Stock Exchanges Control Amendment Bill; Pension Funds Amendment Bill: briefing & finalisation; Pension Funds Second Amendment Bi

1. INTRODUCTION

2. BACKGROUND TO THE BILL

2.1 THE ORIGINS OF THE "SURPLUS"

2.2 OWNERSHIP OF RETIREMENT FUNDS AND OF "SURPLUS"

2.3 THE BILL AND PROCESS OF NEGOTIATION

2.4 THE ADVERSE EFFECTS OF THE ABSENCE OF LEGISLATION

2.5 THE PARLIAMENTARY PROCESS

3. MAJOR OUTSTANDING CONCERNS

3.1 EMPLOYER ACCESS TO SURPLUS

3.2 STRUCTURE OF THE BILL AND REGULATION

3.3 DEFINING "IMPROPER" USE OF SURPLUS

3.4 POSSIBLE EXCLUSION OF CERTAIN CATEGORIES OF FUNDS

3.5 POTENTIAL FOR AVOIDING/EVADING THE LEGISLATION

3.6 HOW EMPLOYERS CAN USE THE SURPLUS

3.7 INSTITUTIONAL ISSUES

4. ANNEXURE A: LEGAL AND ACTUARIAL BACKGROUND TO COSATU'S SUBMISSION

4.1 THE NATURE OF RETIREMENT FUNDS

4.2 HOW "SURPLUSES" ARE GENERATED

4.3 EMPLOYERS DO NOT HAVE A RIGHT TO BENEFIT FROM THE "SURPLUS" ASSETS OF A FUND

4.4 RIGHTS AND DUTIES OF THE TRUSTEES

5. ANNEXURE B: GLOSSARY OF TERMS

1. Introduction

COSATU welcomes the opportunity to address the Select Committee on Finance on the Pension Funds Second Amendment Bill ("the Bill"). The Bill is of tremendous significance – and concern – to our members, and workers and former workers in general. We believe that the Select Committee has an important role to play in ensuring that, by the time the legislation is enacted, it provides adequate restitution to the victims of the past looting of pension funds by business. We need to address the inequitable situation which currently exists, restore to members and former members what rightfully belongs to them, and ensure that the same situation does not arise in future.

COSATU has been extremely disappointed at the passing of the Bill by the National Assembly. As it currently stands the Bill will deprive hundreds of thousands workers and former workers of the full value of their hard-earned pensions. Instead it will legalise certain forms of past looting by employers and give them further access to the R80 billion "surplus".

This is a highly explosive issue for workers, understandably given that it is their own pension assets which employers are hoping to gain further access to. COSATU has engaged in a lengthy process in order to get our proposed principles taken on board. While the Portfolio Committee has effected some improvements to the legislation, significant sections of the Bill are still unacceptable to us in the present form.

The Bill has been described by some as a "compromise", a "balance between the positions of business and labour". A crude analogy is if goods are stolen, and the thief is told that as a compromise he need only return some of the goods, to balance between the thief’s desire to keep the stolen property and the victim’s desire to have their own goods returned to them. This is clearly not a just resolution of the matter.

In COSATU’s submissions we have outlined the seven core principles which we believe should inform the resolution of the "surplus" issue, namely:

The Bill as it stands does not fully give effect to these basic principles, and would fail to ensure that people are able to access their hard-earned pensions. Members, former members, and their dependants would be exposed to a much large financial risk than they should be, with potentially dire consequences for workers in this country and resulting social implications. Among these consequences the burden to the state would increase substantially because former retirement funds members would be more reliant on the state social security system due to inadequate retirement benefits. Members that did not receive their full benefits have to deal with the vagaries of cost of living and supporting their families on meagre pensions.

The weaknesses of the Bill also raise constitutional questions and we are seeking legal advice on the options open to us in this regard.

Much of this submission is actually background information around the origins of the "surplus", the nature of retirement funds, and the background to this process. Section 3 of the submission summarises and clusters our key outstanding concerns with the Bill. COSATU will be able to provide legal drafting to remedy these outstanding concerns.

1. Background to the Bill

An understanding of how "surpluses" have arisen in retirement funds is critical to answering the question as to who should be entitled to benefit from these "surpluses" and in assessing whether the Bill will effect the appropriate and necessary amendments to the Pension Funds Act.

What is commonly referred to as "surpluses" that currently exist in funds are in fact not surpluses at all, but represent assets that defined benefit funds originally set aside to provide sound investment to meet members’ reasonable benefits expectations. Over the past 20 years an inequitable practice developed whereby these assets were not given to members when they left funds as a result of resignation, retrenchment, retirement and outsourcing of pensions.

