PFA rules that salary increases can be capped in defined benefit pension payouts

A defined benefit pension fund cannot be held liable if its rules restrict increases in pensionable compensation since any such large increments can place additional burden on the fund, which it may not be able to fulfil.

This was the gist of three determinations by Dr Elmarie de la Rey, Acting Pension Funds Adjudicator, in dismissing three separate but similar complaints lodged by PJ Durand, R Rossouw and HM Van der Berg against Johannesburg Municipal Pension Fund (first respondent), NMG Consultants & Actuaries (Pty) Ltd (second respondent) and City of Johannesburg (third respondent).

In a defined benefit pension plan, an employer commits to paying its employee a specific benefit for life beginning at his or her retirement. The fund is liable to pay the member’s retirement benefit, but in the event of it being under-funded the employer becomes liable to top up the difference. That is why a defined benefit fund is often referred to as a balance-of-cost fund.

The complaints that came before the Pension Funds Adjudicator concerned the discrepancy between the complainants’ pensionable emoluments and the actual rate of contributions that were deducted from their salaries, which affected their fund value in the Johannesburg Municipal Pension Fund.

The complainants were employed by the City of Johannesburg and were members of the Johannesburg Municipal Pension Fund by virtue of their employment.

During 2001 the third respondent introduced new uniform retirement fund arrangements for its employees in order to eliminate racial disparities and to introduce a single fund for all employees.

In November 2001 the third respondent issued a notice to terminate its participation in the first respondent and its “sister” fund, the City of Johannesburg Pension Fund (CJPF).

However, the third respondent’s participation in the first respondent and the CJPF could not be finalised as a result of a dispute relating to the funding position of both funds.

The funds took the view that the third respondent was obliged to fund certain substantial unfunded benefits in the funds, while the third respondent disputed that it was obliged to do so.

While negotiations were ongoing in order to settle the dispute, the funds’ liabilities continued to outgrow their assets as a result of annual salary increases.

During 2003 the first respondent agreed with the third respondent that pensionable emoluments for the purposes of the first respondent’s rules would increase in future only by the general level of salary increase granted by the Johannesburg City Council from time to time to all employees across the board. This meant that higher salary increases granted to employees would not be taken into account for the purposes of determining their pensionable emoluments.

However, an administrative error occurred in the implementation of the salary increase policy agreed between the first and third respondents. This administrative error, which affected some members including the complainant, resulted in the third respondent deducting pension fund contributions based on the higher salary increases granted to certain employees rather than the general level of salary increases.

In order to resolve this issue, the first and third respondents offered to refund the affected members the overpaid contributions to the fund, plus interest. The refund of the overpaid contributions formed the basis of the complaints.

The funds and the third respondent concluded a settlement agreement in November 2005 that resolved their dispute relating to shortfalls in funding and the restructuring of the funds. In April 2006 the settlement agreement was approved by the majority of members of both funds and the parties are in the process of implementing the agreement.

The complainants maintained that their pensionable emoluments did not reflect the actual rate of contributions that were deducted by the third respondent over the past three years, which was 9.5% of basic salary.

Each complainant’s post was re-graded in January 2006, which resulted in a salary increase. The complainants were advised that in terms of the first respondent’s rules, their pensionable emoluments were restricted to their basic salaries prior to 2005 plus the average annual general salary increases. They were further advised that the salary increases that were granted to them in January 2006 would not be considered in the calculation of their pensionable emoluments.

However, the complainants asserted that their monthly pension contributions had remained at 9.5% of total monthly salary (including the salary increase) and they were not advised that their pension fund contribution rate had been restricted.

Therefore, the complainants submitted that as a result of the failure of the respondents to inform them of the restriction on their pensionable emoluments, they had a legitimate expectation that their pension benefits would be based on the actual pension contributions (including salary increases) that were deducted from their salaries.

The complainants requested the Pensions Funds Adjudicator to determine whether or not the first and third respondents should be held liable to pay their pension benefits on the basis of the actual rate of contributions that were deducted from their salaries as they believed that they had suffered financial prejudice in this regard.

