Posted on August 3rd, 2011 in Industry News
Valuation exemption is now easier to obtain than ever. Recent changes to regulations mean that many DC funds could now qualify for exemption. Exempted funds do not need to submit triennial actuarial valuations to the FSB. In fact, they don’t need to have an actuary at all: the fund can be managed purely by the administrator. There is a cost saving to be made there – and surely, if the FSB has allowed the exemption, nothing could possibly go wrong?
Trustee responsibility
The FSB’s stance on this subject is clear: it is up to the Trustees to decide whether their fund is suitable for a valuation exemption. The criteria set by the FSB are minimum guidelines; qualifying under these does not mean that it’s “safe” to be exempt. That decision is left to the Trustees. The question to consider is simple: are the Trustees willing to take responsibility for future administration errors once the fund is exempt?
This makes valuation exemption a risky play: administration errors are common in the South African environment. They can range from investment instructions not being correctly implemented, to contributions not being reconciled, member data being coded incorrectly, investment returns being incorrectly calculated or allocated – and the list goes on. Most of these errors are easily corrected once they are picked up: a switch, reallocation or a small top up benefit are often all that is required. The issue is: are these errors going to be picked up?
Who’s checking?
A small discrepancy in a member’s credit is difficult for a member to spot. Members generally only have a vague idea of how retirement funds work; they are not able to confirm that the contribution has been correctly allocated or that investment returns accurately reflect their underlying investments. Members are also not usually aware of how fees and risk premiums are calculated and the effect these deductions have on their retirement savings. Not all members are equally financially literate – it would be unfair to expect every member to confirm that their retirement savings have been correctly calculated.
The administrators themselves are well placed to find errors – clearly, they have access to all relevant data and information. It is however difficult to independently check on one’s own processes. For one, any errors based on incorrect reasoning or understanding of a transaction, or system errors, are unlikely to be spotted internally. Secondly, the temptation to not disclose errors always exists within a closed system.
The snowball effect
Undiscovered errors tend to grow more serious over time. A small misallocation will increase as incorrect investment returns accumulate over time. Members become more difficult to trace. Errors may be compounded if they result from a flawed process. A small correction today may grow into many thousands of Rands in cost ten years down the line. Even worse, errors may go undiscovered, potentially leading to members retiring with insufficient benefits.
The role of the Actuary
One of the chief roles of an actuary in a DC retirement fund is to reconstruct the events in the fund independently and check if all member funds have been correctly allocated, accumulated and paid out. This prevents errors from going undetected and ensures smooth functioning of the fund. The FSB acknowledges this role by making triennial valuations the standard, and valuation exemption the “exception” one has to apply for.
We recommend that actuarial reviews are conducted annually rather than every three years. The actuarial work involved is not significantly greater, but results are delivered sooner and corrective action can be taken more promptly.
Having an actuary on board has other benefits too – such as access to advice on benefit levels, the calculation of net replacement ratios (which indicate whether members are sufficiently provided for) and advice on industry developments.
Bottom line
In conclusion, Trustees need to think carefully before applying for valuation exemption. The regulator expects them to consider the accuracy of their administrator and the potential for future errors. Anticipating administration errors is prudent: even the best administrators are capable of making them. However, with regular valuations, Trustees are able to sleep easy in the knowledge that someone is independently monitoring their fund.
