RETIREMENT FUNDS – DISTRIBUTION OF SURPLUS

This is another article in our series on the boards of trustees of retirement funds, sponsored by Liberty Life to inform trustees in the public interest. Liberty Life does not endeavour to promote, through the content, its own products or services.

The Act provides that, after deducting the cost of increases to former members and pensioners, the balance of the actuarial surplus should be equitably split between existing members, former members and the employer, in such proportions as the board has to determine after taking into account the financial history of the fund.

This article looks in more depth at the distribution of surplus in retirement funds.

Introduction

The Pension Funds Act was amended to redress what is now perceived by the authorities to be abuses of surplus in the past. This was brought about by the Pension Funds Second Amendment Act, 2001 (“the Surplus Act”), and it provides for the distribution of actuarial surplus to:

Former members who, on leaving the fund after 1 January 1980, received less than their full share of the fund.

They may be entitled to receive the difference between the benefit they actually received and their full share of the fund or the actuarial reserve at the time, together with interest calculated to the present day.
Pensioners receiving an income from the fund, and deferred pensioners, if the pensions have not been increased to counteract inflation since their retirement.

Pensioners who have been outsourced by the fund at the surplus apportionment date are former members and will qualify to share in a surplus distribution.

After the needs of former members and pensioners have been met, existing members and the employer should be looked at.

Surplus apportionments must be done to the later of 1 January 1980 and the commencement of the fund.

What is surplus?

Surplus in relation to a defined-contribution fund means the assets in excess of the total sum of the individual shares of the members.

This surplus could have arisen from:

Members leaving the fund with a benefit less than their full share of the fund.
Any additional or ad-hoc contributions made by the employer.

In relation to a defined-benefit fund surplus is the excess of assets over the actuarial liabilities of the fund, based on actuarial assumptions. Surplus could arise due to:

Investment returns in excess of those anticipated by the actuary in setting the contribution rates.
Over-contributions made by the employer.

Minimum benefits

In terms of the Surplus Act, members are also entitled to minimum benefits upon the occurrence of certain events. The minimum benefit is the member’s “minimum individual reserve”.

In the case of a defined-benefit fund, the minimum individual reserve is the full actuarial value, and in the case of a defined-contribution fund, it is the member’s share of the fund. In both instances this means a refund of both employer and member contributions with fund interest, as well as a share in certain reserve accounts.

As regards active members, minimum benefits are payable irrespective of the member’s reason for
leaving the fund, ie on:

Resignation
Dismissal
Retrenchment
Transfer
Conversion from defined-benefit to defined-contribution fund, and
Liquidation of a fund after 7 December 2001

Minimum pension increases

The Act also prescribes minimum pension increases where pensions are being paid from a pension fund, ie the lesser of a full inflation adjustment and the increase that the fund can afford.

In addition, trustees must set and communicate a policy concerning a target pension increase and must aim to pay increases in line with or in excess of the amount implied by this policy.

The minimum pension increases must be reviewed at each statutory valuation date, which in the case of a defined-benefit pension fund is once every three years and probably once a year for a defined-contribution fund.

Timing of minimum benefits

The effective dates on which minimum benefits became payable, were as follows:

Funds in existence at 7 March 2002

The minimum withdrawal benefit payable on a member’s resignation, dismissal, retrenchment or transfer to another fund applies within 12 months of the fund’s surplus apportionment (statutory valuation) date.

Any fund that liquidates or converts from defined benefit to defined contribution after 7 December 2001, but before the fund’s surplus-apportionment date, must introduce minimum benefits from the date of liquidation or conversion, as the case may be.

Minimum pension increases apply from the surplus apportionment date on or after 7 December 2001.

Funds registered on or after 7 March 2002

The minimum benefits on withdrawal and the minimum pension increases apply from the date of registration and must be provided for in the rules of the fund.

Surplus-apportionment dates

Although the legislation envisages that valuation exempt funds (eg insured defined-contribution funds) should also be subject to the surplus-apportionment and minimum-benefit provisions, it does not provide for dates from which such provisions can be effected.

Regulation 36, which was issued in April 2003, rectifies this omission.

Regulation 36 provides that the Registrar must withdraw valuation exemption from a fund at the end of the:

financial year after 7 December 2003 if the fund is audited
scheme anniversary following 7 December 2003 if the fund was audit-exempt.

This will be the fund’s surplus-apportionment date and the fund must submit an actuarial valuation to the Registrar as at such scheme anniversary or financial year-end.

A fund that, after compliance with these requirements, satisfies the Registrar that there is no surplus to apportion, can reapply for valuation exemption.

The surplus-apportionment process

A valuation is required to determine if the fund has a surplus.

Step 1
The actuary must value the fund’s assets and liabilities (including contingencies) at the fund’s surplus-apportionment date.

Step 2
The actuary must value any improper usage of surplus* by the employer prior to the surplus- apportionment date and add it to the above.
If the amount allocated to the employer pursuant to the surplus-apportionment exercise is less than the value of improper usage, the difference constitutes a debt that the employer owes to the fund. The employer must then pay the debt within such period as agreed with the trustees of the fund.

