You know what they say about assumptions

08 February 2006 Angelo Coppola

The pension funds adjudicator this week issued a landmark ruling in respect of the calculation of benefits for disabled persons in pension funds.

We carry the synopsis and at the end of this we have comments from Naleen Jeram, the deputy pension funds adjudicator on what members should be doing.

FA News also posed several questions to the FSB about the actuarial assumptions and we will carry their response in a separate newsletter.

Dutrieux v Agricultural Research Council Pension Fund
In Dutrieux v Agricultural Research Council Pension Fund, the complainant filed five separate complaints arising from the calculation of her disability retirement from the fund.

The complaint relating to the mortality factor used in computing the amount of her benefit was upheld by the Adjudicator, the other four being dismissed.

The fund is a defined benefit fund, in terms of which a retirement benefit is calculated with reference to years of service and final salary. The complainant was eligible for a retirement benefit on the grounds of disability at the age of 54, and became entitled to receive one third of her benefit in cash and utilize the remaining two thirds for the purchase ofa pension with an insurer.

Actuarial Reserve Value (ARV)
An Actuarial Reserve Value (ARV) was therefore arrived at, representing the funds future liability to her for the payment of a pension over her estimated lifetime. In order to determine an ARV for a member, the fund actuary has to make predictions about future events.

Examples are the projected inflation rate, the amount by which investment return is going to exceed inflation (from which is derived the capital discount rate), the likely pension increases a retiree could expect from the fund over a lifetime, the length of time for which the member is going to live after retirement (mortality rate), and so forth.

In the present case the complainant was entitled to retire early from the fund on the ground of permanent disability arising from her occupation. There was no indication that her disability would have affected her life expectancy in any way.

In line withindustry practice
However, the fund actuary, apparently in line with industry practice, assumed for purposes of calculating her ARV that she was already 65 years at the time of her disability retirement.

Since the complainant was only 54 years at date of retirement, this had the effect of reducing what is normally an estimated mortality rate for women of 82 years by 11 years, resulting in a significantly reduced ARV (that is, the actuary assumed that she would live another 17 years as opposed to 26 years).

According to the fund, all persons who become disabled irrespective of the nature and extent of the disability or state of health of the individual are for purposes of an early retirement benefit fictionally regarded as being 65 years of age at time of retirement to reflect the generally lowered life expectancy of permanently disabled members.

The Adjudicator agreed that mortality tables (life expectancy rates) are generally necessary for calculating future liabilities because it would not be administratively feasible to make more precise estimates about individual members.

However, because they aspire to be prophetic in nature, an attempt is made to ensure that they are as precise as possible. For that reason, mortality tables are usually compiled as far as possible with reference to homogenous groups according to gender, race, and so forth.

However, a group of permanently disabled members is anything but homogenous. There would in fact be tremendous variation with regard to age, nature of disability, extent of disability, impact of disability on general health, impact on mortality, gender differences and so on.

What is average?
The present case was a good illustration of the danger of averaging non-homogenous groups, since the average will only be true for a very small percentage of cases in the middle zone, but untrue for the probably larger proportion of cases which cancel each other out in order to arrive at the average.

In the Adjudicators view the use of this mortality assumption failed the rational proportionality test.

Had the majority of disability members benefited from the assumption at the expense of only the complainant, or a few members, the situation may have been different. But the very methodology suggested that for only very few individuals would the assumption hold true, and the majority would either benefit substantially or be severely short-changed. By implication therefore the discrimination against the complainant (or class of disability retirees) was not justifiable and could not be sustained.
Never assume
Given the small number of cases of permanent disability within a fund relative to other types of retirement fund benefit, there was, according to the Adjudicator, no need to make such sweeping and, for the most part, inaccurate assumptions when empirical evidence could be obtained in each particular case.

This could be established for instance by ascertaining the age of the member, the specific nature of the disability, and information about whether it was likely to have any effect on mortality, and if so to what extent. If needs be, expert medical advice could be sought on a case by case basis.

The Adjudicator therefore directed the fund to establish a mortality factor for the complainant that was appropriate to her particular circumstances, ascertained if necessary with reference to medical evidence, as at the date of her disability.

FA News spoke to Naleen Jeram, the deputy pension funds adjudicator and he indicated that members who are disabled or suffered from ill health and took retirement early should not rely on this judgement if they feel disgruntled. This is particularly the case for members of a defined benefits scheme or provident fund.

If you think that the benefits are out of line, you can request the calculation that the fund and the actuary used, and more importantly, the assumptions that the actuary used to reach the calculation. The fund has to provide you with both.

The life expectancy tables are in order says Jeram. The issue focuses on the fact that there was no medical investigation into the member and the condition, and thus the assumptions were inaccurate.

Once the member has the calculation and assumptions they are then able to evaluate whether they have been discriminated against. A clue would be the age assumption, and if you are or were younger than the age assumption made, well, it is possible that the member may well have a case.

Interestingly enough the actuary of this particular fund made the comment that his assumptions were based on industry norms. The deputy said that they didnt test the validity of this statement as they were looking specifically at this particular claim.

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