PRA 2014 and management of private sector gratuity and pension schemes (2)

Absence of guidelines on actuarial valuation method

The statutory regulation, PRA 2014, does not give any guidelines on pension scheme valuation method. Therefore, the choice of valuation method is at the discretion of the actuary, leading to non-standardization of valuation results, which makes peer reviews and comparative analysis quite impossible for regulatory purposes. Furthermore, employers operating unfunded (PAYG) gratuity schemes tend use the book reserving methodology (which requires making provisions in the company’s accounts for unfunded benefit liabilities payable in the future for which no funds have been set aside) being the most appropriate valuation method for unfunded schemes. The balance sheet of the company will show the full value of the unfunded benefits as liabilities of the company and there will be no specific assets earmarked to provide the benefits. The challenges of book reserving are insecurity of reserves, liquidity problems, overstatement of profits for taxation and insecurity of benefits.

No minimum level of adequacy: Regulator(s) require that defined benefit (gratuity/pension) schemes must always have appropriate and adequate assets available to pay the benefits. The financial assessment framework (which defines the statutory funding objective) is normally part of the Pensions Act and sets out the requirements for the financial position of a gratuity/pension fund. A gratuity/pension fund’s financial position is reflected largely by the coverage ratio. This expresses the relationship between the fund’s assets and the liabilities to be paid in the future. There should be a minimum coverage ratio (e.g., 105 percent), that is, the assets must amount to 105 percent of the liabilities. However, section 50 (2) of PRA 2014 only specifies that any defined benefits scheme in the private sector shall undertake an actuarial valuation to determine the adequacy of the pension fund assets, but without stating clearly the level of adequacy (i.e., no minimum coverage ratio) required which is a regulatory challenge. The above implies a minimum coverage ratio of 100 percent (i.e., the assets must amount to 100 percent of the liabilities) which no doubt is likely to create an insolvency risk for private sector schemes, particularly when there is volatility in the financial market.

In addition to the minimum coverage ratio, a gratuity/pension fund must also hold enough buffers to be able to cope with financial setbacks or volatility in the financial market. The size of these buffers depends on many factors, but for an average gratuity/pension fund the required coverage ratio, including the required buffers, is approximately 125 percent. On average, the greater the investment risks and the higher the average age in the gratuity/pension fund, the higher the buffer requirements. The determination of the level of buffers is a task that requires actuarial techniques, having considered the risk appetite of the scheme.

No guidelines on recovery plan: Section 50 (1) (g) of PRA 2014 requires that an employer shall undertake to the PENCOM that the pension fund shall be fully funded and any shortfall (in scheme assets required to meet the liabilities) to be made up within 90 days. This means that if there is a funding shortfall (i.e., coverage ratio of less than 100 percent), the employer must submit a recovery plan to PENCOM. The steps to be taken to regain the minimum coverage ratio within the period of 90 days (i.e., the requirements of a recovery plan) are not clearly specified by the regulator, PENCOM. The challenge is that this regulatory function has not been effectively carried out and/or neglected by PENCOM.

Lack of adequate supervision of private sector schemes: There are no clear regulatory guidelines on the administration of private sector gratuity/pension schemes since the Pension Reform Act was first enacted in 2004, despite the fact that the number of gratuity schemes operating in the pension industry are on the increase. Thus, private sector gratuity/pension schemes have not been effectively regulated and supervised by the regulator (PENCOM) relative to CPS, probably because the supervisory roles (e.g., to determine an appropriate level of adequacy of scheme assets, section 50 (2) of PRA 2014) relating to the former schemes require more actuarial involvement and expertise.

Tax disadvantage: There is a tax disadvantage for an employer’s contributions into gratuity schemes relative to paying the same amount as AVCs into CPS (section 10 (1) of PRA 2014). The contributions, investment returns and retirement benefits in the CPS are tax exempt section 10(1)(2) (3) of PRA 2014 while the employer’s contributions and gratuity benefits are not taken as tax exempt. However, any income earned on any AVC under CPS is taxable at point of withdrawal within five years of making the AVC. Furthermore, the retirement benefits payable from CPS are also not taxable (section 10 (3) of PRA 2014), whereas the gratuity benefits are taxable in the hands of the employees.

Management and custodian of private sector pension funds: Section 50 (4) of PRA 2014 states that the management and custodian of pension funds for private sector pensioners shall be undertaken by licensed Pension Fund Administrators (PFAs) and Pension Fund Custodians (PFCs). This is also applicable to every employee in the existing pension scheme in the private sector who wants to exercise the option of coming under the new CPS. The above provision may require a bulk transfer of private sector pensioners’ and/or individual employee funds to the PFAs and PFCs for effective management and custody respectively. This process would involve the determination of the bulk transfer value by an actuary for the pensioners and/or individual employee. The challenge is that the bulk transfer value would have a negative impact on the future financial position of the private pension scheme for the remaining active members.

Opportunities of managing private sector schemes

Standardization of actuarial valuation methods – IAS 19: The accounting regulation, IAS 19, specifies that the projected unit credit method (PUCM) should be used in the valuation of gratuity/pension benefits, leading to standardization of actuarial valuation results of private sector schemes.

Actuary’s expertise in managing risks: The engagement of actuaries (as required by law and/or scheme trust deed/rules) in the management of private sector gratuity/pension schemes would result in adequate assessment of funding needs thereby reducing the risk of insolvency. Actuary’s expertise can be used in managing the risks arising from the administration of gratuity/pension scheme by: modelling the asset and liability stochastically in order to determine an appropriate investment strategy in line with the volatility risk in employer’s contribution(s) into a balanced of cost scheme over time (arising from the effect of gearing and also lower than expected investment returns on the fund assets); providing appropriate advice to meet new accounting and statutory regulations for technical provisions and/or solvency margins of the schemes that will emerge in the future; and determining bulk transfer value of gratuity/pension scheme in event of mergers and acquisitions of a company.

Enforcement of accounting regulation by FRCN

The enforcement of accounting regulation, IFRS as set out in IAS 19, for listed companies operating private sector gratuity/pension schemes in Nigeria effective from 2012 by Financial Reporting Council of Nigeria (FRCN) is a welcome development.

Conclusion

The major stakeholders, namely sponsors, regulators and operators require actuarial services in order to effectively manage the private sector gratuity and pension schemes.

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