– By Corné Heymans
The decision to place a fund into voluntary liquidation or, alternatively, to just deregister the fund after the Fund’s assets reduced to zero, generally rests with the Trustees when a fund comes to the end of its life. There are no clear guidelines on which option to follow and one option may not appear to be better than any other. The Trustees are therefore often left to their own devices to make this difficult decision and very few trustees have a full understanding of the potential consequences of the different options at their disposal.
What better way to learn than from someone else’s successes or failures? Some of the advantages and disadvantages of different termination options are illustrated through the following case studies. These real-life stories* highlight a couple of the good, the bad and the downright ugly outcomes that were experienced under these different scenarios.
*(Names and places have been changed to protect the innocent.)
“Really Big Umbrella Fund”
Bulk transfer of multiple employers
Background – This commercial umbrella fund had to terminate due to a corporate restructure of the Fund’s administrator. A new administrator could not be secured and the Trustees considered liquidating the Fund. The liquidation fee of 0.5% of the Fund’s assets appeared excessive to the Trustees. The Trustees could, however, not find a Liquidator who was willing to accept the responsibility and risks associated with a liquidation of this scale for less than the prescribed fee.
The Trustees, being confident that there were no clear and obvious administrative risks, decided to do bulk transfers of the respective Participating Employers to alternative funds and to then deregister the Fund once all assets and liabilities reduced to zero.
The Good – For the majority of the Participating Employers this was a quick and painless transition from one fund to the next.
The Section 14 (Transfer) process is a very time- and cost-effective method to transfer members’ benefits to a new Fund. This also ensures full preservation of retirement benefits and members have continuous access to their benefits if they should retire or withdraw during this transfer process.
The Bad – The distribution of the reserve accounts posed serious challenges to the Trustees as some data or processing variations are bound to accrue during transactions of this magnitude. Managing this moving target became the thing of nightmares for the Trustees. Distributing too much of the reserves too soon could expose the Fund to very real financial risks if there should be any major data or processing variations once the reserves have been depleted. Distributing too little from the reserves at first, on the other hand, could leave a disproportionate balance to be allocated to the last transferring employer.
The Ugly – Not all Participating Employers were cooperative during the transfer process and neither were some of the receiving funds. Certain transfers were therefore significantly delayed.
Time was not on the Trustees’ side, as the next set of Annual Financial Statements became due … and the next set … and another … and now the next Statutory Actuarial Valuation is also due. By this time the sum of all these expenses, plus the cost of having professional Trustees, significantly exceeded the original cost of liquidation. And still there is no end in sight with a couple of stragglers still left in the Fund.
To make matters worse, a substantial unexplained surplus arose in the reserve account as a result of the accumulation of minor processing variations during the transfer process. This could now require agterskot transfers and top-up payments to thousands of members.
The transfer of benefits via the Section 14 process remains the most time- and cost-effective method to move members’ benefits from one fund to another, provided that all parties involved play their part.
Liquidation provides a better structure to manage the distribution of reserves and all processing variations in a regulated and controlled manner.
The liquidation process removes some of the unknown future variables that could, amongst others, impact on the overall termination costs to the Fund.
“Workers’ Provident Fund”
Background – Contributions towards this free-standing fund for the union members of a blue-chip employer ceased following salary restructuring negotiations. The Unions demanded that the Fund pay their members a cash benefit even though members were still employed at the time.
The Fund had a complex history including various legal battles regarding eligibility disputes and the constitution of the Board, amongst others. The Fund’s administration records were also questionable. This history made liquidation the obvious choice for Trustees to protect the Trustees against potential risks and for members to get cash in hand.
The Bad – There were delays in getting the Liquidator appointed as the Fund had many outstanding statutory requirements that needed to be brought up to date first. The Rules of the Fund further had to be amended to allow for the appointment of a Liquidator and the Fund’s assets were invested in non-compliant and illiquid asset classes.
These delays started getting members impatient who already got wind of “imminent” cash pay-outs.
The Good – With effective and pro-active support to the Liquidator, the Union Leadership assisted with communication to their members to manage expectations regarding the liquidation process. The legal issues were resolved and no objections were received from any stakeholders in liquidation, thereby drawing a line under a history that was fraught with operational and financial risks.
The FSCA further assisted with quick turn-around times and the Preliminary Liquidation Accounts were prepared, submitted, advertised and approved for payment to more than 2 000 members within 4 months from appointment of the Liquidator.
