By Jenny Gordon, Head of Technical Advice at Alexander Forbes
The Taxation Law Amendment Act of 2020 was signed into law by the President on 20 January 2021. This has enacted the long awaited legislation which provides for the same annuitisation rules that apply to members of pension funds, pension preservation funds and retirement annuity funds, to be applied to members of provident funds and provident preservation funds, after 1 March 2021 (T Day).
However, the legislation protects the accrued rights of provident fund and provident preservation fund (“these funds”) members as at T day. This means that:
- on retirement, members of these funds who are under age 55 on T day, will still be permitted to take amounts which accrued before T day plus fund return in cash.
- Members over age 55 on T day will have access to all amounts in the fund in cash on retirement from that fund.
- This is referred to herein as “vested benefits”.
- Amounts that are subject to the annuitisation rules will be termed “non-vested benefits” .
- The vested benefit rules have been extended to provident preservation funds of which the member had membership on 1 March 2021.
The annuitisation rules will apply to the non-vested benefits of all pre-retirement funds going forward. Fund administrators will have to keep separate records of amounts in funds which apply to the vested benefits and non-vested benefits which emanated from “these funds” as at T day. This will not only be required in “these funds”, but will apply to all funds. When members of “these funds” transfer benefits to other approved funds, records of the vested benefits will need to be kept in the new fund and administrators will need to keep separate records of vested and non-vested benefits. This will be explained herein.
Therefore, the legislative changes which defines vested and non-vested benefits appear in the definition section of each type of retirement fund and not just in the definitions of “these funds”.
Understanding the legislative framework relating to vested rights
An important distinction is made in the legislation between members of “these funds” who are under age 55 on T day (“ under 55”) and those who are age 55 and over on T day (“over 55”).
***In all cases, the determining factor will be if a member had membership of one or more of these funds on T day.***
Members of “these funds” have been entitled to retire from age 55 with a full cash lump sum. Therefore members over 55 are given greater vested benefits than members who have not yet reached age 55 on T day.
- Members age 55 and older on T day
For members over 55 on T day, their vested benefits will be:
- • All contributions to a provident fund and transfers to a provident preservation fund of which they were a member on T day, both on and after T day.
- • Any amount credited to the member’s account on and after T day
- • Any fund return on the above
This means that the vested benefits of members over 55 include amounts at T day as well as amounts contributed after T day and any amounts, including fund return, credited to the Page 2 members account after T day. The full value at date of retirement will be vested benefits. This applies in the provident fund they were members of on T day
Example: On T day value of member’s account is R 5 million. On date of retirement the value has grown to R 6 million. Between T day and date of retirement, the member contributed contributions of R500 000 and with growth is R1million. Member retires on 1 March 2025
The member may take R7 million in cash on retirement. No annuitisation is required.
Transfers to other approved funds (over 55)
On transfer to another approved fund, all amounts at date of transfer plus fund return on the transfer value in the new fund going forward will be vested benefits.
However, new contributions and fund credits plus fund return thereon in the new fund, will be non-vested benefits.
This applies to voluntary transfers as well as to compulsory transfers in terms of section 14. A section 14 transfer can occur when a section 197 transfer takes place as well as when a stand alone fund seeks to consolidate in an umbrella fund. Contributions which would have been vested benefits in the transferring fund, no longer qualify in the new fund.
Example: On T day, the value of the member’s account in a provident fund is R 5 million. Contributions after T day are R100 000 .On date of transfer to a pension fund, with fund return, the vested benefit is R 6200 000. On transfer to the Pension fund, R6 200 000 plus all future fund return on that amount will be vested benefits. If the member makes contributions to the new fund, those contributions plus fund return will be non-vested benefits.
Lump sum disability benefits (over 55)
If the member is in a provident fund on T day, all amounts which are contributed or accrue to the fund after T day are vested benefits. Therefore a lump sum disability benefit will be part of the vested benefits in the provident fund of which the member had membership on T day.
If the member were to transfer to a new approved fund after T- day, a disability benefit which pays out in the new fund, will be non-vested benefits.
- Members under age 55 on T-day
For members under 55 on T day, their vested benefits will be:
- • all contributions made, prior to T day, to a provident fund; or transfers to a provident preservation fund, of which they were a member on T day;
- • with the addition of any amounts credited to the fund-up to T-day
- • and any fund return on the above amounts
This means that the fund value on T day plus all future growth on that fund value going forward will be vested benefits and the member will always be entitled to that portion as a lump sum.
All contributions made to a provident fund of membership after T day plus any fund return or credits after T-day, will be non-vested, and on retirement will be subject to the annuitisation rules.
