Download Wanted: Trustees who relish challenges!

SUPERBENEFITS
AS F O N Z
Wanted: Trustees who relish challenges!
The challenge in a nutshell
By John Melville
Head of Melville
Jesup Weaver
superannuation
practive
Assets:
twenty shillings
Assets:
Liabilities: nineteen shillings and sixpence
Result:
Result:
misery
M
any trustees and employers,
having received the results of their
scheme actuarial reviews in 2003,
must have wished that the scale of their own
misery was in line with that of the misquoted
Mr Micawber, rather than the large holes they
have seen develop in the funding positions of
the schemes for which they are responsible.
A recent letter to members of the Institute
of Actuaries of Australia stated: “It is estimated
that a significant proportion of the defined
benefit funds in Australia are currently in
an Unsatisfactory Financial Position”. An
John Melville is a consulting Unsatisfactory Financial Position arises
actuary with 30 years
formally in Australia when realisable assets
experience in consulting to
fall short of members’ vested benefits.
superannuation schemes, as
There is no similar regulatory definition
well as two terms of service as
in
New Zealand. The range of definitions
Government Actuary.
of ‘unsatisfactory’ that parties here might
think reasonable could include assets falling
short of vested benefits, assets falling short
of accrued benefits, restrictions on payment
of discretionary benefits, the end of an
employer’s contribution holiday, and an
employer having to increase contributions
from previous levels.
Taking any general meaning of the word
unsatisfactory, the Australian situation of
widespread financial problems is present
in New Zealand. Trustees face the prospect
of having to consider what they should do
in these difficult circumstances, and how
best to meet their obligations to act in the
best interests of members and beneficiaries.
Trustees also need to recognise that the
sponsoring employer will be a key participant
in the decision-making process. All of what
follows is as important to employers as it is to
trustees and scheme members.
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twenty shillings
Liabilities: twenty shillings and sixpence
happiness
Why it happened
It is useful to understand the reasons for
deterioration in a scheme’s financial position,
as reasons may point to solutions.
Schemes that seemed well-funded only two
or three years ago are now facing shortfalls
or much reduced levels of comfort arising
from continuing negative or low investment
returns. Schemes invested primarily in New
Zealand government stock over the three
years to 30 June 2003 will have earned about
5.5% per annum net over that time. Schemes
invested in a balanced fund will have done
well if they have managed to earn a zero
return. Any schemes invested substantially
in overseas equities will be pleased to have
lost as little as 10% per annum!
The impact of these low returns on a defined
benefit scheme can be measured by comparing
actual returns to the ‘expected’ return implicit
in the previous actuarial valuation. As the
valuation assumption is generally 4% to 6%
in each year, shortfalls have been large. The
effect is further compounded by downturns
in the outlook for future investment returns.
Some actuaries have the view that assumed
future returns should be reduced, which
results in higher liabilities and an increased
requirement for future contributions to
maintain existing benefits.
The existence of large surpluses may have
lead to some employers taking contribution
holidays, reducing their own immediate costs
rather than improving members’ benefits, or
increasing the security of members’ benefits.
The surpluses may have also resulted in
schemes taking in new members at benefit
levels higher than the contribution rates
could provide.
SUPER BENEFITS SUMMER 2003
SUPERBENEFITS
ASFONZ
The Association of Superannuation Funds of New Zealand
Key first step
The first step in any solution is to
communicate. Trustees need to
explain the position to the sponsor
of the scheme, the employer, and
the resulting discussion will be much
easier if the various options are
understood. The employer’s attitude
to superannuation will be critical.
Some might willingly discuss the full
range of possibilities. Others might
take the easier option, and simply
decide that it’s a good opportunity to
get out of superannuation altogether.
Consideration of the possible
outcomes, and what is in members’
best interests, will give trustees
significant food for thought.
Investment review
Mr Micawber’s approach of assuming
that something would always turn up
is certainly not recommended for
trustees or for their advisors!
Hoping the investment markets
will improve is not a proper response.
Trustees faced with an unsatisfactory
position should review their investment
policy and objectives. Even if funding is
available for an immediate correction,
trustees may need to consider revised
investment strategies, to place greater
emphasis on protecting members’
current benefit levels and reduce the
potential for future deterioration.
‘Aggressive’ approaches to
investment have been taken on the
assumption that they will reduce the
future funding costs to employers.
Recent events should focus attention
on the risks of the various stakeholders
in superannuation schemes in a way
that the relatively easy ride of the
previous decade did not. Many of
the so-called funding mechanisms
presently in use may be better described
as budgeting advice, focused as they are
on predicting costs to sponsors.
SUPER BENEFITS SUMMER 2003
It is conventional wisdom that
equity returns are ‘highly likely’ to
exceed returns on bonds, and therefore
equities as scheme investments will
reduce the contributions required
from employers. There has been little
consideration of what ‘highly likely’
actually means in practice, particularly
the implications for members if the
presumably highly unlikely scenario of
scheme deficit and employer default
occur at the same time.
Options
Option 1 The ideal solution is for
trustees to have the perfect foresight
to ensure that their scheme has as
sponsors only employers willing and
able to fund the future contributions
necessar y to meet a shortfall.
Clearly, this is easier said than done.
Nevertheless, if employers are both
willing and able, the issues faced by the
trustees may be more easily resolved.
Option 2 At the other end of the
spectrum, the prospect of a demand
for additional funding may lead to the
employer initiating a wind-up. (Such
action, particularly if a scheme is in
deficit, must be considered in the
context of broader law as well as the
specific deed and relevant employment
agreements.)
While termination may not be the
outcome trustees prefer, it may be in
the best interests of members if the
employer will not make the financial
commitment to continue. Immediate
wind-up may be preferable to being
faced later by a scheme effectively
funded on a pay-as-you-go basis.
This latter form of financing gives
members and pensioners virtually no
security. Wind-up may be followed
by the ‘good’ employer opening a
replacement defined contribution
scheme, or at least making salary
deductions for private provision.
Option 3 An intermediate position
would involve amending the scheme
provisions. For example, closing
the scheme to new members may
be considered as preventing further
deterioration. Reducing future service
benefit levels for existing members is
another possibility.
Continuing duty of care
Trustees should inform members of an
unsatisfactory position, and tell them
of the actions being taken to correct
the position. Legal advice should
be taken if there is any doubt as to
obligations in this area.
In some countries, action to restore
a satisfactory position must be taken
within a specified (short) time period.
New Zealand’s lack of detailed regulation
does not mean that trustees can be any
less concerned about their obligations.
The Government Actuary has
recently reminded the industry that
the Superannuation Schemes Act 1989
requires him to consider the adequacy
of a scheme’s financial position and
the security of benefits, and that he
has discretion to take action if he
considers it necessary. He also stated
that he expects prompt action to be
taken if the financial position of a
scheme is in question, while drawing
attention to the whistle-blowing
provisions contained in the Act.
And finally ………..
Trustees will naturally turn to their
professional advisers. Past practice
may have been for actuarial advice to
be sourced by the trustees for the threeyearly valuation, and in effect then
used by members and the sponsor.
The issues that arise with schemes in
what might euphemistically be called
reduced circumstances are such that
each party needs independent advice.
A second opinion may be valuable,
either on a formal basis or just as a
sounding board.
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