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Module 7:

IN ASSOCIATION WITH ERNST & YOUNG AND E-DEGREE

How to be …A RESPONSIBLE RETIREMENT FUND TRUSTEE

INTERPRETING FINANCIAL STATEMENTS

MODULE 7Karin Biggs CA (SA)

Karin Biggs, the lead partner inErnst & Young’s retirement

funds division, joined Ernst & Youngin May 2000. She chairs the SA In-stitute of Chartered Accountants(Saica) Pension & Provident FundInterest Group and is helping theFinancial Services Board and Saicaredraft requirements for retirementfunds’ financial statements.

WHAT IT’S ALL ABOUT

South Africans face a be-wildering array of pensionfunds and even more com-

plex retirement fund legislation.While every fund is bound bylaw to appoint trustees to lookafter members’ interests, fewtrustees elected to representtheir colleagues’ interests havethe skills to fulfil their dutiesp ro p e r l y.

In addition, new legislationis making all trustees respon-sible for signing statementsdeclaring that they have com-plied with their duties as

trustees. There will be no placefor a trustee who does not fullyunderstand the rules and theenvironment in which they op-erate.

The Responsible Trusteeship se-ries, brought to you by theFinancial Mail, Ernst & Youngand eDegree, is designed to fillall the gaps.

This section of the coursewill help you understand howto read and interpret financialstatements.

If you are a trustee and wantto get to grips with your duties,sign up for the eight-part onlinecourse at www.financial-mail.co.za or fill in the form onthe back page and fax it to (011)328-2095. n

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Financial statements

The quest for moreinformationAll retirement funds, inclusive of pension and providentfunds, will be required by section 15 of the PensionFunds Act of 1956 to submit financial statements withinsix months of the expiry of their respective financialyear-ends.

These financial statements havelargely been ignored or neglectedby trustees. However, if under-

stood and correctly interpreted, thesestatements could give a wealth of in-formation about the fund.

So why have these reports receivedso little attention?

The answer could be twofold,namely that they are outdated or notunderstood. To place this in perspec-tive, let’s look at the history of re-tirement fund annual financial state-ments.

Where did it all start?Upon establishment of the Fi-

nancial Services Board (FSB) inApril 1991, an abbreviated form offinancial reporting was inherited,originating from the previousGovernment Office of FinancialInstitutions. At the time thisformat was found to be in-adequate in certain areas and itwas decided to redesign theformat of financial reporting tocomply with developments inthe retirement fund industry.

One of the most important changesthat had to be incorporated into thenew financial statements was the in-troduction of the then new regulation28. Regulation 28 superseded section19(1) of the act, which had prescribedinvestments in certain categories. Withthe scrapping of section 19(1), the re-quirement to invest 53% of a fund’sassets in government or quasi-govern-ment institutions fell away, leavingfunds with more freedom to decide how

the fund’s assets are to be invested.Another major change to the format

of financial reporting was the advent ofthe trustees’ report. The purpose of thereport was to provide members offunds with more clarity about who wasresponsible for their affairs, what ben-efits were provided, the financial resultsand any other important issues per-

funds industry. In addition to the pen-sion fund circulars there have beenchanges to the accounting treatment ofvarious issues, evident from the pub-lishing of more and more accountingstatements and procedures affectingmore than just retirement funds. Therehave also been vast changes to what isperceived to be good management, cor-porate governance being the term oneveryone’s agenda.

The involvement of both membertrustees and employer trustees on

retirement funds has made mem-bers more conscious of how theirfunds are managed and has pro-vided transparency into the af-fairs of their fund. The role of aboard of management has alsocome under the magnifyingglass.

Arriving at the crossroadsThe retirement industry has

arrived at a point where financialstatements might not be fulfilling

their role completely.There has been a concerted effort

from role players in the retirementfunds industry to address this. Recentlythe Pension & Provident Fund InterestGroup, under the guidance of the SAInstitute of Chartered Accountants(Saica), proposed a set of financial state-ments to address the shortcomings ofthe present set of financial statements.In addition, the imminent withdrawalof audit exemption for previously audit-exempt funds will bring more trans-parency to members of funds who didnot previously enjoy the benefits ofaudited financial statements. The newfinancial statements will aim to in-corporate all the latest requirements andexpectations and should again be a

taining to their respective funds.All of this resulted in the current

format of financial reporting, which wasintroduced by way of Pension FundCircular PF.83 in March 1994. The ef-fective implementation date of this cir-cular was December 15 1993. However,the implementation date for the ap-plication of the new financial statementswas announced as April 1 1994.

Winds of changeThe pension funds industry has

evolved in leaps and bounds. Variouscirculars were issued by the FSB to takenote of the changes in the pension

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WHAT HAS BEEN PROPOSED?

Accrual basis

Cash basis

Large privately administered fundsSmall privately administered funds

Large previously audit-exempt fundsSmall previously audit-exempt funds

useful tool in providing information toall stakeholders.

The current format of financial state-ments of retirement funds — which isprescribed by the regulations to thePension Funds Act — has not changedin the past 10 years and no longer meetsthe governance needs of funds.