Example: On T day, the value of the member’s account is R 5 million. On date of retirement the value has grown to R6 million. Member retires on 1 March 2025. Between T day and date of retirement the member contributed contributions of R500 000 and with growth is R1.2 million.
On retirement the member may take R6 million +1/3 of R1.2million as a lump sum, R800 000 must purchase an annuity.
De minimis amount of R247 000
The legislation provides that at least 2/3 of the value on retirement (less the vested portion) must purchase an annuity unless the value does not exceed R247 500.
Example: On T day value of member’s account is R 5 million. On date of retirement the value has grown to R6 million. Member retires on 1 March 2025. Between T day and date of retirement the member contributed R 150 000 and growth was R90 000 = R240 000, then the full fund value including the vested portion may be taken in cash on retirement and no amount would have to purchase an annuity. R 6 million + R240 000 = R 6240 000 can be taken in cash.
Transfers to another approved fund
Vested benefits and non- vested benefits that are transferred by a provident fund member or provident preservation fund member to any other retirement fund after T-Day (excluding the GEPF) must retain their vested and non-vested nature in that new retirement fund. This general rule is also true for any of those vested benefits and non-vested benefits that may be transferred to successive retirement funds. Vested and non-vested benefits will retain their nature irrespective of how many times they are subsequently transferred to other transferee retirement funds and irrespective of the type of retirement fund they are transferred to.
Example: On T day, the value of the member’s account in a provident fund is R 5 million.(vested benefit) Contributions after T day are R100 000 (non-vested) On date of transfer to a pension fund, with fund return, the vested benefit is R6 million. The non-vested benefits of post T day contributions plus fund return is R200 000.On transfer to the Pension fund, R6 million plus all future fund return on that amount will be vested benefits. The R200 000 and all future fund return on that will be non-vested benefits. All future contributions plus fund return thereon in the pension fund will be non-vested benefits
Deductions under the Pension Funds Act
The legislation provides for amounts which are permitted to be deducted in terms of the Pension Funds Act to be deducted proportionately from the vested benefit and the non-vested benefit. Examples of these deductions are housing loans, divorce orders and damages claim to employers.
For example, a divorce award to a non-member spouse will reduce the member’s vested and non-vested benefit proportionately where there is both a vested benefit and a non-vested benefit in the fund.
Transfer of divorce award to non-member spouse approved fund
Although a divorce award will reduce a member’s fund proportionately, the vested benefit is not extended to a fund of a non-member spouse. If a non-member spouse elects transfer of a divorce award to an approved fund, it will all be a fully non-vested benefit.
On leaving employment a member may elect to take a lump sum in cash and transfer the balance to a new employer fund; to a preservation fund; or to a retirement annuity fund. There has been some debate as to whether this type of partial withdrawal is permitted to be deducted proportionately from the vested benefit and non-vested benefit. Every fund is a pension fund approved under the Pension Funds Act and therefore the legislation is capable Page 4 of being interpreted to extend to pre- retirement part withdrawals. The regulators are examining this point. Unless we receive an indication that this is contrary to National Treasury policy, we shall be interpreting a pre- retirement part withdrawal to be withdrawn proportionately from the vested benefit and non-vested benefit.
February 2021 contributions to funds which are paid later than 1 March 2021
Due to the way in which the legislation is worded, it has been a point of uncertainty, whether contributions of members which are due in February 2021 or earlier and which are paid to the provident fund by employers later than 1 March 2021, will be included in the vested benefits of members under 55. At National Treasury hearings on the Taxation Laws Amendment bill, SARS was of the view that they qualified as contributions prior to 1 March 2021. We will monitor whether there are any communications from the regulators to the contrary.
Lump sum disability benefits under 55
Only amounts which have accrued before T day fall into vested benefits. Therefore if a member is disabled after T day, the lump sum disability benefit payable to the fund will not fall into the vested benefits. The payment will fall into non-vested benefits.
The legislation states that any amount contributed to a provident fund or provident preservation fund forms part of vested benefits. However, amounts contributed to funds include risk benefits as well as charges. We are of the view that the intention of the legislation is that only the contribution allocated to retirement funding should be vested benefits and we are interpreting and applying it accordingly.
Transfers within the same fund.
Where a member has membership of an umbrella provident fund on T day, whether over or under 55, and later leaves an employer and becomes employed by an employer who participates in the same umbrella fund, that member’s vested and non-vested benefits will not change at all. The member has changed employers but is still a member of the same retirement fund.
Tax free transfer between funds
Since members of provident funds will be required to annuitise retirement benefits going forward, subject to the vested benefits, there is no need to disincentivise pension to provident fund transfers or pension preservation fund to provident fund or provident preservation fund transfers. With effect from 1 March 2021, transfers from pension and pension preservation funds to provident and provident preservation funds may be effected without paying tax.
