Chaos or clarity?

By André Oosthuizen

Source: De Rebus

Developments in the pension funds industry

War has, it seems, broken out in the formerly staid world of pension fund organisations. The combatants are the Pension Funds Adjudicator, a functionary appointed in terms of s 30A of the Pension Funds Act 24 of 1956 (the PFA), and the pension fund governing boards, whose lives are, to say the least, being made more interesting by the string of determinations handed down by the Adjudicator (See ‘PFA throws down the gauntlet’ in 2005 (Aug) DR 26 – Editor)

No one can deny that pension funds have in the past been subject to abuse by certain stakeholders. Pension holidays, pension fund stripping, Maxwell – all sorts of examples spring to mind. On the other hand, it would be foolish to regard the pension funds as some sort of inexhaustible cash cow from which claimants can extract money irrespective of whether the process of extraction has any legal or logical basis. There is, after all, a factor that must be borne in mind. If over-zealous pension reforms impose too crippling a burden on the pension funds, the insurance and investment companies, which operate and underwrite such funds, will simply divest themselves of this particular line of business – and where will that leave us?

This article aims to analyse certain of the Adjudicator’s recent determinations and, in so doing, to highlight and discuss some of the controversial issues surrounding pension fund organisations.

Pension fund organisations and the minimum benefits legislation

The Adjudicator’s determination in Ngubane v South African Retirement Annuity Fund & Another (2005) 6 BPLR 516 highlights certain anomalies surrounding the definition of the term ‘pension fund organisation’ in s 1 of the PFA and raises the issue whether the minimum benefits legislation is applicable to all pension fund organisations.

Ngubane was a member of a pension fund operated exclusively by way of insurance policies. It was not funded, as are traditional pension funds, by a particular employer for the benefit of its employees – membership was in fact open to the public generally. The fund used contributions to buy annuity policies, the benefits of which were, on a member’s reaching retirement age, made available to that member. The sole assets of the fund consisted of claims against the relevant insurer in terms of such annuities. Ngubane claimed that his benefits as member should be increased by reason of ss 14A and 14B of the PFA (hereinafter referred to as ‘the minimum benefits legislation’). The Adjudicator agreed, but was unable to assist Ngubane because the stipulated actuarial valuation date referred to in the minimum benefits legislation had not yet arrived.

The Ngubane determination fails to consider at least three important issues properly. Firstly, the extended definition of the term ‘pension fund organisation’, as contained in s 1 of the PFA, creates certain anomalies. . A pension fund organisation is defined as any association of persons established with the object of providing annuities or lump sum payments for members of that association, or any business carried on under a scheme or arrangement established to provide annuities or lump sum payments for that class of persons for whose benefit that scheme has been established. The words ‘employer’, ‘employee’ and ‘pensioner’ are absent from the definition. Many schemes therefore become pension fund organisations, simply because of the extended definition, even though they are not pension schemes in the traditional sense of the word. In ordinary parlance, a pension fund is based on an employment relationship. As was said by Murray CJ in S v Commissioner of Taxes 1959 (3) SA 455 (SR),

‘[a]lthough pensions may take different forms the essentials of a pension – to my mind – is that it is a money payment usually of periodic sums which the ex-employee receives not as an earning from existing service but after the termination thereof and in consideration or in respect of or as a reward for past service’ (458E–F).

It requires little insight to appreciate that the dictum of Murray CJ is wholly inapplicable to an investment fund of the type dealt with in the Ngubane determination. One is therefore faced with an oddity – not all pension fund organisations are in the business of administering pensions.

Secondly, the Ngubane determination assumes, without analysis, that the minimum benefits legislation is applicable to all pension fund organisations. This must be incorrect, if regard is had to the formula contained in s 14B(1) pertaining to defined contribution funds. One of the components of that formula is ‘a fixed rate contribution made by the employer on behalf of the member’. Similarly, the defined benefit formula contained in s 14B(2)(a) has, as one of its components, ‘such share of the employer contribution paid in respect of the member as has vested in the employee in terms of the Rules of the Fund, augmented with the same rate of interest’. It is thus clear that the minimum benefits legislation applies only to those funds to which an employer contributes, which necessarily presupposes the existence of an employment relationship.

Thirdly, the Ngubane determination leads to an arithmetical absurdity. Section 14B(b)(i) states that the board of a fund must determine the increase resulting from an accumulation of the liabilities for pensioners at their date of retirement, adjusted to an equivalent fair value of assets. The formula is perhaps not as clearly worded as it should be. In a retirement annuity fund operated exclusively by way of insurance policies, however, the liabilities towards members will, at all times, equal the assets of the fund, fairly valued. The claims which the members have under the policies (ie, their claims against the fund) would at all times equal the policy values, and the calculation required by s 14B(4) would necessarily result in a zero sum. Quite why the Adjudicator did not implement the arithmetic is unclear from the determination. Quite how he envisages that such a fund will comply with its obligations under s 18 of the PFA to remain in a sound financial condition is equally shrouded in mystery.

