Issue: December 08/February 09


Out of the rough

Had the Adjudicator been supplied with essential information he’d requested, this epic battle over “smoothing” might have been resolved with less hassle. Nevertheless, Old Mutual has won a court victory as important to insurers as to investors.

Hear the heavy sigh of relief from life offices that the Durban High Court has sanctioned use of the “market-level adjuster” (MLA) for calculating the payout on premature termination of smooth-bonus policies. Had the ruling gone against Old Mutual, in favour of the Pension Funds Adjudicator, the consequences could have been potentially horrendous for all life offices that underwrite these products:

  • The life offices might have been vulnerable to pay for reversals of MLA deductions on many thousands of smooth-bonus policies, on a principle similar to their R2,6bn payment under a “statement of intent” for deductions that the Adjudicator had disallowed on early termination of retirement annuities;
  • Smooth-bonus policies are designed to obviate the risk to investors of a weak return from weak share prices on a policy’s maturity. Without an MLA, policyholders with an eye for the gap would be able to switch to and fro, from smooth-bonus policies into market-linked when share prices are high and back into smooth bonus when prices are low, at the insurer’s expense. It was never intended that the policies be a short-term one-way bet, open to arbitrage.

It’s hard to imagine, had the Adjudicator (joined by the Registrar of Pension Funds and Registrar of Long-Term Insurance) won this court action, how life offices could have persevered with policies that perverted their purpose and exposed the underwriters to losses that were never contemplated. Going backwards, they would have had to recalculate the surrender value of existing policies – based on the disastrous level of present-day share prices – without resort to the MLA. This wouldn’t exactly be in the interests of insurers.

Going forwards, they’d have had to reconsider whether they’d be able to offer smooth-bonus policies in the way they now work. This would hardly be in the interests of savers prepared to compromise on share-market upside for protection on the downside. For the underlying rationale of these policies, essentially long term, relies on years of good investment returns supporting the bad.

An MLA – also known as a market-value adjuster or market-level indicator – is simply an actuarially determined rate to calculate downwards a fund’s market value against its smoothed value, when the fund’s market value is below its smoothed value, for an investor who surrenders his policy before it matures. It is not applied when the fund’s market value exceeds its smoothed value.

Its purpose is to protect investors who remain in the fund, to ensure the fund’s assets are not eroded by investors who exit early at times of market weakness. The MLA is the mechanism by which the crosssubsidisation, which enables the “smoothing” of returns, can take effect. It is always a downwards adjustment; the flip-side is bonuses, which are always upwards.

The concept is more pertinent today than in many years, for those who mightn’t have noticed the current condition of the stock market. Investors in smoothbonus policies are among the conservatives who’d planned with the foresight that share prices can also go down, correct, crash.

The application by Old Mutual was for the High Court to set aside the Adjudicator determinations that the insurer was not entitled to apply an MLA, in determining the surrender value of an insurance policy held by a pension fund, where the fund member withdraws from the fund before the original maturity date. The early withdrawal could be either by surrendering the policy or by advancing the retirement date.

Vusi Ngalwana

Ngalwana . . . kept in the dark

It’s a great pity, or perhaps intentional so that a court judgment could be obtained, that Mutual had not at the outset explained to then Adjudicator Vusi Ngalwana how it arrived at the MLA rate (TT Sept- Oct ’06). The omission led Ngalwana to conclude that, under the definition of “surrender value” in the policies, neither the charges listed nor the appropriate rate could reasonably be applied. Also, he’d held, Mutual could “capriciously” include its costs “of running an entirely unrelated business without members of the fund’s management board being able to pick it up”.

Justice Sishi underlined the point: “It is unfortunate that the expert advice of the actuaries, placed before this court in support of the parties’ cases, was not placed before the Adjudicator when determinations were made. The Adjudicator . . . made determinations without the guidance of the expert evidence tendered during these proceedings.”

There had been two complaints that Ngalwana had upheld. One was from R J Mungal, who had surrendered his policy, and the other from TV Freeman, who had advanced his retirement date.

Martin Brassey SC, for the Adjudicator, argued that there wasn’t a condition of the policies which contemplated that Mutual could take 10%-15% “off the top” of the policies. Malcolm Wallis SC, for Mutual, submitted that the underwriter was entitled to impose conditions – which the insured was not bound to accept – if the insured wanted to take the benefits before the policy matured.

In light of the expert evidence (unavailable to the Adjudicator), the court found that the MLA is not a charge and no product provider benefits from its introduction. Neither is it a fee paid by the insured to Mutual, which was entitled to apply the MLA so that it could determine the policies’ termination values. Rather, he held, the MLA is “part of the actuarial process applicable to such policies and an important component of the actuarial basis of such policy”.

Accordingly, Justice Sishi set aside the Adjudicator’s determinations. This, in effect, dismissed the Mungal and Freeman complaints. It also gives smooth-bonus policies, in their present form, a clean bill of health.


  • A smooth-bonus policy is essentially a “with-profit” endowment policy. It aims to provide a smoothed growth as opposed to a fixed predetermined sum assured (as in a without-profit policy) or a potentially volatile sum assured (as in a unit-linked policy);
  • Smooth-bonus funds are designed to smooth out the fluctuations in market returns of the underlying assets. This is achieved by retaining a portion of the returns during times of strong market performance to beef up the returns in weak markets. Normally, bonuses are declared annually and added to the fund’s value;
  • A minimum or vested bonus is guaranteed. After its declaration, it cannot be taken away from investors provided the policy is held to maturity;
  • At the same time as this vested-bonus declaration, an interim bonus rate is set in advance. Its aim is to provide a fair return to policyholders who exit the fund before the next bonus declaration. This rate might be adjusted upwards or downwards during the year, depending on market movements, to provide fair values for investors who exit and investors who remain.
  • The market-level adjuster (MLA) is the actuarially determined rate used to calculate downwards the market value against the smoothed value of the fund, when its market value is below its smoothed value, for an investor who surrenders his policy before maturity. The MLA serves to protect investors who remain in the fund by ensuring the fund’s assets are not eroded by investors who exit early, at times of market weakness. Smoothing is effected by cross-subsidising strong with weak market returns. The MLA is not applied when the market value of the fund exceeds its smoothed value.