The Ugly – The state of the Fund’s affairs created significant initial pressure on the process. Was it not for the close cooperation between the Liquidator, Union Leaders and the FSCA, this could have turned out very ugly very quickly. There have been known past instances where the offices of the FSCA were occupied or where a Liquidator was physically held hostage by disgruntled members who insisted on the immediate payment of their benefits!
Another less tangible but truly ugly consequence of this case, which will only be evident when these members reach retirement age, is that there were almost zero preservation of retirement benefits once members were given access to cash benefits through liquidation.
Through liquidation, the Trustees can achieve complete closure on any legacy legal and administrative issues that could have haunted the Fund in future.
Management of stakeholders’ expectation through proper cooperation and communication is key to the successful completion of any termination process, not only liquidation.
Be wary of assets which are illiquid, e.g. infrastructure bonds or private equity investments, where the costs of early termination can be significant.
Trustees should keep their funds’ statutory affairs in order and make sure their rules allow for any eventuality.
The unfortunate reality is that members, almost without exception, prefer cash over preservation whenever they are presented with this option through liquidation.
“So-and-So and Sons Retirement Fund”
Background – This was a small free-standing defined contribution retirement fund to a family owned business. The Fund only had a single orderly change of administrator in the past. It is a well governed and stable fund that is exempt from the requirement to submit valuation reports.
Following a corporate merger, all employees are now contributing towards the “New Corporate Provident Fund” and contributions towards So-and-So’s fund ceased. All benefits were subsequently transferred and the fund was reduced to an empty shell a couple of months after the merger. An application was submitted to the Authority for the Fund to be deregistered.
The Good – For all practical reasons, the transfer of benefits from the one fund to the other was a mere formality as far as members were concerned. The transfer costs were minimal and all benefits were fully preserved. This could be the scenario for the vast majority of funds that are terminated.
The Bad – The Free-standing DC Fund has still not been deregistered, some 6 years later. And not due to a lack of trying from the Trustees or their advisors, but unfortunately the Authority has not processed this deregistration to date.
The Ugly – While awaiting deregistration, the orphaned child of a former deceased employee came to light who was owed part of her father’s benefit upon reaching maturity. This benefit fell through the cracks during the change of administrators when it was supposed to be transferred to a Beneficiary Trust some 15 years ago. This is therefore a 100% valid claim, but there are no assets left in the Fund to honour it.
The Trustees could therefore be held liable for failing their fiduciary duty to this beneficiary by transferring all the Fund’s assets, even if the Fund was already deregistered.
If the Fund was liquidated, the Trustees would not have faced any liability. The liquidation process includes a formal opportunity for any beneficiaries to lodge any claims, or forever hold their peace. However, this would have left the beneficiary without any recourse if she only lodged her claim after the liquidation was approved.
Luckily for all concerned, the generous employer settled this claim on behalf of the fund which let the Trustees off the hook without any prejudice to the beneficiary.
The Section 14 transfer process can be quick and efficient and preserves members’ retirement savings.
Even if a fund does get deregistered, it does not mean it is dead and buried for ever. Such deregistration can be reversed for various reasons and could present an open-ended liability for Trustees or the Employer if there should ever be any valid claims against the Fund at some point in the future.
Liquidation does provide protection to the Trustees in the long term as it will close the door to any future claims. However, this protection could be at the expense of a former member or beneficiary with a valid claim.
“Sinking Ship Retirement Fund”
Background – The employer of this small Defined Benefit fund went into sudden and unexpected liquidation. These circumstances prompted a compulsory liquidation of the Fund in terms of the rules. The Fund had a large Employer Surplus Account (ESA) at the time.
Mr. IR Greedy, the appointed liquidator of the company, lodged a claim to the Fund’s Liquidator for the balance in the ESA. The Fund’s Liquidator rejected this claim as the employer went into liquidation before the Fund did and, rightfully so, indicated that the value of the ESA will be distributed to members in terms of the Pension Funds Act (as opposed to paying creditors of the company).
The Bad – During the liquidation process, all benefit payments are frozen until such time as the Authority approve the payment of liquidation benefits. Due to the ongoing legal dispute, this approval was not forthcoming.
The Act allows for advance payments to be made in cases of proven “financial hardship”. However, there is no guarantee that such an application will be approved and, if it is, then less than half of the total benefit payment can be advanced.
