Valuation Exemption Unpacked
Trustees are ultimately responsible for the compliance of a retirement fund with a multitude of statutory requirements that funds are subjected to. Anything that may reduce the corresponding administrative burden will probably be welcomed by most Trustees, like the opportunity to apply for exemption from having to submit statutory actuarial valuations. The application is made to the Financial Sector Conduct Authority (FSCA).
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.