Issue: June 2005


Test case beckons over retirement annuity ruling. The ramifications run deeply, not only for the thousands of people who hope for rulings similar to the Pension Funds Adjudicator on De Sousa, but potentially for financial institutions and the long-term savings industry as a whole. Dominant matters of public interest will need to be decided.

Hold your breath. It’s too early for aggrieved holders of paid-up retirement annuity (RA) policies to expect the sort of refunds ordered by Pension Funds Adjudicator Vuyani Ngalwana in the complaint of Carlos de Sousa. While the myriads begin to line up at Ngalwana’s door, expecting their complaints to be rubber-stamped as a formality on principles similar to De Sousa and other recent determinations (TT May 2005), a spanner smacks into the works.

McCulloch McCulloch... sail into headwind

McCulloch counters that the Adjudicator’s determination “rests on several errors of fact and mistaken views of the relationships between the parties, which ultimately led to the Adjudicator exceeding his powers under the (Pension Funds) Act and making a determination which is wrong in law”

Lifestyle Retirement Annuity Fund is taking the Adjudicator and De Sousa to the Witwatersrand High Court for the Adjudicator’s ruling to be set aside. Its grounds are that Ngalwana’s determination on De Sousa’s complaint is incorrect and outside his jurisdiction.While the Adjudicator has said on a number of occasions that he will not defend an appeal against his determinations, preferring to abide by the decision of the court, intimations are that De Sousa will oppose it.

It’s not merely a matter of paying out a single individual, as the Adjudicator has ordered (see box). De Sousa would only qualify as a precedent if another case replicates his in every respect. However, assuming that Ngalwana’s thinking will be consistent in other complaints still to be adjudicated, much more is at stake.

It extends from the authority of the Adjudicator to the consequences for RA members and even life-assurance policyholders (perhaps to be tested at another time in another forum) who find minimal paid-up value in a policy’s first two years; from the implications for life offices as insurers and administrators to the impact on national savings. In the tide of public glee that has greeted the Adjudicator’s swipe against “horrendous fees”, endorsing Finance Minister Trevor Manuel, much of the response is misplaced and ominously misunderstood.

Frequently obfuscated are the distinctions between a fund, the board representing a fund, and a financial institution (which typically is the fund administrator as well as the investment manager) and the insurer of fund members’ death and disability benefits. These services are often provided by the same business entity, but operating in quite different and distinct legal capacities in their relations with a fund.

Vuyani Ngalwana Ngalwana... High Court challenge

"If the fee structure of these life offices is such that people are penalised for discontinuing contributions to retirement annuity funds due to no fault of their own – but by reason, for example, of retrenchment or dismissal -- then it is my firm view that the business of life offices in this regard cannot be allowed to continue as usual but that some regulation must be put in place."

Most critical in this instance is the Adjudicator’s determination that the Lifestyle fund, not Liberty Life as its insurer, is liable for payment to De Sousa. Here lies the crunch. In effect, the fund’s only assets are insurance policies Liberty took out to provide promised retirement benefits to the fund’s individual premium-paying members. Other than these policies, the fund has no assets. How then is the fund to comply with the Adjudicator’s order? There appear to be three alternatives:

  • LIBERTY PAYS DE SOUSA. But the Adjudicator has specifically said that payment by the fund to De Sousa does not depend on whether the fund is able to recover the same amount from Liberty. If there were to be a recovery, it could open the gate to claims not only against Liberty but potentially against all other life offices administer RA policies and have customers who discontinued their RAs in circumstances similar to De Sousa. Also, because the legal relationship between Liberty (as insurer) and the fund (as insurance policyholder) is based on the terms and conditions of the insurance policy, the only basis on which Liberty could be obliged to make the payment is if it was obliged to do so in terms of the insurance policy. Here, the fund trustees do not see any legal basis for such an obligation on the part of Liberty;
  • THE FUND PAYS DE SOUSA, as per the order. But the fund has no assets, so the trustees would have to call on the individual fund members each to contribute. If members refuse, presuming they can, what happens? If they don’t refuse, those who continue to save will be prejudiced for the benefit of those who’ve discontinued their savings.Were this to become a precedent, multitudes of similar policies could be similarly affected to an unquantifiable nth degree;
  • THE FUND IS LIQUIDATED because it has no assets to make the payment. But this would invite liquidation costs, the transfer of members – at a price – to another fund, and the realisation of billions of rand in assets, eg the sale of shares by funds similarly affected.