Without any basis in law or equity, the industry has driven the practice of treating actuarial values as market values, even though the former is about a third less than the latter. Members have therefore left their investment reserves in their previous funds and the profit generated by retaining the reserves is then referred to in the industry as "surplus". These profits or "surpluses" have been considerable and have severely disadvantaged many former members of retirement funds, who as a result will have inadequate private provision for retirement.

When employees transfer from a defined benefit fund to a defined contribution fund, employer and employee contributions usually remain unchanged from the levels of contribution in the defined benefit fund. The two funds, pension and provident, therefore run in tandem with the same contribution rates. The same investment process and the same accumulation of assets process take place. However, in the defined contribution fund the members receive full benefit from the investment process. In the defined benefit fund they do not, because of the need to stabilise asset values and meet guarantees.

However, once the guarantee is released, as happens at retrenchment, retirement, transfer, outsourcing of pensioners, there is suddenly and somewhat mysteriously to most observers, a "surplus" or profit in the defined benefit fund. In such instances, the risk has been transferred, but one of the most important means to manage that risk has been left behind, namely, the "investment reserve".

The benefits of members who exited from defined benefit funds were thus calculated in such a way that they left behind a significant portion of the assets that had in fact been paid into the funds to secure their retirement benefits. Employers and trustees convinced members that they were being paid the benefits they were entitled to in terms of the rules of the funds. Members did not have sufficient knowledge of how defined benefits funds worked or access to proper information to realise that they were effectively being robbed of their benefits.

The practice in South Africa is therefore, that while the parallel pension and provident arrangements in almost all companies have the same contribution rates, employers and company shareholders in retirement funds ultimately enjoy the windfall benefit from the release of investment reserves. This windfall is used to either enhance profits through contribution holidays or "repatriation", or to benefit future members or different classes of employees. There are countless examples of these.

The effect of these inequitable practices was to produce "surplus" over and above what existed in funds prior to these events. COSATU will refer to this as "extraordinary" surplus.

COSATU recognises that, in a defined benefit fund, after members and pensioners receive their fair share of the fund, the fund's assets may still exceed its liabilities. In such a situation it would be correct to say that a surplus existed in the fund. We will refer to this situation as an "ordinary" surplus. In the normal course of events, the ordinary surplus would be a relatively small proportion of a fund. The reason for this is that pension funds are akin to non-profit organisations and that employers would normally avoid building ordinary surplus beyond prudent minimum requirements.

The Financial Services Board (FSB) estimates that these two categories of "surplus" together amount to at least R80 billion in current terms. Most of the R80 billion can be categorised as extraordinary surplus. These monies must be returned to their rightful owners – the members and former members of funds. The legislation therefore needs to provide for restitution of members’ retirement benefits. The fact that millions of members of retirement funds do not have sufficient savings in their funds to survive after retirement or retrenchment will have devastating social consequences and condemns millions of South Africa’s working people to a life of extreme poverty and destitution.

The devastating consequence of these practices for members has not inhibited many employers’ continued abuse of these funds. The main form of the abuse was to treat the extraordinary surplus, created through the inequitable practices described above, as if it were ordinary surplus. From the late 1980’s up to now many employers stopped paying contributions to the defined benefit funds on a massive scale and used the extraordinary surplus to fund the contributions for which they were liable in the ordinary course of events. This is referred to as so-called "contribution holidays". The extraordinary surplus was also allocated to employer reserve accounts.

A particularly disturbing and highly irregular practice that has developed in the South African retirement fund industry is that, when profits or "surpluses" are generated in defined benefit funds, these are frequently transferred to employer reserve accounts in the defined contribution funds. The employer contributions are then paid from the employer reserve accounts. Employers are therefore obtaining a direct financial advantage from the members’ investment reserves.

On the one hand it may be argued that the regulatory authorities turned a blind eye to many of these illegal practices. On the other hand, many of the schemes were cleverly structured and designed to ensure that it was not possible to detect from the documents submitted to the authorities what the real purpose of the transaction and rule amendments were. Assets were never transferred into "employer contribution holiday accounts", they were transferred into for example "reserve account number 2" or an "employer protection account" – effectively employer slush fund accounts. Pension increases were granted in return for the members’ agreement that they would forfeit their right to post retirement medical aid funding by the employer, but were never recorded as such in the reports submitted to the regulator.

