A retirement fund could not reduce a member’s defined benefit pension to whatever annuity an actuarially determined reserve value could buy where its rules did not clearly authorise that approach, Deputy Pension Funds Adjudicator Naheem Essop has ruled in a determination the Office of the Pension Funds Adjudicator (OPFA) says sets an important precedent.
The determination arose from the ZF of South Africa Pension and Group Life Assurance Fund’s conversion of a pension calculated under its rules into a capital amount to purchase a compulsory annuity from a registered insurer.
Although an independent actuary found the fund’s capitalisation factor to be reasonable, Essop held that the dispute ultimately turned on the wording of the fund’s rules, which did not expressly authorise the fund to substitute the defined pension with whatever annuity an actuarially determined reserve value could secure.
The complainant, GGP van Zyl, was employed by ZF Services South Africa from 1 April 1995 until his retirement on 31 October 2023. He was a member of the ZF of South Africa Pension and Group Life Assurance Fund by virtue of that employment.
The fund calculated his pension in accordance with the formula in its rules at R1 347 595.47 a year, or R112 299.62 a month. That amount was not in dispute. The dispute arose when the fund calculated the actuarial reserve value of that pension at R14 468 962.88 and made that amount available for the purchase of a compulsory annuity from a registered insurer.
According to the determination, a Sanlam quotation based on the R14.47m capital value produced a starting pension of about R91 200 a month, compared with the R112 299.62 a month calculated under the fund’s rules. A second quotation indicated that about R17m would be required to secure a comparable starting pension. Van Zyl argued this demonstrated that the fund’s approach materially reduced the defined benefit promised by the rules.
Dispute turned on rules, not actuarial reasonableness
The fund maintained that its calculation complied with the rules. It said the capitalisation factor reflected actuarial assumptions including mortality, future investment returns, pension increases, and a 60% spouse’s pension payable on the complainant’s death.
The fund also pointed to a later surplus allocation that increased Van Zyl’s total benefit value to R18.346m on 1 September 2024. The independent actuary treated the surplus allocation and the complainant’s additional voluntary contributions as amounts “in addition to” the queried benefit and did not take them into account for purposes of assessing the calculation in dispute.
The independent actuary appointed by the Adjudicator confirmed that the annual pension had been correctly calculated under the fund’s rules and found the fund’s capitalisation factor to be reasonable.
The actuary calculated a factor of 10.737, rounded, and regarded the fund’s resulting capital value of R14 468 963 as a fair reflection of the actuarial value of the underlying pension and the fund’s benefit promises.
The actuary also noted that many funds would have followed the same broad approach: calculate the pension in terms of the rules, determine the capital value of that pension by applying the fund’s benefits and assumptions, and make that capital value available to the member to purchase a pension in the insurance market.
However, the actuary said the matter ultimately turned on the wording of the rules. He observed that, to reflect the approach followed by the fund, the rules should likely have stated that the pension is calculated in terms of the formula, the actuary determines the capitalised value of that pension, and the capitalised value is made available to the member to purchase an annuity from a registered insurer.
The actuary also identified reasons the Sanlam quotations were not directly comparable with the fund’s calculation. These included differences between the benefits being purchased and those promised by the fund, insurer commissions, profit and solvency loadings, market conditions at the time of quotation, and differences in underlying mortality bases.
Rules, not industry practice, determine the benefit
Essop agreed that the decisive issue was one of interpretation rather than actuarial methodology.
Referring to Supreme Court of Appeal and Constitutional Court judgments, he reaffirmed that a retirement fund’s rules are its constitution, and trustees may exercise only those powers conferred by those rules. If the rules do not authorise a particular course of action, it falls outside the fund’s legal powers.
The Deputy Adjudicator accepted that the fund’s approach was supported by actuarial evidence and reflected a practice followed by many funds. But he said that did not answer the legal question.
“The question is not whether the fund’s approach is sensible or orthodox. It is whether the rules authorise it,” Essop said. Although the fund’s interpretation “may be commercially and actuarially attractive”, he added, the rules “must say so. They do not.”
Examining the rules, Essop found that they defined the member’s pension by formula and regulated how that pension was to be provided through an annuity purchased from a registered insurer. They did not, however, expressly authorise the fund to replace that defined pension with whatever pension an actuarially determined reserve value could purchase in the market.
“In the absence of clear language to that effect, the fund was not entitled to compute the capital sum on that basis,” he held.
Essop said concerns about the fund’s financial soundness did not answer the prior question whether the rules authorised the approach the fund had adopted. He noted that rule 4.2.5 expressly provided that if payment of a benefit placed undesirable strain on the fund’s financial soundness, the employer could be called upon to make additional contributions. There was, in any event, no evidence before him that paying the complainant’s pension as defined in the rules would have that effect.
Relief ordered
Essop upheld the complaint and set aside the fund’s determination of the complainant’s capitalised value of R14 468 962.88.
He did not simply adopt the Sanlam quotation relied on by the complainant. The determination said the quotation was useful in demonstrating the practical shortfall, but it reflected product features, pricing assumptions, and market conditions at a particular time and could not, on its own, provide the basis for determining the capitalised value to be ordered.
Instead, the fund was directed to recalculate, within 30 days of the determination, the capitalised value required to secure the pension determined in terms of rule 5.2, namely R1 347 595.47 a year at commencement, subject to the rules governing the nature and incidents of that pension.
The fund was also directed to make available or procure the capitalised value necessary to secure that pension from a registered insurer in accordance with the rules, and to provide the complainant with a written calculation and explanation demonstrating compliance with the order. If the fund contended that payment of the benefit would place undesirable strain on its financial soundness, it had to invoke and apply rule 4.2.5.
The determination also records that the fund accepted its rules could have stated more explicitly that the lifetime annuity would be purchased with the associated actuarial reserve. Essop held, however, that the absence of such wording meant the fund could not rely on actuarial reasonableness and industry practice to supply what was missing from its rules.
‘Important precedent’
In a statement issued on 27 July, the OPFA said Essop’s ruling sets an important precedent. “It affirms that while actuarial reserve values remain the legitimate basis for lump sum conversions – even in defined benefit schemes – the rules themselves must be interpreted strictly. Where the rules define a pension by formula, the capitalised value must be recalculated to secure that pension, ensuring members are not left worse off when benefits are transferred to insurers.”
