Reform pension regulations now!!

The recent decision by the court to award Mr. Michael Fraser an additional six million dollars out of the surplus of the pension fund scheme of Island Life once again highlights the need for the pension fund reform to be finalized.  I believe the court to be wrong in its interpretation and that its ruling is not in the interest of natural justice.  In addition Mr. Fraser may have been found to have a legal right to the money but from a strictly moral point of view he is wrong.  In order to explain my reasoning, I need to take some time to explain the workings of the pension funds and their inherent weaknesses.

There are principally two major types of pension fund schemes, defined benefit (DB) schemes and defined contribution (DC) schemes.  In a defined benefit scheme, persons contribute to a pension fund in which at the time of their retirement they will receive a certain benefit.  Usually this benefit is expressed as a percentage of their salary in their final year of work.  Thus their benefit to be received is not calculated in relation to how much they have contributed but rather is “defined” by a calculation that is applied to each person who retires.  Because there is uncertainty about what salaries will be at the time of retirement and how many persons will retire then an actuarial valuation is needed to assess whether there is a surplus or deficit in the fund.

In a defined contribution scheme the contributors to the pension fund receive a pension which is based upon their accumulated savings in the scheme.  Thus the longer one has been in the scheme and the greater percentage of your salary that you contribute to the scheme then the larger will your pension be at the time of retirement.  Since each person’s benefit is based upon their accumulated savings then there is no need for an actuarial valuation to determine if there is a surplus in the scheme.  It is not possible to have a deficit in this type of scheme as one’s entitlement can never exceed what one has contributed to the scheme. One might think that this type of fund could not have a surplus in it but as I will explain this is in fact possible.

In the next part of this series I will go into details about how a pension fund scheme ends up with a surplus or deficit.  Understanding this issue is the key to seeing why I think that the court has made an error in the ruling of this case.