to be a debt if employer liquidated

• Previously, employer could walk away

• If employer is to get rights to surplus, then employer must have an obligation to fund deficit

Additional information

Typical TransferBefore Transfer After

Fair value of assets 115 64 51

Actuarial value of assets

100 64 44

Liabilities 80 64 16

Surplus (AV) 20 0 28

Funding level (AV) 125% 100% 275%

Surplus (FV) 35 0 35

Funding level (FV) 144% 100% 319%

30/9/1998 (after crash)

No. FV assets Surplus Ave F/L

<100% 3 109 (21) 84%

100-110% 43 14810 703 105%

110-120% 10 19879 2645 115%

>120% 22 31144 9235 142%

Total 78 65942 12562 124%

Effect on funding level of 2% higher real return

139%35

132%30

126%25

120%20

114%15

109%10

104%5

Ratio of fair value of assets to accrued liability

Period from entry