These schemes saved employers many millions of Rands on an annual basis. However, the assets left behind by members were so extensive that many employers could not use all the assets through their various devious schemes. Employers got greedier – they decided that they wanted to be able to take all forms of "surplus" money out of retirement funds to use for whatever purpose they deemed fit. This includes so-called "repatriation of surpluses’" (the term incorrectly implying that there is some sort of legitimacy to the claim).

The object of a retirement fund is therefore to provide retirement benefits to its members and death benefits to its members’ dependants. Employers set up and contribute to retirement funds as a form of delayed remuneration (or deferred wages) to employees. If, with the benefit of hindsight, it becomes apparent that the employer contributed at a rate higher than was actually necessary to fund the benefits of the retirement fund, this does not change the fact that the contributions became part of the assets of the fund. There is no basis in law to argue that an employer is entitled, for reasons of equity or otherwise, to claim back assets which were properly paid in the contemplation of a pattern of investment, withdrawals or whatever, that subsequently proves to be unduly conservative or pessimistic. If a "surplus" arises, it is not distinct from the fund, it remains part of the fund’s assets.

An analogous situation is the payment of insurance premiums (for example for household goods) over a period of time. Even if the person realises with hindsight that they had overvalued their possessions and hence paid higher premiums than were necessary, they have no claim on the premiums that were paid all along to the insurer. An employer has no more claim on the contributions paid to a retirement fund.

Under the rules, the amount that an employer must contribute is decided by the actuary (who is appointed by the board of trustees). Calculations performed by the actuary depend on a number of assumptions, including the future performance of the investment market. In making these assumptions, actuaries tend to be cautious, and as a result one can, particularly in investment market booms, achieve a significant level of ‘over-funding’. The "surplus", it should be clear, is an actuarial conception. The underlying asset it represents remains the property of the fund, and the fund only.

In South Africa, there is no common law principle or statutory provision that allows a "surplus" in a retirement fund to be distributed to the employer. At common law, trustees are obliged to act in the best interests of the fund. This precludes them from exercising their discretion in order to promote their own interests or the interests of third parties (such as the contributing employer). COSATU submits that this duty precludes the trustees from making distributions to the contributing employer out of considerations of liberality. Such distributions would in effect constitute a donation and, within the context of company law, such donations are plainly impermissible.

South African law acknowledges that the members and beneficiaries of a fund may have reasonable benefit expectations in retirement funds that exceed their specific benefit entitlements under the rules. In many funds the rules provide that if there is a substantial "surplus" in the fund benefits may be improved and/or pensions increased. In these funds the members and beneficiaries have a reasonable expectation that, if there is a substantial "surplus" in the fund and there are more than sufficient assets to allow benefit improvements and pension increases, the trustees will amend the rules to effect an improvement in benefits and will grant reasonable pension increases.

Therefore, legislative amendments which make provision for "surplus" assets to be used for the employers' benefit (other than by way of a reduction by the actuary of the contribution rate required by the employer) would have the effect of diminishing the members’ reasonable benefit expectations and would obviously not be in the best interests of the funds and their members.

If the assets of retirement funds had not been used for the benefit of employers, including by way of transfers the contribution holidays to defined contribution funds, the trustees of the fund would have had to exercise their discretion regarding how the assets could be applied for the benefit of the fund and its members. The members therefore had a reasonable expectation that their benefits would be improved by application of "surplus" assets in the fund. COSATU submits that the transfer or use of assets for the employer’s benefit is at the expense of the rights and reasonable benefit expectations of the members and beneficiaries of the retirement funds.

Notwithstanding the fact that the law currently prevents an employer from using the assets of a defined contribution fund to fund a contribution holiday, the Bill proposes that employers be allowed to do so.

In summary, the use of retirement assets for the benefit of the employer constitutes an unlawful alienation of trust money that improperly advantages the employer at the expense of the members and beneficiaries of the retirement fund. Consequently, where an employer has utilised the assets of a retirement fund in this manner it is not unfair or unlawful to require that an employer pay to the fund such assets as are necessary to reimburse former members of the funds at whose expense these assets were retained.

As discussed in section 2.1 above, employers have attempted to devise schemes to extract all forms of "surplus" out of pension funds. However, based on the current statutory and common law provisions, the Financial Services Board (FSB) correctly refused to register rule amendments making provision for the "repatriation of surplus assets". Employers then pressurised for legislation to be introduced to legalise the final plunder of retirement fund assets through the amendment of the Pension Funds Act to make provision for the repatriation of "surpluses" to employers. In June 1998 a Pension Funds Amendment Bill was tabled in Parliament.