Given that the liquidation process is so tightly regulated (which is a good thing), there is unfortunately not much room for discretion for the Liquidator to accommodate stakeholders’ expectations (reasonable or not) prior to the Authority’s approval for payment.
The Ugly –The Company’s liquidator had access to company resources to fund his legal battle, regardless of the time and costs wasted, while the wheels of justice were turning at an excruciation slow pace. The court cases dragged on for the better part of 3 years before the liquidation could proceed.
As a result, many of the members, who also just lost their jobs, were left without any access to their retirement benefits. Verbal abuse and threats against the Liquidator from desperate members were at the order of the day.
The Good – The well-regulated liquidation process, in the end, meant that members received their rightful benefit from the Fund, which included a whopping 90% enhancement from the amount in the ESA. (Following which the abuse from members to the liquidator stopped somewhat unsurprisingly!)
The Pension Funds Act favours members over the Employer under these circumstances.
Any legal disputes should be avoided, although members’ rights should be defended where necessary.
Communication to all stakeholders to manage expectations remains a key factor.
The liquidation process is strictly regulated for all the right reasons which provides significant legal protection to all concerned.
Achieving the best outcome for members could take a very long time.
The lesser of two evils
History has unfortunately not proven either liquidation or normal deregistration as the default option to terminate a fund. It all depends on the specific circumstances.
There are clearly advantages and disadvantages to both options. If anything, these case studies illustrated how badly a wrong decision can end, but also that the “right” decision will have some disadvantages that should not be underestimated. Terminating the vehicle that is supposed to support individuals in retirement is unlikely to result in a “good outcome”, whichever way you approach.
The lessons learnt from these experiences are for Trustees to gather all possible information and to obtain expert advice in advance. Then to make the decision that will best serve the interests of all stakeholders, knowing that there may be pitfalls. The key to managing these inevitable pitfalls is to manage stakeholders’ expectations through open and transparent communication.
– Article featured on EBnet on the 13th of August 2020
– By Manja Serfontein
However, the unintended consequences of valuation exemption should be carefully considered as it significantly increases the Trustees’ own responsibility towards ensuring the fund’s financial soundness if they no longer use the services of an actuary to support them in this regard.
The actuarial perspective
Some might argue that an actuary’s role in a defined contribution retirement fund is redundant where the assets in such a fund should, per definition, remain equal to its liabilities. However, for this argument to hold one must assume that the fund’s administration and financial records are 100% accurate at all times.
There are various specialists involved in the prudent management of a retirement fund, each with a different focus towards ensuring the accurate operation of the fund. A consultant provides advice on benefit design and the rules of the fund in accordance with the applicable regulations; the administrator is responsible for the day to day operation of the fund and to maintain accurate member records; investment consultants manage investment portfolios in line with the fund’s strategies; auditors provide an opinion on the fund’s governance and controls and on the reliance that can be placed on financial statements based on, amongst others, procedures and sample testing of some transactions.
Broadly speaking, an actuarial valuation brings together all of the above separate functions to produce a consolidated view of the fund’s overall financial position:
The actuary checks the operation of the fund for consistency with the rules of the fund and any policies of the fund (e.g. investment policy);
He or she further confirms whether all contributions received are reflected in the financial statements and that net contributions towards retirement are accurately allocated to members in terms of the rules;
Investment returns provided by investment consultants are reconciled to returns as reported in the financial statements and those allocated to member records;
Combining the preceding 2 points, the actuary effectively checks that the build-up of each member’s fund credit /member account is correct;
Benefits accrued in the audited revenue account are reconciled with individual member movements on the administrator’s records;
Investment statements are reconciled to the fund’s cashbook. This effectively verifies the accuracy of all cash flows as reported in the financial statements; and
A detailed analysis of experience is then performed to identify and quantify all data or processing variations that occurred during the period since the previous valuation.
There are bound to be some level of processing variations in a fund that will result in unallocated amounts. It is important to thoroughly understand the origin of such unallocated amounts in order for Trustees to make informed decisions as to the utilisation of such amounts. This could include changes in operational processes, corrections to member records where applicable or distribution of any surplus or shortfall amongst members and reserve accounts.
In short, the actuary’s role is to provide an independent professional view on all facets of the fund, i.e. both assets and liabilities, in order to assess the overall financial soundness of the fund. The results of such an actuarial review then allows the Trustees to make informed decisions and/or to implement corrective measures, if required.