The following are regarded as improper usage of surplus: 
Benefit enhancements paid to executives from surplus on withdrawal or retirement, which they would not have received if they were ordinary members.
Added years of service awarded to certain members and funded from the surplus.
Any contribution holiday taken by an employer after the passing of the Act is considered an improper usage of the surplus by the employer.
Increases in retirement benefits in lieu of post-retirement medical-aid subsidies.

The Registrar may exclude these improper usage amounts if he is satisfied that the stakeholders
properly negotiated the utilisation of the surplus at the time.

Step 3

If the fund has a surplus, former members (ie those who left the fund on or after 1 January 1980) must be brought up to the minimum benefits. That means they must be paid the difference between the minimum individual reserve and the withdrawal benefit paid on the date of exit from the fund, together with interest over the period.

Pensioners must also be brought up to the minimum pensions.

The above must be done pro rata if there is insufficient surplus.
Step 4

The balance of the surplus will be split equitably between existing members (which include pensioners), former members and the employer in such proportions as the board of trustees will determine after taking account of the financial history of the fund. In this regard, the Registrar may prescribe the methods to be followed.

Trustees’ duties

The trustees must draw up a surplus-apportionment scheme as at the valuation date coincident with or following the commencement date of the Act (7 December 2001), otherwise known as the surplus- apportionment date.

The responsibility for the apportionment exercise is placed squarely on the shoulders of the board of trustees. They must investigate matters thoroughly and then exercise their discretion in the apportionment of surplus.

The trustees must inform former members, active members, the employer and funds to which former members may have been transferred of the surplus-apportionment scheme in a clear and understandable manner. These stakeholders must be allowed 12 weeks from the date they receive the communication to lodge any complaints in writing to the board. The trustees must handle any objections adequately.

If there are no complaints, or if the objections have been dealt with adequately, the trustees must submit the surplus-apportionment scheme to the Registrar for approval and this must be done within 18 months from the surplus-apportionment date.

Representative for former members

The trustees must appoint a former member representative to represent the interests of former members and to assist the board with:

- identifying former members
- communicating proposals to former members
- conveying their proposals to the board, and
- collating any objections.

The former member representative must also submit a report to the Financial Services Board on the adequacy of the steps the trustees took to include former members in the surplus apportionment and whether or not they have exercised their discretion in a reasonable manner in this regard.

Specialist Tribunal

The decision taken by the board of trustees (as reflected in the surplus-apportionment scheme) is subject to the approval of the Registrar of Pension Funds, whose approval will be of no force and effect unless all the prescribed documentation has been presented to him.

If the trustees fail to submit the surplus- apportionment scheme to the Registrar within the prescribed period or cannot satisfy the Registrar that the scheme is fair and equitable, the Registrar will require that the trustees refer the apportionment of surplus to a specialist tribunal, which will then exercise the powers of the trustees and submit its recommendation to the Registrar for approval.

The matter could also be referred to the tribunal at the request of the trustees or the former member representative.

Future use of surplus

1. Active members

The Act prescribes that specific member and employer surplus accounts must be created and, once the surplus has been allocated to the respective stakeholders, they will obtain a right thereto. The surplus allocated to the member surplus account can be used to:

   - improve the benefits of existing members

   - improve the benefits previously paid to former members, or the amounts previously
      transferred in respect of former members

   - reduce current member contributions

   - meet expenses that would otherwise reduce benefits.

The employer-appointed trustees on the board will not have a vote on the usage of surplus allocated to members. Only member-elected trustees may vote.

2. Employer

The surplus allocated to the employer may be used for the following purposes, notwithstanding anything to the contrary in the rules:

   - funding a contribution holiday

   - improvement of benefits

   - transfer to the employer reserve account in another fund in which the employer participates

   - payment in cash, but only on liquidation of the fund, or to avoid retrenchment
   of a significant proportion of the workforce.

The surplus allocated to the employer will be under its control, therefore the member-elected trustees will not have a vote in respect of the use of the employer surplus account.

Some practical advice to trustees

The following suggestions might be helpful to prepare your fund for the apportionment exercise:

Conduct a preliminary exercise to see if there is likely to be a surplus. In the case of a defined-contribution fund, the existence of a reserve account is proof that the fund has surplus.
Prepare a standard letter to respond to enquiries. It should contain the surplus-apportionment date, make allowance for people to leave their contact details and give the name of a contact person for enquiries on the progress of the exercise.
The law requires that trustees actively seek out former members. A few ways of doing this are via:
   - Fund records
   - Trustee minutes
   - Payroll records
   - Advertising in the press
   - Asking existing staff
Former employees might contact you as soon as the news gets around. Insist on some proof of former employment, such as a pay slip, tax returns or even an affidavit if necessary. Bear in mind that some former employees may not have qualified to be members of the fund at all, so just being employed is not necessarily adequate proof.
Once former membership has been established, the biggest hurdle will be to work out what benefit was actually paid so that it can be topped up to the minimum. Fund growth since leaving will also have to be added and taken from the surplus.