The 1998 Bill was withdrawn after COSATU raised objections about the lack of protection afforded to members and the easy access employers were given to repatriate "surplus" assets in retirement funds. COSATU, after extensive research and after meetings with the FSB and the Department, submitted a proposed revised Pension Fund Amendment Bill to the Department of Finance. Subsequently a number of meetings were held between COSATU, the Department of Finance and the FSB to seek a solution to the pension "surplus" question. The matter was then referred to Nedlac in January 2000 for government, labour and business to seek consensus and agreement on the proposed Amendment Bill.

The Nedlac negotiations were seriously hampered by business’s unco-operative attitude and foot-dragging using various stratagems including not seeking appropriate mandates before the meetings. This made it extremely difficult to arrive at a consensus on the Bill. Government and COSATU reached an in-principle agreement on almost all the critical issues regarding the proposed Bill. Due to business’s attitude Nedlac was unable to deal conclusively with the Bill and develop a comprehensive report that should be tabled before parliament. In other words, the parliamentary process almost has to restart from the beginning. COSATU therefore hopes that this process will now conclusively resolve the matter.

Delays in finalising the legislation and the fact that no legislation is in place causes serious prejudice to members of funds because "surplus" assets, which are currently in funds, including both ordinary and extraordinary surplus, are being reduced on a daily basis. The "surpluses" are being depleted through inter alia:

1. Employer contribution holidays;
2. Restructuring exercises in which members’ share of the funds are stripped of their investment reserves and the extraordinary surpluses created by this are allocated to employer reserve accounts in defined contribution funds for employers’ exclusive benefit;
3. Employers offsetting their post-retirement medical aid liability by using the "surpluses" in the funds.

The FSB has informed COSATU that it is powerless to prevent these practices. COSATU has consistently raised its concern that if these practices continue, by the time legislation is in place, any remedies members are given to recover monies which should have been paid to them may be worthless, because there will be no "surplus" assets remaining.

COSATU has subsequently engaged with the Portfolio Committee on Finance around the Bill. We presented a submission to the Committee, together with clause-by-clause detailed legal drafting to give effect to our proposals. The other two labour federations, NACTU and FEDUSA, also presented submissions which were broadly consistent with COSATU’s approach and supported almost all of our proposals.

Unfortunately, however, the process was not as comprehensive as it could have been. Due to the tight timeframes of the Committee in processing the Bill and the sequencing of processes, we feel that other ways of addressing COSATU’s concerns were not fully explored.

While there are no doubt certain issues where the Committee did not share COSATU’s view and consciously rejected our proposals, in other areas we believe that this is not necessarily the case. In at least one instance (to be elaborated in the course of this submission) we believe that problems in the Bill are not necessarily the intention of Parliament but are the outcome of drafting errors, which could have significant unintended consequences. In fact the spirit of the Bill could well be undermined by a number of the actual provisions.

We have also subsequently met with the FSB to put forward various amendments aimed at tightening up the Bill. The FSB indicated that they would not be opposed to the majority of these amendments.

We are thus optimistic that at least some of our outstanding concerns will be resolved through the NCOP process, and in the NA process thereafter.

1. Major outstanding concerns

COSATU’s major outstanding concerns with the Bill can be summarised as follows:

The Bill provides for employer access to surplus. As discussed elsewhere in this submission, this goes against the very purpose of pension funds. As the Bill stands employers will definitely get access to ordinary surplus and may get access to extraordinary surplus (investment reserves belonging to individual workers which they have been denied until now). This will not only legalise the misappropriation of workers’ funds which has taken place in the past, but will open the way for further looting of assets belonging to members and former members.

The Bill retains the "stakeholder" definition, despite the fact that this concept is foreign to pension law and will cause trustees of pension funds to breach their fiduciary duties, by requiring them to act in the interest of "stakeholder" parties who are not members of the fund.

The claim of former members and pensioners will be a prior charge on the surplus before any other stakeholders, including the employer, will be able to stake any claim in the surplus assets. However, the extent of the claim will be limited to a minimum benefit that is not determined in terms of what the former members and pensioners were entitled to at the time.

Related to the above concern, the Bill leaves issues of central importance to be prescribed in regulation, rather than setting them out clearly in the legislation itself. These include the statutory valuation basis for determining minimum benefits on exit from a defined benefit fund; the actuarial assumptions for calculating members’ actuarial reserve value; and the assumptions on which the calculation of minimum pension increases will be based.

