The Post Surplus Apportionment Era

If surplus distribution has pre-occupied the minds of those within the retirement fund industry in the last few years, then the Government's proposals to revamp the retirement fund industry will most certainly be at the top of the agenda for the industry for the next few years. The proposals are currently in the public domain for discussion and debate amongst stakeholders.

The Pension Funds Second Amendment Act of 2001 was signed into law by President Thabo Mbeki in December 2001 and had the twin objectives of distributing surpluses in Funds and providing for minimum benefits on exit. For the past six years or so, funds have been pre-occupied with registering either their Nil Surplus Certificates or their Surplus Apportionment Schemes with the Registrar of Pension Funds. Funds that were not able to comply with the Act and the various directives of the Financial Services Board ran the risk of having tribunals appointed by the Financial Services Board to oversee the Surplus Apportionment process.

"Following on from completing their surplus apportionment schemes, the major focus of retirement funds would ordinarily have been on the investment of fund assets and decisions on an appropriate mechanism to pass investment returns to members," says Rob Williams, CEO Aon Consulting. "Governance issues and the governments retirement funding proposals have, however, dominated recent headlines."

The National Treasury has released proposals that have far reaching implications for the Retirement Funding Industry. "If schemes are not allowed to contract out of the proposed National Social Security Fund, this would have serious implications for the viability of existing retirement funds," says Williams. "Additionally, the role of the private sector still needs to be clearly mapped out as government considers the responses of the various stakeholders."

Retirement Funds have benefited greatly from South Africa's strong economic growth and buoyant investment markets. Whilst members have consistently benefited from double digit investment returns over the past few years; it is important to note that these investment conditions may not persist in future. Another interesting debate amongst defined contribution Funds has been the question of how to pass investment returns to members.

According to Williams, traditionally defined contribution funds have smoothed investment returns from year to year, holding back returns in good years and passing more returns when returns are relatively poor. "This was achieved by holding an investment reserve at a fund level. However, legislation now prescribes that exiting members must receive a share of their investment reserve on exit," he says.

Administratively it can be an extremely difficult task to track the investment reserve whenever members exit the Fund in order to precisely determine the exit benefit. In addition the payment of the investment reserve effectively compromises the ability of retirement funds to smooth returns from year to year. There has therefore been a trend towards funds becoming unitised, whereby the full investment returns are passed onto members without any element of smoothing returns at a fund level. Williams cautions that the returns earned by members may be positive or negative.

"Where returns were smoothed, the Fund effectively bore the investment risks in the short term. If members left shortly after a market crash, these members could still have benefited from having a higher reserve value than the corresponding market value," he says. "Under a unitised system, however, the members' reserve value tracks the unit prices of the various investment portfolios and members bear all the investment risks of the market."

Whilst markets are buoyant, these salient features may not necessarily be appreciated by Trustees and members and effective communication is necessary to ensure that members appreciate the nature of the risks they take.

"Members must appreciate that whilst higher exposure to equities provide the potential for high upside returns; the converse is true in that market corrections may affect those portfolios with the highest equity content the most," he says. "Members may seek to mitigate risks by choosing a more conservative investment portfolio although this may not always be in their long-term interest."

Trustee training is also likely to feature high on the agenda of the regulators. Whilst there is some debate on who would be the most qualified to provide trustee training, it does seem that independent trainers who have no vested interests in the Fund may be the most suitable persons to provide objective and unbiased training. Legislation is likely to enforce this position.

Retirement Fund Reforms

Williams says retirement fund proposals are likely to dominate discussions and debates over the next few years. "These reforms have to be seen in the context of governments overall fight against poverty. By making retirement savings and preservation compulsory, government is seeking to ensure that members reaching retirement have an even greater safety net than currently provided by the governments social security program. Currently 12 million South Africans benefit from social security grants which are provided on a means tested basis."

Whilst there are still uncertainties regarding the benefits and the ability of schemes to contract out of the proposed National Social Security Scheme, it will be difficult for funds to make long term decisions on benefit design. Also, importantly, the industry awaits details of transitional arrangements.

Williams advises trustees not to wait for legislation or FSB Directives to address any governance issues. "From compelling Trustees to declare any interests to having a register to record gifts; Trustees should pro-actively seek to embrace a sound governance framework," he cautions. "The same is true for service providers who need to conduct themselves with the utmost honesty and integrity. Where there are grey areas, it is critical that stakeholders act with good faith and the challenge for the Trustees is to ensure that there is an alignment of interests towards members needs."

Retirement Funds have played a key role in assisting millions of South Africans prepare for retirement and in recent times, retirement funds have benefited from buoyant investment conditions.  This has, however, been overshadowed by governance issues that continue to make headlines. The retirement funding industry must appreciate that that in order to win credibility amongst stakeholders, it must address and resolve issues relating to transparency, disclosure and conflicts of interests and also act with the utmost good faith at all times.