Edition: November 2018/January 2019
Editorials

ADJUDICATOR

R40,5m to be recovered. Will it?

Huge damages award against actuary. Fundís reserve account cannot be used to offset loss. Trustees and administrator in the clear.

Every actuary in the land will read with horror the determination of Pension Funds Adjudicator Muvhango Lukhaimane that one of their number, independent practitioner Vivian Cohen, must pay R40,5m to the Amplats Group Provident Fund.

Instead of challenging the Adjudicator in court, under new legislation he can now appeal to the Financial Services Tribunal (see Currents). Should he lose, he’d have to pay the R40,5m from his own pocket – plus interest at 10% pa from the July determination date, less perhaps the R1m or R2m that might be covered by a valid insurance policy of professional indemnity.

In the result, the 40 000-member AGPF probably has little chance of recovering the full amount as per the determination. When actuaries can be held liable for such hefty amounts, they might do well to review the adequacy and validity of their insurance cover.

And not only actuaries. So serious are the implications of the determination that they potentially affect all funds, trustees and service providers within the retirement-fund industry as a whole.

Nene
Lukhaimane...Amplats fund exposed

The fund had complained to the Adjudicator that the respondents – 14 trustees who then comprised the AGPF board, actuary Cohen and administrator Sanlam – should jointly and severally compensate the fund for their failure timeously to discover a unit-pricing error made by Cohen. The error had caused the fund’s unit price being overstated by 4%, resulting in members who exited the fund since September 2012 being given more than their entitlements at R40,5m in aggregate. This amount was the loss to the fund.

Lukhaimane dismissed the claim against the former trustees and Sanlam. She ordered the AGPF to pay the former trustees’ legal costs on the punitive attorney-client scale, and Cohen to make good the entire loss.

In Cohen’s submission, the fund had incorrectly concluded that the error related to the assumptions and methodology used. The actuarial error was that a cell on the spread of an investment portfolio was inadvertently “hardcoded” as the value on 31 July 2012. It should have referred back to the value from the previous month’s balance by means of a standard excel formula.

As a result of the error, he contended, unit prices were overstated. The weighted average investment return still looked reasonable when he did an overview of the calculations. There was no negligence on his part and the fund, through its significant free reserves, was able comfortably to absorb the financial impact without any remaining members being adversely affected.

He’d been diligent, he said, in obtaining an experienced actuarial expert to do these calculations on his behalf and these were also checked. It was an error unfortunately missed by the normal levels of actuarial scrutiny.

According to the Adjudicator’s determination, Cohen had further argued: “Even if the actuary ensures that diligent calculation and checking procedures are followed, it is not possible to eliminate every human error. This would be an unacceptable financial risk for actuaries if there was a possibility that an unfortunate error that goes undetected were to result in a substantial financial penalty.”

For its part, Sanlam noted that the administration agreement then in place did not contain a term obligating it to reconcile the fund’s assets and liabilities. Also, by contractual agreement, the administrator would not incur any liability for any loss or damage suffered by the fund from incorrect information that the fund had provided. The administrator’s duty of good faith could only extend to obligations set out in the agreement.

The AGPF’s allegation against the former trustees was that they’d omitted to ensure proper administration of the fund. Their negligence was a breach of their fiduciary duty, making them liable for the maladministration that caused loss to the fund.

However, the former trustees submitted that the fund’s system of delegation and control over the service providers were sufficient and reasonable. They did not fail in their duty or give rise to the calculation error. Neither could they reasonably have been expected to notice it.

In the case of an expert such as an actuary, the test for negligence is the test of the so-called reasonable expert. The tribunal had engaged the services of an independent actuary to assess whether Cohen had acted reasonably.

The calculation error had caused the loss, held the Adjudicator, and it was real. It could not be offset by replenishment from the fund’s processing-error reserve as Cohen had suggested. This account is for mismatches that occur when there are timing differences between the time that the actual transactions occur, and when these transactions are deemed to have occurred, for purposes of calculating benefits or costs or accruing fund return.

Because of daily movements in unit prices, there is invariably a mismatch between the values of the units and the actual values of the fund’s investments. This will result in profits or losses as members leave the fund or other benefits are paid, depending on whether the unit price is lower or higher than the than the actual value of the fund’s investments on the day that benefits are paid.

In this instance, she said, the error was not due to a timing mismatch but to a unit-pricing error that Cohen had made: “The processing-error reserve account was not meant to cover occurrences like the current.”

In the case of an expert such as an actuary, the test for negligence is the test of the so-called reasonable expert. The tribunal had engaged the services of an independent actuary to assess whether Cohen had acted reasonably.

This actuary had submitted that hardcoding (on an excel spreadsheet) is the act of physically typing or otherwise inserting text or numbers in absolute terms. The implication of erroneous hardcoding is the risk of typographical error that damages the integrity of the process.

In this case, the erroneous hardcoding of the affected spreadsheet cell reduced the opening balance by R40,5m and increased the fund return by the same amount, causing exiting members to receive benefits higher than their entitlements. Because review at the level of individual portfolios was lacking, Cohen’s conduct as the expert advisor was unreasonable.

Due to the nature of the calculation error, neither the then trustees nor administrator Sanlam would have been able to detect the error. It could only have been detected by an expert advisor, stated Lukhaimane, and so they could not be held jointly and severally liable with Cohen.

Accordingly, she ordered that Cohen compensate the AGPF for the R40,5m loss; further, that the AGPF pays the former trustees their costs on the attorney-client scale as a refund of expenses they’d actually incurred. No costs order was made in respect of Sanlam.

INSURANCE EXAMINED

Teri Solomon, risk management specialist at insurance broker Marsh, addressed a breakfast meeting of the Pension Lawyers Association specifically on the AGPF determination. Of the several points made in her pertinent analysis, one which shone through is her emphasis on accurate minutes being kept: “This is the first document that the insurer will want to see, not only for what was said or not said but also for what was done.”

Similarly, it’s critical that trustees look at the wording of their fund’s indemnities for the terms relating to fraud and negligence. Fidelity insurance typically covers a fund against loss of fund assets as a result of errors and omissions, theft and fraud, and third-party computer crime. These must be “committed by an officer”.

Solomon...basic cautions

Trustees and principal officers would be covered for personal liability in the event of, amongst other things, breach of their fiduciary duty. All costs and expenses incurred require the written consent of the insurer.

For actuaries, there is no compulsory professional indemnity cover. However, there is a practice note of the Actuaries Association. That the actuary in the AGPF case had R1m in cover was “wholly inadequate”.