The concerns raised by the Ngubane determination need to be addressed urgently, by legislation if necessary.

Lapsing

The tone underlying this particular debate is perhaps set by the opening paragraph of the determination in Khumalo v Prosure Retirement Annuity Fund and Another (case PFA/GA/1811/2004 unreported), which reads as follows:

‘This complaint concerns the liability of the respondents to pay a death benefit in respect of a deceased member in circumstances where the underlying insurance policy had “lapsed” owing to non-payment of contributions. This “lapsing” of the underlying policy is informed by the second respondent’s practice that policies with values of less than R250 are “trivial” and thus “not financially viable for the company to administer”. It is a general practice of many life insurance companies administering and underwriting retirement annuity funds and one which, in my respectful view, needs to be brought to a halt in the retirement industry as a wholly undesirable business practice. One wonders how many billions of rands bulge the pockets of life [insurance] companies’ shareholders after similarly “trivial” fund values have been “lapsed”. Moreover, members of these retirement annuity funds are – as in this case – never informed of this practice.’

As a preliminary observation, one may note that the adjudicator makes no attempt, in the passage quoted above, to analyse the nature of the expenses incurred by the insurance company. It is generally understood, in the insurance industry, that certain categories of expenses are incurred initially and upfront, when a policy is issued, which are then written off over the life of the policy. A policy that is prematurely terminated due to non-payment of premiums obviously has adverse financial consequences to the insurer – the upfront expenses remain unchanged, but the income generated by the policy is much less. This factor has been drawn to the attention of the Adjudicator in several cases with which he has been seized, but he has thus far made no discernible attempt to take these factors into account in reaching his determinations.

The essential complaint in the Khumalo matter was that, on the lapsing of the policy, the paid-up benefits were lower than the policyholder had expected – an aspect dealt with more fully below. In making the determination, however, the Adjudicator found that the practice of lapsing insurance policies which had a minimal value was ‘undesirable’ and forwarded a copy of his determination to the Registrar of Pension Funds and the Minister of Finance to enable them to consider whether they should exercise their powers under s 32A of the PFA and prohibit the practice of lapsing policies in a retirement fund situation.

One must assume from the determination that the Adjudicator was unaware of s 52 of the Long-term Insurance Act 52 of 1998. This affords a statutory right to a long-term insurer to bring to an end a policy where the premiums have not been paid, and prescribes the manner in which such rights shall be exercised and the consequences to the policyholder. Section 52 of the Long-term Insurance Act applies to all long-term insurance policies, irrespective of their value. For the Adjudicator to suggest that such rights should be abolished where the policy relates to ‘a retirement fund scenario’ or where the policy has a minimal value is, to say the least, startling.

Essentially, his suggestion means that insurance companies will be obliged to keep such policies in force, whether the insured has complied with his obligations or not. The insurance company will, upon the happening of the insured event, be obliged to pay the full benefit stipulated by the policy, even if the insured has never complied with any of his obligations beyond the payment of the first premium. One can only imagine the lucrative possibility which will be created if the Minister and Registrar do act in terms of s 32A, as suggested by the Adjudicator. Small-time investors would sign up as members of five, six, seven RA-driven pension schemes, not pay their premiums, and wait for payday to arrive.

The reasoning of the Adjudicator in the Khumalo case also unceremoniously ditches the entrenched contractual principle of pactum sunt servanda. Policy lapsing occurs, after all, in a situation where the policyholder fails to comply with the obligations under the policy to which he agreed. Ordinary contractual principles would indicate that the insurer acquires a right of cancellation in such circumstances but, according to the Adjudicator, this amounts to a ‘undesirable business practice’.

Shortfalls and deductions on premature termination of policy

In a growing number of determinations, the Adjudicator has managed to find that expenses deducted by insurers from pension fund based policies where such policies are prematurely terminated are unlawful, and has ordered the reimbursement of such expenses to the beneficiary. The determinations in question include the Khumalo case, as well as Botha v Central Retirement Annuity Fund (2005) 5 BPLR 376 (PFA); De Beer v Central Retirement Annuity Fund and Another (2005) 3 BPLR 257 and Louw v Central Retirement Annuity Fund (2005) 7 BPLR 622.

No one would quibble with the proposition that the expenses which an insurer deducts from the value of a policy must be reasonable, clearly defined and made known at the time that the contract of insurance is concluded. It is, however, facile to assume that expenses are unreasonable, or not defined, simply because the end value paid out to a policyholder is substantially smaller than what he was hoping for.

The insurance industry is statutorily regulated by, in the case of life insurance policies, the Long-term Insurance Act which came into operation on 1 January 1999. Its predecessor was the Insurance Act 27 of 1943.