SA has gone through an interna-tional harmonisation process with ac-counting statements. This means that ifyou pick up a set of financial statementsfrom any organisation in the UK — orelsewhere in the world — and a setfrom SA, the same set of principlesshould be apparent. The accountingprinciples used for listed entities havethus changed significantly in the past 10years. Sadly, the format and content ofthe financial statements of retirementfunds in SA have fallen behind as nochanges have been made in 10 years.

In addition, there have been manydevelopments in the retirement fundindustry over the past 10 years and thefinancial statements do not make pro-vision for these changes. For instance,

there has been a huge move from de-fined benefit to defined contributionfunds in SA and the country has newlaws relating to the apportionment ofsurpluses that built up in the old styledefined benefit funds. Another area notreflected in the financial statements cur-rently is smoothing reserves. Thetrustees of defined contribution fundsoften hold back some of the investmentreturns in good years to smooth thereturns to individual member accountsin years when markets perform poorly.

In 1996 the FSB — which regulatesthe nonbanking financial services sector— in conjunction with the Saica interestgroup, embarked on a process of up-dating the financial accounting and au-diting requirements for retirementfunds. The FSB published the proposednew standard for public comment to-wards the end of last year and thecomments are being worked into thenew draft regulations.

It is hoped that the new regulationswill be effective from January 2005.

What will this mean for trustees?The new proposed format will give

all boards of trustees the financial in-formation they will require to managetheir funds better. These financial state-

ments encourage good administrationand will demand proper reconciliationof financial data, thus giving thetrustees proper management tools overthe financial affairs of their fund.

What has been proposed?Currently there will be four sets of

financial statements for funds.The format of financial statements is

prescribed in the regulations to thePension Funds Act. As mentioned be-fore, some of the main changes to theregulations being proposed will providefor far greater financial control of fundsand it will allow the trustees of funds tohave a much better instrument to keeptrack of what is happening with thefinances of their funds.

What are some of the proposedchanges?

With regard to rule amendments, the

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financial statements will record the rulechanges for which the fund has appliedto the FSB and whether they have beenapproved. No mention has been madeof rule amendments and this will givethe trustees the status of all rule amend-ments at a glance.

At present reserve accounts andmovements in reserve accounts are notdisclosed at all in the financial state-ments. This is ironic if one takes intoaccount what has been happening withthe promulgation of the surplus leg-islation, not to mention what risk isinvolved in reserve accounts. Now far

greater detail on reserve accounts willhave to be shown. The proposed fi-nancial statements will accommodatethe full disclosure of surplus appor-tionment. All reserve account move-ments and allocations will be reconciledand disclosed. Hence the inflow andoutflow of the various pockets of thefund will be better reflected in the newre g u l a t i o n s .

Section 14 transfers, which normallyaccount for very large movements inthe financial records, are not disclosedat all. This happens when memberstransfer their membership from one

fund to another. The fund, which istransferring the pension assets of mem-bers, must apply to the FSB for ap-proval to transfer the money. This is arequirement in terms of Section 14 ofthe Pension Funds Act. Currently, suchtransfers are reflected only in one line inthe income statement. The proposednew reporting standards will requirethat funds reflect where the transfer willbe coming from, to which fund it will

be made, the number offund members involvedand other details.

Another enhancementwill be cash-flow recon-ciliations: the proposedregulations will requirethe financial statements toreflect the cash flows ofthe fund in greater detail.Cash-flow items wouldtypically include transfers,benefit payments and em-ployer contributions. Theproposed detailed report-ing on cash flow will al-

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l Ensured that proper in-ternal control systems wereemployed by or on behalf ofthe fund; andl Ensured that adequateand appropriate informationwas communicated to themembers of the fund, in-forming them of their rights,benefits and duties in termsof the rules of the fund; andl Took all reasonable stepsto ensure that contributionswere paid timeously to thefund or reported where nec-essary in accordance withSection 13A and regulation33 of the Pension Funds Act,1956; andl Obtained expert advice onmatters where it lacked suf-ficient expertise; andl Ensured that the rules andthe operation and admin-istration of the fund com-plied with the PensionFunds Act, 1956, the Finan-cial Institutions (Protectionof Funds) Act, 2000, and allother applicable laws; andl The fund’s board oftrustees confirms that, dur-ing the period under review,fidelity cover of R<insertamount> was maintained.This cover was deemed ad-equate and in compliancewith the rules of the fund.l Investments of the fundare in accordance with theinvestment strategy and in-vestment decisions in re-spect of individual invest-ment choice. n

low the trustees to see whatthe fund owes or is owed atany point.

These are some of theproposed enhancements. Allof these will, of course, beuseless unless understoodand correctly interpreted bythe trustees.

Have you ever consid-ered comparing the mem-bership statistics to benefitpayments? Have you com-pared the reinsurance recov-eries to death payment? Allthese ratios should revealwhat has or should havebeen recorded in the finan-cial statements.

The proposed format willrequire trustees to sign offcompliance with their dutiesand this should not be con-sidered lightly. The follow-ing statement will have tobe signed:

STATEMENT OF RE-SPONSIBILITY BY THEFUND’S BOARD OFTRUSTEES

ResponsibilitiesThe fund’s board of

trustees hereby certifies tothe best of its knowledgethat, during the period un-der review, in the executionof its duties it:l Ensured that proper reg-isters, books and records ofthe operations of the fundwere kept, inclusive ofproper minutes of all res-olutions passed by theboard; and