Reform Pension Schemes – part 2 – Surpluses

We have previously looked at the two main types of pension funds and now we are going to look at why surpluses or deficits occur in pension funds.  Deficits only occur in defined benefit (DB) schemes and are due to two main factors.  The first is where the return on the assets of the pension fund is lower than the rate of increase in salaries.  Thus the accumulated contributions are insufficient to buy an annuity as defined by the scheme based on their final salary.  The other factor that can contribute to deficits is where older persons are introduced to the scheme.  This is because in the shorter period of time that they are in the scheme their accumulated contributions will not be sufficient to fund their entitlement based on their final salary.  It must be noted that in such circumstances the company was required to fund the shortfall.  This resulted in many countries closing DB schemes and changing to defined contribution (DC) schemes.

There are two main reasons why surpluses occur in pension funds in Jamaica.  The first reason is due to what is known as “vesting”.  When one joins a pension scheme, in addition to the contribution that a member makes there is also a contribution that is given by the employer.  It is a common practice that these employer contributions do not belong to the employee until he/she has served a minimum period of time with the company.  For many companies that period of time is ten years after which the employee becomes entitled to the employer’s contribution or is said to be “vested”.  If employees serve for the whole of the vesting period, say ten years, and leave the scheme they would be entitled to both of the employers and their own contributions plus interest.  If persons leave the scheme before the end of the vesting period then they are only entitled to their contributions plus interest and the employers contributions remain in the fund.

The second and I believe the main contributor to surpluses in Jamaican pension schemes is the rate of interest credited to the members of the scheme.  In the 1990’s when property prices were booming and the stock market was soaring to new heights, it was not uncommon for pension schemes to have returns on investments of more than 50 and even 100 percent.  However in many cases the interest credited to the members was only 6 – 8 percent.  This was said to have been done because the company was being cautious not to send the fund into deficit.  In reality however companies discovered that if the fund was in surplus then the company no longer had to contribute to the fund.  In addition if the surplus was large enough companies could withdraw the excess surplus from the scheme.

It thus became standard practice to have a surplus in a pension fund and in the next installment we will revisit the decision of the court to see what alternative actions could have been taken.