All these precedent-setting scenarios share dangerous features. They threaten confidence in RAs specifically and in savings generally. As such, and more so if like principles are applied to paid-up life policies that offer minimal value in their early years, they can potentially undermine the structures of the financial system. And they invite hordes of innocent victims among long-term savers.

By the same token, the issues to have emerged in the De Sousa case are unpalatable. It will be to their peril that funds and their sponsors, the major financial institutions, fail to address them. Granted that the force of precedent is mitigated by detailed policies and rules of different funds, De Sousa does represent a broad commonality of practice applied over decades.

Arising from the Adjudicator’s ruling on De Sousa is a conflict for boards of trustees in how they are to protect the interests of all fund members. This is trustees’ main fiduciary responsibility. If they comply with the ruling in De Sousa, for the fund to make the payment, they’d be favouring members who withdraw early over members who remain for the full term.

Multiply the De Sousa case by several hundred thousand RAs, administered by numerous life offices, and the magnification is apparent. Multiply its principles to life assurance policies, perhaps to be tested in another forum at another time, and the magnification is all the greater.

Instituting the litigation against the Adjudicator and De Sousa, Liberty Corporate Benefits divisional director Alan McCulloch is careful to wear only his hat as chairperson of the Lifestyle fund’s management board. Liberty itself is not an applicant in these proceedings. The central question before the Adjudicator, says McCulloch in his founding affidavit, was whether De Sousa’s paid-up benefit had been properly determined. It had been, in that the “net investment value” was correctly given at R5 637. However, the Adjudicator had decided that the fund was not entitled to reduce the “total investment value”. This was R37 178 on the day before the policy was made paid-up. The sum of De Sousa’s contributions over 11 months was R37 983. The Adjudicator found that the fund had no right to reduce the policy’s paid-up value to R5 439 because:

  • The contractual relationship between the fund and De Sousa was governed by the fund’s certificate and rules;
  • The paid-up benefit was brought about by Liberty’s deduction of R31 601, which was effectively a penalty;
  • Neither the certificate nor rules of the fund provided for the imposition of a penalty, and in any event the basis for its calculation was not properly justified, so the fund (not Liberty) had to repay the “penalty”.


Pension Funds Adjudicator Vuyani Ngalwana has determined that Lifestyle Retirement Annuity Fund (not Liberty as the insurer) must pay complainant Carlos de Sousa an amount of R37 983 less the monthly management, premium contribution and premium guarantee charges. This R37 983 equated to the sum of his contributions over the 11 months before De Sousa made his policy paid up.

In his ruling, Ngalwana begins by referring to the statement by Finance Minister Trevor Manuel, who last November “publicly lamented” the “horrendous fees taken by the institutions from people who find that they have less than they paid into (retirement annuity) funds”. Upholding De Sousa’s complaint, Ngalwana said it demonstrated that the problem was “not the figment of the Minister’s imagination”.

In August 2003, Liberty had advised De Sousa that the “total investment value” of his paid-up policy (after deduction of unrecouped expenses) was R5 439,68.

Ngalwana held that De Sousa was “correct on the facts” when he said he would have been better off saving the money himself by perhaps putting it into a bank account.

The Adjudicator added: “If the fee structure of these life offices is such that people are penalised for discontinuing contributions to retirement annuity funds due to no fault of their own – but by reason, for example, of retrenchment or dismissal -- then it is my firm view that the business of life offices in this regard cannot be allowed to continue as usual but that some regulation must be put in place.”

McCulloch’s affidavit shows that by far the largest deductions were for commission and marketing expenses actually incurred on De Sousa’s policy. Liberty’s actuary had put the first-year commission at R28 342 and marketing at R13 723; after recoveries or “clawbacks”, in computing the “actual premium cessation charge levied” at R31 601 to arrive at the R5 439 paid-up value, the actuary had included commission at R15 352 and marketing at R1 143.