HOW DO YOU ADAPT YOUR INSURANCE PRICING STRATEGY IN THE FACE OF INCREASED PRICE COMPETITION?
By Ketil Kristensen, Senior Advisor, Insurance, SAS
Many countries in Europe have in previous years experienced increased price competition for general insurance products. Especially in Southern Europe, the competition has been very fierce, fuelled by online price comparison websites. In Spain, Portugal and Greece, there has been a substantial drop in average premiums for products like motor, home and health insurance. This poses a real threat to the profitability of property and casualty insurers.
While some insurance products are highly specialised and almost impossible to compare, most common products have increasingly become commodities. Consumers can now easily compare them online.
When comparing insurance policy prices and details becomes as effortless as getting quotes for airline tickets or hotel accommodation on price comparison sites, more insurance companies will eventually enter the market. And thus price competition will increase.
Preparing for a price war
Once the price war starts, there is no way to avoid it. And insurers need to meet their competitors head-on.
To win a price war, insurers need to be meticulous when they set the premium levels. They might also need to rethink the definition of “profit” when they are making pricing strategies for the future. In a market where premium levels are volatile and the competitive situation may change rapidly, insurers also need the capability to evaluate potential future scenarios in a short period of time.
Setting the premiums right
In the fast-paced digital era, customers expect insurance prices to be easily available online. They will make inquiries for insurance covers for their cars or homes on price comparison websites and expect the prices to be available immediately. From an insurer’s point of view, the premium customers will see on their screens when comparing insurance policy prices is the sum of the insurer’s technical premium and the commercial loading.
The technical premium represents the break-even price that the insurance company would charge for the policy if it had no costs and no desire to make a profit. Commercial loading represents the sum of the insurance company’s costs and the profit it expects to make on the policy. Technical pricing is the subject of many actuarial textbooks. But as machine learning algorithms make their way into actuarial departments, we will need to rewrite those books. Modern pricing techniques that include machine learning algorithms are a notable improvement compared to traditional models. If applied properly, ML models will result in more accurate technical pricing given the same data.
But what about commercial loading? How much profit should the insurer aim for?
Every one of us has a different tolerance for how much we would pay for, e.g., a car insurance policy. Some customers don’t consider price to that important. Others will try to search for a better deal elsewhere, regardless of how much time the process would take. Most customers are somewhere in between.
Being able to price the insurance products analytically based on the “willingness to pay” is, for many actuaries, seen as the holy grail of insurance pricing.
Most insurers already do personal pricing to some extent today. For example, they give different discounts to policyholders with equal risk. However, there is often a great potential to do segmentation and price calculations in a more analytical manner. Ideally, insurers would like to set the premiums as high as possible, but not so high that customers move their policies to another insurer.
On the other side, insurers would like to move customers away from their competitors by offering low premiums – but not too low. The insurer must first determine the price sensitivity of insurance customers and then price each insurance policy so that it maximises the profit for the insurer.
Insurers that can quickly reoptimise changing prices in the online market will also quickly identify customers that are at risk for churn. They can then perform the appropriate actions to prevent this from happening.
When insurers think “profit,” they usually mean the income statement for next year. This is about to change. The concept of Customer Lifetime Value (CLV) is becoming more and more common in the insurance industry. And many insurers are now refining their pricing strategy based on a maximisation of the CLV of all its customers, thus not focusing solely on the profit definition in the income statement. The CLV of an insurance customer is the net present value of this customer for the insurer, where behavioural effects like renewal, cancellation and cross-selling of other insurance products are considered for the entire lifetime of the customer.
To accurately compute CLV for a customer, the insurer will need data that describes the behavioural patterns of the customer. Most insurance companies have quite a lot of such data available – the problem is usually that it is not adequately structured. In practice, to quantitively identify the customer lifetime value, insurers need to integrate both actuarial and customer behaviour models. Once a system for this is in place, insurance companies will have a strong quantitative foundation to compute the customer lifetime value of their policyholders.
Competitive insurance pricing
When a customer determines where to buy insurance, the price is the most important factor. Thus, to stay competitive and still run a profitable business, insurers need to set their premium levels just right. The evolution of price comparison websites – which provide real-time quotes on competitor prices and increased access to data that contains information about the customer’s insurance risk – has made the actuary’s job of calculating the premium more complicated.
Over the years, SAS has worked together with insurers to ensure that strong system support is in place to compute premium levels down to an individual policy level. These pricing systems have been put through the test in some of the most competitive insurance markets in Europe. They have turned out to be a valuable strategic tool for insurers to balance the desire for profit against the desire for market share. And maybe most important of all, they have enabled these insurance companies to effectively join the price war, fight it and still make a profit.
