SI 162: Too little, too late?

Some pension funds may face different impacts of compensation on their financial sustainability, intergenerational equity, and member satisfaction.

DURING the hyperinflation period between 2007–2008, a lot of wealth in Zimbabwe was lost, and amongst those who were prejudiced were pensioners.

The country then dollarised early in 2009 and started to recover, but even though some of the economic agents, who had contributed a portion of their earnings throughout their entire career towards their pension still lost valuewhen their benefits were converted into US dollars.

This led to an investigation, named the Justice Smith Commission of Inquiry, which aimed to assess the conversion methods and processes of insurance and pension assets and liabilities to US dollars and to establish the extent of prejudice if any to policy holders and pensioners amongst other things.

One of the recommendations of the Commission has led to Statutory Instrument 162, which instructed pension funds to compensate for loss of value.

Albeit recognising that the full indemnification of losses by pensioners during the hyperinflationary period might not be practicable, the government nevertheless, felt it appropriate for the prejudiced to be somehow compensated.

In that regard, the funds that were in existence during the hyperinflationary period and had members that lost value were given 90 days to come up with a compensation scheme for submission to the Insurance and Pension Commission (Ipec).

These schemes at minimum should be able to distinguish between the shareholder and policyholder funds during the hyperinflation period, an exercise which other players in the market have already undertaken. Insurance and pension assets should also be clearly separated and a list of assets that backed the policyholders during the hyperinflation period should be availed.

The compensation schedule should also group different pension contributors, past and present into cohorts and clearly outline which cohort will be eligible to receive compensation and assumptions around how much and where the compensation will be coming from.

This is to ensure fairness amongst different cohorts of pension contributors and maintain these funds' solvency.

Upon submission of the compensation schedule proposal, Ipec will review it within a month and once it approves a schedule, compensation should start in the following thirty days. In the event that the scheme is rejected, the fund will have to come up with another to avoid penalties.

How can these funds comply?

Broadly speaking there are two types of pensions, the Defined Benefit (DB) that promise a certain level of income to their members based on a formula that usually depends on their salary and years of service and Defined Contribution (DC) that allow their members to accumulate savings in individual accounts that are invested in various assets.

DB pension funds bear the investment and inflation risk, while DC pension funds transfer these risks to their members.

 Typically, pension funds may offer different types of inflation indexation to their members, such as full, partial, conditional, or discretionary depending on the type of pension.

For DB, the pensions might use a combination of investment returns, and reserves to finance the indexation, while ensuring that they maintain adequate funding levels, solvency ratios, and risk management practices as per the Statutory Instrument.

Although the inflation risk lies with the contributor for DC schemes, the funds might have to compensate some cohort for loss of value when the currency was changed and offer a range of investment options that can hedge against inflation risks, such as inflation-linked bonds, real estate, commodities, or equities instead of just cash pay-outs in the future.

Impact of compensation

Some pension funds may face different impacts of compensation on their financial sustainability, intergenerational equity, and member satisfaction.

Financial sustainability will in this case refer to the ability of the pension fund to meet its current and future obligations.

Intergenerational equity (as opposed to intergenerational transfers) refers to the fairness of the allocation of costs and benefits between different cohorts, leading to the last point of "member satisfaction", which is self-explanatory and simply refers to the degree of happiness and loyalty of the members towards a particular pension fund.

If it so happens that some of these pension funds do not have enough cash or near cash assets to finance the new obligation, they might be forced to consider liquidating other investments.

Considering that pension funds are some of the biggest players in the equities and property market, if not well coordinated and structured, their attempt to comply by selling these investments might lead to a fire sale that will tremble the markets.

 The effects of such will affect not only the intended beneficiaries but the market as a whole.

Overall opinion

One of the findings of the Justice Smith Commission was that the loss of value in insurance and pension benefits was mainly caused by macroeconomic regulatory and institutional factors as opposed to the malpractice of the pension funds.

Based on that and to maintain the solvency of the pension funds, it might be important for the government to shoulder the burden by putting structures that allow the compensation process to proceed smoothly and in extreme cases actually compensate itself.

There might be a need to design a formula that can tell in advance, how long the compensation pay-outs will run for.

This is as opposed to the structure described in the Statutory Instrument where regulations shall be repealed when the minister, in consultation with the Commission, is satisfied that the compensation exercise has been completed. In that way, the pension funds might be better prepared for the extent to which they have to compensate and be more prepared for that.

Pension funds might be better off monitoring the inflation trends and expectations in their relevant markets and jurisdictions, and reviewing their indexation policies and strategies regularly in the future.

  • Hozheri is an investment analyst with an interest in sharing opinions on capital markets performance, the economy and international trade, among other areas. He holds a B. Com in Finance and is progressing well with the CFA programme. — 0784 707 653 and Rufaro Hozheri is his username for all social media platforms.Dube is a non-executive director at FinAcco Capital, providing strategic leadership for the holding business and finance functions for the operating units.

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