McCulloch counters that the Adjudicator’s determination “rests on several errors of fact and mistaken views of the relationships between the parties, which ultimately led to the Adjudicator exceeding his powers under the (Pension Funds) Act and making a determination which is wrong in law”:

  • Lifestyle is an “underwritten fund”. It procures insurance policies to underwrite the benefits promised individual members. Apart from these policies, the fund has no assets. All these policies are issued by Liberty, the defined “insurer” under Lifestyle’s rules;
  • In the resulting relationship, the fund and not the member is the insurance policyholder.Member benefits are determined by the terms of each member’s RA policy;
  • Life insurance policies are administered by Liberty under the Long-term Insurance Act (LTIA). Under it, the Adjudicator has no jurisdiction to enquire into “life” and “fund member” policies or to make determinations. Neither is a complaint concerning these policies a “complaint” as the LTIA defines it;
  • The Adjudicator has no jurisdiction or power to order the fund to make payment of any amount to any member. The fund’s rules provide that a member’s entitlement is restricted to the benefits under the insurance policy relating to the member’s benefit. This amount is payable by Liberty to individual members;
  • The amount deducted from the value of a paid-up RA is incorrectly described as a “penalty”. The reduction is an adjustment in value to cover costs actually incurred by the insurer in issuing the policy and which can no longer be recovered in the normal course from the member’s ongoing contributions;
  • De Sousa elected to cease his contributions prematurely. He paid only 11 months’ premiums, although his selected retirement term was about 24 years.Where RA contributions are paid over the full term, no such adjustments take place. In addition, argues McCulloch, the fund’s certificate is material. Its rules and conditions, to which De Sousa contractually agreed on taking the policy, provide among other things that:
  • The fund shall be controlled, managed and administered by a management board;
  • Total liabilities of the fund to grant benefits shall be insured by the insurer (Liberty), which shall insure the liability of the fund as well as “manage and administer the business of the fund and pay any fees and expenses of the (fund’s management) board”;
  • If a member prematurely discontinues his contributions, having made contributions for a minimum period under the insurance policy, he will be entitled to paid-up benefits “for an amount determined in relation to the actual contributions paid”;
  • No further contributions shall be payable. Provided the contract has an asset value, “all benefits otherwise payable shall be reduced accordingly”.

Disclosed at the outset to De Sousa was a table of illustrated (not guaranteed) asset or paid-up values that could be expected at the end of each of the first five years for his investment. At the conclusion of the first year, when he’d have contributed R41 436, the illustrated paid-up value was shown at R9 887 (assuming a six percent bonus rate) and R11 156 (assuming 12 percent).

That he got back much less than he’d contributed over 11 months is common cause. So too is the probability that, had his policy run for its full term, he’d have done much better as expenses incurred in the earlier stages were recouped during the later stages.

But these aren’t the immediate issues. These are broader and deeper:

  • Whether the Adjudicator has the power to make such determinations (beyond whether the paid-up value had been correctly calculated);
  • If he does, how payment is to be made by the fund and ultimately its members;
  • Where the Adjudicator substitutes his valuation for that of the insurer’s actuary, how the paid-up values of policies do not undermine the financial viability of the insurer.

Overarching is the response of the long-term savings industry, in its structure of RA and life products, to address innate questions of fairness.Whatever has happened, has happened. Whatever is to happen had better be recast if reputations and confidence are to be restored. In particular, under the spotlight of De Sousa, the industry is compelled to review its justifications for:

  • Commission expenses being loaded upfront instead of being paid to intermediaries as and when policyholders’ contributions are made;
  • Marketing expenses incurred for the benefit of insurers, and commissions incurred for business placed with insurers, being deducted from benefits to policyholders.

The outcome of this High Court action is critical because of its potential impact on liabilities of many funds for many thousands of similar products issued in years gone by. At least as critical, both for the financial institutions and for long-term savings, is the credibility of the institutions and their products for the years to come.