In terms of the Pension Funds Act every retirement fund must appoint a valuator and must submit a statutory actuarial valuation at least once every 3 years. However, a fund may be exempted from these requirements if it meets certain criteria. This is commonly referred to as valuation exemption and needs to be renewed once every 3 years.
To apply for valuation exemption, the valuator of a defined contribution fund must certify that the fund meets the following main criteria:
The fund must be fully funded, i.e. assets should exceed all liabilities. For the purpose of this certification the valuator can rely on the results as set out in audited financial statements without performing a review of this information;
The fund may not carry any open-ended pensioner liabilities. All pension payments must therefore be fully secured by annuity policies or, in the case of in-fund living annuities, must be limited to the amount available in the member’s account;
Any death or disability benefits in excess of the value of the member’s individual account must be fully insured; and
The rules of the fund must explicitly provide that any contingency reserve account, other than a processing error reserve, could never have a negative balance. This often requires a rule amendment if the existing rules are not specific enough.
Once valuation exemption is granted the fund no longer has an appointed valuator in its service. The onus is then placed on the Trustees, or any other whistle blower, to notify the FSCA of any subsequent developments that may cause the fund to no longer meet any of these criteria.
Arguments for and against valuation exemption
Being valuation exempt has a number of attractive advantages. The most obvious advantage is the corresponding saving in actuarial fees since it is substantially cheaper to obtain a valuation exemption certificate than to have a statutory actuarial valuation performed.
It also removes other statutory requirements which impacts on both cost and the fund’s administrative burden, like:
transfers in terms of section 14 is no longer reviewed and certified by a valuator;
No valuator’s report is required for inclusion in the financial statements; and
The valuator does not need to certify the financial soundness of any rule amendments.
The downside of valuation exemption is the added risk and responsibilities given to the Trustees and the Principal Officer who take over the responsibility to sign these statutory certifications.
The Trustees expose themselves to the risk that if the fund is poorly administered, they can be accused of not having followed a more rigorous risk management process by having the fund regularly investigated by an actuary. By opting for the valuation exemption route, Trustees are placing a larger reliance on themselves, the administrator, the consultant and the auditor to ensure the fund is properly managed.
Finally, in terms of a lesser known technicality in the Act, an employer remains ultimately responsible to fund any shortfall that may exist upon liquidation of a defined contribution fund that is not valuation exempt. While this does present some protection to members under extreme circumstances, it exposes the employer to a financial risk that they are often not aware of. While a deficit in a well-run defined contribution fund is unlikely, the risk to the employer can only be removed through valuation exemption.
Best of both worlds
We generally recommend that Trustees apply for valuation exemption in order to benefit from the above advantages. However, at the same time we recommend that regular non-statutory actuarial reviews continue to be performed to give Trustees and members the peace of mind that the fund remains in a sound financial position.
Actuarial reviews then become an integral part of the Trustees’ internal governance and risk management framework, as opposed to merely meeting a statutory requirement. This will unfortunately re-introduce some actuarial expenses, albeit at a reduced cost from a statutory valuation, but will provide all the benefits to members and Trustee’s that a statutory valuation would have done without any of the disadvantages.
Valuation exemption is an easy, quick and cost-effective solution to alleviate some of the statutory duties imposed on Trustees of most defined contribution funds. There is however a lot to be said for the confidence that Trustees can derive from a consolidated view of the overall operation of the fund, which can only be provided through an independent actuarial review.
– Article featured on EBnet on the 15th of July 2020
– By Corné Heymans
South Africa, and indeed the entire world, is finding itself in an unprecedented situation of having to deal with a pandemic that is causing havoc in all spheres of life where the “new normal” changes on a daily basis. The challenges are not limited to our physical health, but our emotional and financial well-being is also taking severe strain.
With lockdown restrictions being reduced, the economic activity is slowly coming out of hibernation in most industries. But I suspect that there are still many who will not be able to return to work. Some of these individuals will not just temporarily loose part of their income, but may eventually be unemployed in cases where employers are unable to survive this crisis.
As if it is not already difficult enough to make ends meet from one day to the next, one should at same time also consider how this will change your longer-term retirement plans. The question is how can you possibly meet your immediate financial needs while also keeping an eye on retirement planning?
A break in saving towards retirement
The golden rule when it comes to retirement planning to consistently contribute towards your retirement savings throughout your working life and to preserve these savings when changing employment. This continuous accumulation of savings for retirement is the key to securing an adequate income that will sustain you in retirement.