These and other assumptions and formulae will be central in determining whether former members receive the redress to which they are entitled, as well as whether members will receive equitable pension increases in future.

These issues are thus not incidental to the Bill, but go to the heart of how surplus will be apportioned out. COSATU has been calling for the determination of these crucial aspects to be part of the public discourse in Parliament and subject to the decision of elected representatives, as part of the body of the Bill itself.

While certain formulae and assumptions pertaining to the future may need revision from time to time, and it could thus be argued that the flexibility of Regulations could be appropriate, when dealing with the past this does not apply and there is no convincing reason for them not to be in the body of the Bill.

A large chunk, if not the majority, of the R80billion "surplus" which members are waiting to be repatriated to them, may well be given back to employers as a result of the way the Bill defines past "improper" use of surplus. Past "contribution holidays" by employers – where they failed to contribute to pension funds – is condoned by the Bill even where these were funded from extraordinary surplus, not approved at the time or where the employer could afford to pay.

Furthermore, at the last minute the Bill was amended so that past improper use of fund assets will be condoned if it was "approved" by members or unions at the time - this was a proposal of BSA which had previously been rejected in the Nedlac process. Particularly in the light of repressive conditions and the lack of awareness about "surplus" issues at the time – even on the part of the FSB – as well as the failure of employers to disclose all relevant information, it is unfair to deny former members their rights on such a basis.

A major problem is that employers will only be required to pay back surplus which is defined as having been improperly utilised (in terms of the above and other problematic criteria); meaning that members/ former members in funds where the employer has successfully depleted surplus through various disingenuous schemes will be unfairly prejudiced.

The definition of improper use in the Bill does not include circumstances such as the following:

1. contribution holidays that were unaffordable at the time;
2. contribution holidays that were not, at the time, approved by the valuator or the FSB;
3. contribution holidays that were funded from extraordinary surplus; and
4. any other benefit granted in stead of a liability of the employer to the employee.

The way that the Bill is currently crafted, the requirement to allocate "surplus" seems to be (possibly inadvertently) limited to funds which are compelled to undertake a "surplus" apportionment exercise. This may actually exclude defined contribution funds from having to apportion surplus in terms of the Bill.

It also appears that in the case of defined benefit funds, where there is a deficit on termination of the fund, employers may not be required to pay this back. Similarly, where there is a deficit on conversion of a fund, employers will not be required to pay this back.

COSATU is highly concerned that the window period provided for in the Bill opens a gap for employers to contract out of the legislation, at the expense of members whom it is supposed to protect. The window period allows for funds which are unable, or even unwilling, to meet their statutory obligations to renegotiate benefits. This would then apply not just for a limited period but indefinitely.

This means that workers who are unfortunate enough to be in such funds may never enjoy the statutory minimum benefits. This would make a mockery of Parliament’s efforts to introduce a minimum benefits regime in the first place.

COSATU has stated its opposition to employer use of surplus in 3.1 above. Over and above this, even in terms of the future use of "surplus", employers will be allowed to use funds for a range of problematic purposes. An example of this is improving the benefits of a category of staff as determined by the employer, such as a payout to senior management. Another example is the use of surplus to offset post retirement medical aid liability of an employer. The Bill itself acknowledges (with respect to the past) that this is an improper use of surplus by the employer, but strangely enough allows it for the future.

Furthermore, a situation will be allowed in future where employers take contribution holidays and contribute less than members to funds. It would be unfair to members to continue paying while employers are getting away with low or no contributions.

Member trustees will not be allowed to exercise their votes in respect of issues of how surplus will be utilised by the employer.

In terms of institutional issues and decision-making powers, the sole power of apportionment of "surplus" is to rest with the board of trustees in funds in which "surplus" exists – boards which are often in practice controlled by the employer. Once trustees have decided on the scheme for apportionment, members and former members will have no right of recourse to the dispute resolution process provided for in the Bill.

Apportionment of future surplus will be completely discretionary for funds, without recognising members’ entitlements to their share of fund.

Dispute resolution will be by an ad hoc tribunal despite COSATU’s criticism of this. We are concerned about duplication in function and the dangers of forum shopping.

The purpose of this annexure is to provide the legal and actuarial basis for COSATU’s conceptual approach and proposals. Set out below is an explanation of the nature of retirement funds, who is entitled to benefit from the assets of retirement funds and how "surpluses" have been generated through the depletion of members’ assets. [PMG note: Appendices not included]