Section 62 of the 1943 Act created rights and obligations that arose upon non-payment of an insurance premium by the insured. Section 62(2) provided that if a premium had not been paid, within the period stipulated in subs 62(1), being three years,

‘an insurer who is liable under that policy shall, in accordance with rules made by him and approved by the Registrar, either issue in return for and in lieu of the said policy, a paid up policy which shall be free from the obligation to pay premiums thereunder, or apply the non-forfeiture value of the policy in maintaining the policy in force for a period and by a method to be determined in accordance with such rules, provided that (i) the said rules shall specify the basis upon which and the methods by which the amount of such non-forfeiture value and the amount of any such paid up policy is to be calculated, and whether any such paid up policy shall entitle the owner to any future bonuses thereon’ (my emphasis).

Section 52 of the Long-term Insurance Act similarly provides that if premiums have not been paid the policy shall lapse and the remaining value of the policy ‘after satisfaction of any claim of the long term insurer which is secured solely by the policy benefit to be provided under the policy’ shall be paid as a surrender value to the policyholder or utilised in the payment of premiums until the policy no longer has any remaining value, whereupon it will lapse. Section 52(3) is of importance, and provides as follows:

‘A long-term insurer shall have rules which to the satisfaction of its statutory actuary prescribe a sound basis on which, and the methods by which, a long-term policy is to be valued and otherwise dealt with for the purpose of subsection (2)’.

The statutory actuary is the functionary appointed by s 20 in effect to oversee and monitor the proper functioning of each long-term insurer. The requirement that the statutory actuary must approve the lapsing rules is a mechanism to ensure the fairness and reasonableness of such rules.

Two pertinent aspects need to be highlighted. Firstly, s 62(2) provides that a non-forfeiture value may be attributed to a policy on the insured failing to pay premiums owed by him. Secondly, the method by which the non-forfeiture value is to be calculated must be specified in rules made by the insurer and approved by the Registrar or statutory actuary. Both Acts expressly entitle and require the insured to formulate rules for the calculation of the non-forfeiture value. These provisions constitute terms implied by law into every life insurance policy governed by the 1943 Act, and by every long-term policy governed by the current Act.

The entire debate raised by cases such as Botha, De Beer and Khumalo is actually resolved by asking one simple question – is the particular deduction from the policy which is being scrutinised one authorised by the rules promulgated under s 52(3) of Act 52 of 1998 or, where applicable, by s 62 of Act 27 of 1943? If it is, the deduction is statutorily mandated. This particular point does not appear to have been considered in any of the aforesaid determinations.

Complaint procedure

Section 30A of the PFA provides as follows:

‘Submission and consideration of complaints –

(1) Notwithstanding the provisions of the rules of any fund, a complainant shall have the right to lodge a written complaint with a fund or an employer who participates in a fund.

(2) A complaint so lodged shall be properly considered and replied to in writing by the fund or the employer who participates in a fund within 30 days after the receipt thereof.

(3) If the complainant is not satisfied with the reply contemplated in subsection (2), or if the fund or the employer who participates in a fund fails to reply within 30 days after the receipt of the complaint the complainant may lodge the complaint with the Adjudicator’.

In Insurance & Banking Staff Association v Old Mutual Staff Retirement Fund and Another (2005) 3 BPLR 272 the Adjudicator found that it was open to someone to refer a complaint to him without having complied with s 30A(1). He reached this conclusion by reasoning as follows:

‘Such duplication of process could not have been intended by the legislature. I say so because in those instances where a complaint is first lodged with the fund, the fund’s written response thereto is very often identical to the subsequent response it submits to the Adjudicator and the Adjudicator after the same complaint has been lodged with the Adjudicator and the Adjudicator has called upon the fund to respond in terms of s 30F of the Act. Such is not the procedure that a Complainant who has been promised an expeditious service in the form of the Office of the Pension Funds Adjudicator’s dispute resolution process can be expected to follow’.

It seems that the Adjudicator regards s 30A(1) as tautologous – an approach which violates the well-entrenched principle, expressed in Wellworths Bazaars Ltd v Chandler’s Ltd and Another 1947 (2) SA 37 (A), that legislative tautology is not lightly presumed. Section 30A clearly envisages a double-barrelled procedure for good reason, namely that the complainant and the fund should be encouraged first to resolve the disputed issue inter se. Experience teaches that negotiated solutions are frequently preferable to a determination made by a third party. The finding in the Old Mutual Staff Retirement Fund matter ignores the express provisions of s 30A and nullifies the intention of the legislature.

Conclusion

There are undoubtedly many issues relating to the administration of pension fund organisations which need to be addressed. Problem areas should, however, be resolved by the legislature, after consultation with interested parties. It creates uncertainty and unnecessary turmoil if a functionary such as the Adjudicator attempts to usurp the function of the legislature by embarking on drastic reform measures, sometimes without a full understanding of the applicable legislature and underlying principles.

It would appear that the review remedy created by s 30P of the PFA will be frequently invoked in the months ahead.

André Oosthuizen SC BA (Stell) LLB (Unisa) is an advocate in Cape Town.