Both the Pension Funds Act and the Income Tax Act define pension funds, provident funds and retirement annuity funds as structures that are established for the main purpose of providing income in retirement. Contributions to these retirement savings vehicles, where it is offered by an employer, are compulsory and government’s intention is further to make preservation of these benefits compulsory when you change employment.
However, compulsory contributions and preservation of benefits is not necessarily a viable option right now. Many companies are experiencing severe cashflow constraints at the moment and a number of them have already reduced their employees’ salaries. Planning for a comfortable retirement, which can be many years away, is probably the furthest thing from your mind when struggling to pay the bills on a reduced salary.
The retirement industry regulator, the FSCA, acknowledged that compulsory contributions towards retirement benefits cannot be afforded by all right now. In response to this crisis the FSCA therefore now allows employers to temporarily suspend retirement fund contributions under specific circumstances.
This will mean that employers can now redirect contributions to pay salaries or to meet other essential cash flow needs. Suspending employees’ own contributions towards a retirement fund will similarly bolster employees’ take-home salaries at a time when it is needed the most.
(The full communication document from the Authority on the suspension of contributions (Communication 10 of 2020) can be found on the FSCA website at www.fsca.co.za/RegulatoryFrameworks/Industry Communication/Retirement Funds.)
When temporary relief is not enough
The temporary relief from retirement fund contributions will unfortunately not be enough to save all companies. Some employers and staff may need to renegotiate their terms of employment on a more permanent basis. This could include substantial restructuring which, in turn, may lead to the permanent termination of existing retirement funds.
There are unfortunately many companies that will just not be able to survive this crisis. The statistics reported in the news of the number of companies that are not expected to be around once all of this is behind us, is downright scary. Where an employer ceases to carry on business or is liquidated, the company’s retirement fund will in all likelihood also need to be liquidated, depending on the rules of the fund and the nature of the company’s termination.
Upon liquidation of a fund, whether voluntary or compulsory, all contributions and benefits will cease and accumulated savings are distributed to members upon conclusion of the liquidation in about 6 to 12 months’ time. Members will be given the choice to take their accumulated savings in cash or to transfer the benefits to be preserved for retirement in another fund.
Keeping the long-term goal in mind
While the suspension of contributions will give welcome relief in the short term, the impact of such a “contribution holiday” on one’s long term retirement goals should be considered. Some additional savings may very well be required when the world returns to better days again.
The option to cash in one’s retirement savings where this will be possible in liquidation may be very tempting during difficult times. However, it might be near impossible to recover any savings that you dip into right now. Using retirement savings to maintain your current lifestyle may just be postponing the hard times to retirement when you will have even fewer options for any sort of recovery.
Making the right choices
The impact of current circumstances on your financial situation can differ vastly from one person to the next. If this lockdown period is a mere social inconvenience to you which is intruding on your holiday plans, then you are one of a small hand full of the very lucky ones. Chances are that your retirement planning has not changed at all.
On the other extreme, COVID-19 might have drastically changed your financial situation. Survival from day-to-day is priority right now and having access to your retirement savings may be the only solution to keep bread on the table. Retirement planning is out the door for individuals who find themselves in this position, for the moment at least, and making ends meet in retirement will be a problem for the future.
If you are in a position somewhere between the above extremes, you need to plan with an open mind and be prepared to make some tough lifestyle decisions. Having access to suspended retirement contributions for immediate financial relief will certainly be a welcome addition to the monthly budget, albeit perhaps a much tighter one. You should hopefully be in a position to make up these lost savings, or absorb the impact thereof, at a later stage.
There are proposals being considered to allow retirement fund members to withdraw a portion of their accrued retirement savings. It may be justified where people need this money to survive, but it will be very difficult to recover any retirement savings that you may use up during these times. It is therefore critical to protect your retirement savings if this is at all possible, even if it does require some drastic cuts to your current household expenses. The retirement savings that you have so diligently built up may be the only means to sustain yourself in retirement.
We are finding ourselves in uncharted territory and the financial hardship that many people experience right now is unlike anything we could have imagined just a few months ago. We hope and trust that all of us will find a way through this and will be able to provide for our loved ones, not only during these days but eventually also in retirement.
And if you are in the fortunate position not to be affected by this global crisis and are able to assist those in need, we hope that you will find it in your heart to do so. Stronger together. Always.
– Article featured on EBnet on the 2nd of June 2020