The second respondent filed a response on behalf of the first respondent in its capacity as its administrator. It submitted that the policy of restricting increases in pensionable salary has been in existence since 2003 and was adopted in terms of the first respondent’s rules.

 

The second respondent confirmed that the third respondent had advised the first respondent of its intention to terminate its participation in the fund, which it rejected on the basis that it had to fund a shortfall that existed in the first respondent.

The first respondent had to take legal action against the third respondent in order to force it to continue paying contributions to the fund and also to continue funding certain benefit entitlements, which were in dispute. It indicated that the third respondent had also taken a unilateral decision to pay a lower rate of contribution on behalf of members to an alternative defined contribution fund.

In parallel to the legal action between the parties, there was a process of trying to reach a negotiated settlement relating to the rights of members and the fund’s liabilities.

It averred that the objective of the first respondent during the negotiations was to ensure that the first respondent had sufficient assets to meet its accrued liabilities as a closed fund without any further funding from the third respondent.

However, while the negotiations were ongoing, the first respondent’s liabilities were growing due to large increases in annual salaries and other changes that affected the computation of pensionable emoluments.

This led to the conclusion of an agreement between the first and third respondents, which provided that members’ pensionable emoluments would in future increase by the average level of salary increase granted by the Council from time to time to all its employees. This decision was in terms of the fund’s rules and the policy was communicated to members in various forms, as well as in benefit statements that were issued to them.

The second reason that necessitated the introduction of a restriction on pensionable salary increases was that the third respondent implemented a programme which resulted in members moving from a basic salary structure to a total cost to employer package structure.

The cost to employer structure had adverse implications for the financial well-being of the first respondent as it was open to manipulation by employees in relation to the pensionable salary component.

The definition of “pensionable emoluments” in the first respondent’s rules gives the

fund the right to limit annual increases in pensionable emoluments if it exceeds

inflation.

The above rule is important for a defined benefit fund such as the first

respondent since increases in pensionable salary can place onerous additional

liabilities on the fund. The risk to the funding level of the first respondent is acute in

circumstances where the fund is likely to terminate or to become a closed fund.

The first respondent decided to refund the overpaid contributions to the third

respondent. However, it submitted that this offer was clearly unacceptable to the

complainants as they sought an order that they be entitled to a benefit calculated

on the basis of pensionable emoluments that were higher than the pensionable

emoluments set out in the first respondent’s rules. It contended that the

complainants were not entitled to be paid benefits not provided for in the first

respondent’s rules and in excess of the amounts held in the fund for their benefit.

Dr De la Rey said in her determinations that the point to be considered was whether

or not the complainants were entitled to have their pensionable emoluments in the

first respondent computed on the basis of their actual salary, which was in excess of

the general pensionable emoluments increases as agreed between the first and the

third respondents.

She said from the definition of “pensionable emoluments” read together with

Rule 30(1) (a) of the first respondent’s rules, the board of management may

determine the limit of increases in annual pensionable emoluments.

The board exercises this power in consultation with the employer, the Council and

an Actuary and having regard to the Consumer Price Index (“CPI”) for

Witwatersrand. The power to determine pensionable emoluments included the

right to prescribe restrictions on annual increases in pensionable salary if

these exceeded inflation.

“This tribunal is satisfied that there was a rational basis for the restriction on

increases in pensionable emoluments.

“Firstly, the limitation on increases in pensionable emoluments had to be

implemented in order to deal with the increasing liabilities of the first

respondent as a result of annual salary increases that were granted to

employees while the parties were negotiating a settlement.”

“Secondly, the restriction was important as the first respondent is a defined

benefit fund and as a result any large increases in pensionable salary would

place additional future liabilities on the fund, which it may not be able to

honour,” Dr De la Rey said.

.

The Pension Funds Adjudicator ruled that the complainants did not suffer any loss or financial prejudice as they were not entitled to have their pensionable emoluments computed on the basis of increases to their pensionable emoluments that were higher than the agreed percentage.

All three complaints were dismissed.