FROM EFFICIENCY TO NEW INVESTMENTS – WHY BLOCKCHAIN IS MORE THAN MEETS THE EYE
Thomas Borrel, chief product officer at Polymath
Blockchain has been an extremely hot topic in 2021. With companies and financial institutions internationally having to adapt to an increasingly digital world, the true potential of blockchain is becoming increasingly clear. We have seen hospitals using the technology to track vaccine distributions, major blue-chip companies floating digital assets or ‘stablecoins’, even progress made by central banks in piloting and adopting digital currencies
When it comes to the world of finance, much of the attention has focussed on the booming price of Bitcoin, and there has been much excitement around using cryptocurrencies as an alternative investment. However, the real potential of blockchain technology stretches far into traditional finance and beyond.
Improving access to investment options
Security tokens created and issued on the blockchain are already being used to improve efficiency in a variety of more traditional asset classes, ranging from real estate to green bonds. The Sustainable Digital Finance Alliance (SDFA) and HSBC Center of Sustainable Finance recently joined forces to highlight how security tokens for green bonds can reduce management costs and increase operational efficiency by up to ten times. And in early 2020, RedSwan CRE Marketplace tokenised $2.2B in commercial real estate, making it one of the biggest tokenisations we’ve seen so far.
However, the potential of tokenisation does not only stand to improve the process of trading traditional assets; blockchain can also open up the pool of investors able to participate. To date, the focus has been on how fractionalisation brings benefits to retail investors by lowering the bar to entry. However, the retail regulations are still very stringent, which is important to protect non-professionals from disproportionate losses.
Tokenisation can be used to enable large institutional investors to buy into smaller projects. Referred to as aggregation, this process can be used to bind assets together so that they meet an institution’s minimum investment threshold. Because of the transparency of blockchain, the investor is still able to inspect each individual offering and ensure each element meets their quality and risk requirements, but by packaging it into one larger token, an institution can diversify with assets that would have otherwise flown under its radar.
Optimising efficiency and minimising risk
Risk management and operational efficiency are usually at the core of any financial institution’s wider strategy. However, no matter how much firms optimise their own processes, there are a range of financial instruments that are still very prone to issues in these areas, especially those that are traded ‘over the counter’ (OTC). The best example of this is likely the bonds market – a multi trillion-dollar market, where OTC trades are still common practice.
When an OTC trade is conducted, it is often so over the telephone – one person calling another to make a deal. This introduces significant information risk with securities operations teams reporting error rates as high as 40%. When instructions for the trade are passed on to the custodians, they will spot the discrepancy. They then have to investigate and find out what has gone wrong, often resulting in very long delays to settlement times.
Blockchains go a long way to solving this problem, providing transparent access to trade and clearing information so that operational issues can be caught earlier and help mitigate settlement risk (i.e. settlement failure). For example, on Polymesh settlement instructions must be affirmed prior to settlement, in a case where an OTC trade has been improperly captured by one counterparty, the counterparty which has affirmed the instruction can see that the other counterparty has not affirmed the instruction within a defined period. In this way, the affirming counterparty can reach out proactively prior to the settlement date to rectify the situation and avoid settlement failure.
Trading on blockchain also generates an easily accessible, secure ledger of trading information. When it comes to reporting in traditional asset classes, the process is highly manual and often expensive. But, with a blockchain solution, reporting is built into the ecosystem from the ground up. There are no significant additional costs or resources required to extract this data and share it where necessary, and the number and complexity of the steps required to complete reconciliations between different entities are reduced and simplified.
Is tokenisation a ‘cover all’ solution?
Fundamentally, certain traditional asset classes are not right for the blockchain yet. Instruments with well-established frameworks, like publicly traded stocks, already have very well-formed, rigorous rails in place, and so transferring to a blockchain could cause disruption and incur unnecessary costs.
It is very common to hear blockchain advocates claiming that blockchain technology should be introduced into every corner of the finance space, which is misguided. Blockchain should be introduced where it brings value to investors or institutions. It should be about augmenting and supplementing the marketplace – not overhauling it, or at least not until the incumbent systems no longer keep up with demand.
The costs and infrastructure associated with capital markets have made some assets – like green bonds or real estate – too expensive to bring to market and service, or too difficult to invest in. These use-cases are examples of where tokenisation can really shine.
Blockchain is an extremely powerful tool, with a range of exciting applications and potential benefits for businesses and financial institutions, ranging from risk management and efficiency through to enabling new investments. However, as with any product, it isn’t the answer to all problems, and must be treated as a powerful enabler – not as an agitator.
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