Issue: September/October 2006
Caught? Or Caught Out
The courts will have to decide. From his landmark ruling on smoothed bonuses, the Adjudicator has again shown what a tiger he can be with the life offices. But they can be pretty tigerish, too, and in this instance there’s no alternative.
Pension Funds Adjudicator Vuyani Ngalwana is either horribly right or horribly wrong. In his determination against a provident fund run by Old Mutual, the middle ground is obscure.
His ruling that Mutual cannot apply the market-value adjuster (MVA) to “smooth” the payout on a policy’s early termination, and had to reverse the MVA-calculated deduction for the benefit of complainant R Mungal, creates a precedent riddled with ramifications. It also bears the hallmark of a classic showdown, destined for the courts, between the equity which the Adjudicator seeks to promote and the legality on which the life offices tend to rely.
If Ngalwana is right, the consequences are potentially horrible for the life offices offering smoothed-bonus products. The principle is similar to the deductions he disallowed for early termination of retirement-annuity (RA) products. With RAs, the Adjudicator’s orders were against the funds and sometimes jointly against life offices. Nevertheless, under the “statement of intent”, the affected life offices and not the funds agreed to pick up the whole R2,6 billion bill for reversal of the deductions to RA policyholders.
In the Mungal case, he has made the order against Mutual. So there’s no rigmarole about how a fund, whose assets comprise insurance policies, is supposed to pay for the reversal of MVA deductions from smoothed-bonus policies. It leaves open the question of whether life offices are in for another smack.
What applies in the case of Mungal could apply equally in the cases of thousands, tens of thousands, of other policyholders with an eye for the gap. This is the gap between the surrender value of market-linked and smoothed-bonus policies stripped of the MVA. On the basis of the Mungal determination, investors can switch from the one to the other as relative advantage suits them: to surrender smoothed-bonus policies when share prices are depressed, for life offices to pay them at the (higher) smoothed value and vice versa.
Originally, they’d contracted for smoothed-bonus to obviate the risk of a weak return from weak share prices on their policies’ maturity. Now, when markets are especially strong, they really should be buying smoothed-bonus in anticipation of share prices someday turning south.
That way, they’re protected from the downside by smoothed-bonus and gain on the upside from market-linked. But a merry-go-round of switching between the two mocks both, defeating the purpose of smoothed-bonus and denying the perils in market-linked. It also makes smoothed-bonus products inoperable because, being long-term, they rely on years of good investment returns supporting the bad.
The MVA is always an adjustment downwards. Its flip-side is bonuses, which are always upwards. Without them, there can be no smoothing. Old Mutual executive Dave Hudson points out: “They’re not there just to prevent arbitrage potential, so that investors can’t trade against the funds, but to protect fairness so that people who prematurely leave the fund don’t benefit at the expense of people who stay.”
As smoothed-bonus products are big business for the life offices – particularly for Old Mutual, Sanlam and Metropolitan – the amounts of money involved are huge. In a worst-case scenario, the Adjudicator’s ruling could intone a death knell for these products because application of the MVA is necessarily integral to them; in a best-case, it will cause the insurers considerably to jack up the clarity of their policy- holder communications.
Mutual is virtually obliged to challenge the Adjudicator in court, and has signalled its intention to do so. The life offices have nothing to lose and everything to gain. Until there is a High Court judgment, and appeals are exhausted, it’s as-you-were. And it give investors pause to reflect that the present period of buoyant share prices is the best time to buy smoothed-bonus products, not shy away from them.
If the Adjudicator is wrong, and this all-important Mungal determination is not upheld, it will be a thorn in the superb work of his office that has promoted consumer awareness and fought unfair practice with an impact that nobody else has managed before. To lose the impending court case, coming after his defeat on a substantive issue in the Sanlam case (TT Nov-Dec ’05), won’t enhance his authority or reputation.
For too long, he and the industry have been at one another’s throats. They trade in recriminations of arrogance. Enough! Whichever way this High Court case goes, the value to come of it might yet be a setback for confrontation and an advance for cooperation with an industry trying hard to reform.
WHY THE ADJUDICATOR THINKS HE’S RIGHT
At issue in the Mungal determination was not whether smoothed-bonus products were good or bad. It was about the adequacy or otherwise of disclosure, the discretion and conflicts of Mutual as fund administrator and insurer simultaneously, and the validity of relevant contracts. Ngalwana set out to decide whether the fund rules allowed the MVA when the market value of the smoothed-bonus portfolio decreased against its book value, and when a policy is surrendered before its maturity:
Accordingly, the complaint succeeded.
WHY THE LIFE OFFICES THINK HE’S WRONG
There are two contracts in place. One is between the fund and the member; the other between the fund and the insurer’s policy. The Adjudicator had taken into account only the former.
Accordingly, it’s probable that the appeal against the Adjudicator’s determination will relate less to the structure of smoothed-bonus products than to the effectiveness of disclosing the MVA’s application.
ISSUES AT ISSUE
The Adjudicator looks like a lawyer, talks like a lawyer, thinks like a lawyer, and actually is a lawyer. His determinations, unless overturned by a court of law, have the force of law. But the complaints procedure differs from court procedure in some important respects.
Parties submit their complaints, and counterparties, then respond. This is more limited and selective than the court procedure of affidavit exchanges because, rather than advancing argument, it confines answers to the questions asked. Also, without evidence being led and witnesses being cross-examined, there can be holes in the information on which the Adjudicator makes his findings. The Mungal determination illustrates the point in two respects. First, the Adjudicator was highly critical of Mutual for not having explained – “and the question was directly and expressly put to them” – how the rate of 10 percent as the applicable MVA was arrived at. Neither did Mutual explain the charges listed under “disinvestment costs”, nor the appropriate MVA rate “that can reasonably be applied upon a member withdrawing from the fund prior to the maturity date”.
It isn’t apparent why Mutual elected not to explain. Under cross-examination, it would have had to answer these questions.
Second, the Adjudicator asked in his finding what happened with the accumulation of bonuses that had not vested at the time of withdrawal from the fund: “Is it shared between remaining policyholders, on the one hand, and the insurer’s shareholders at the end of the insurer’s financial year on the other? Or is it treated as a ‘profit’ and declared as a dividend for the benefit of the insurer’s shareholders?”
He left these questions unanswered “because it is not necessary to deal with them for purposes of this determination”.
Here, it isn’t apparent why he asked them only in his determination. Had they been asked in gathering information to assess the complaint, they could easily have been answered. Instead, the life offices have had to embark on a flurry of explanations subsequent to the ruling not least because the Adjudicator – again unlike a court of law – highlighted them in a press release.
Good does come of it, in the sense that public awareness is heightened. But there’s also bad in the implication of unfair practice.