ASIC is encouraging trustees of defined benefit superannuation funds to make timely and appropriate disclosures to members in the wake of poor returns caused by the global financial crisis (GFC).

This follows a review of the disclosure practices of defined benefit funds following the GFC, during which time funds across the superannuation sector experienced poor investment returns. ASIC’s focus is on ensuring trustees make appropriate disclosure to members and improving disclosure practices in relation to defined benefit funds more generally.

Trustees of defined benefit superannuation funds are required to notify members of significant events and changes in their fund’s financial situation, particularly if there is a funding shortfall that an employer will not rectify.

ASIC Commissioner, Greg Tanzer said, ‘While investors in defined benefit funds are typically less affected by investment markets than those in accumulation funds, the GFC highlighted that prolonged market falls can impact a defined benefit fund if there is a funding shortfall and the employer is unwilling or unable to meet shortfall amounts.

‘Many investors in defined benefit funds may not be aware that their ultimate benefit is affected by the capacity of their fund to meet the defined benefit. ASIC therefore encourages trustees to be vigilant about the financial position of their fund and to actively consider making disclosures to help members better understand the financial position of the fund. Trustees are best placed to explain market risk and what happens in the event of a funding shortfall’, Mr Tanzer said.

Mr Tanzer said ASIC would be paying particular attention to disclosures by defined benefit trustees in the future.

‘A failure to provide existing members with ongoing disclosure, where disclosure is required, is an offence. In specific cases, ASIC will consider issuing stop orders on product disclosure statements where it believes there is insufficient disclosure. We will also consider whether further guidance is needed for the industry more broadly’, he said.

Review of disclosure practices

To determine the extent of the impact of the GFC on other defined benefit funds, and examine the disclosure practices of those funds, ASIC contacted defined benefit fund trustees about their funds’ financial position and the disclosures they were making to members about their fund’s financial situation, particularly where there is a funding shortfall. ASIC has appreciated the cooperation of the trustees who provided this information voluntarily to ASIC.

ASIC paid particular attention to the funds' Vested Benefits Index (VBI), a measure of the financial position of a fund. The VBI is the ratio which represents a fund’s ability to pay vested benefits to members if all members were to voluntarily leave the fund on the same day.

ASIC’s review of approximately 470 defined benefit funds and sub-funds found, among other things, that:

• 58% of these funds’ current or most recent VBI is at 100% or above;

• 30% reported a VBI between 90-100%;

• 7% reported a VBI between 80-90%; and

• 1% reported a VBI of less than 80%.

The remaining 4% of funds had either closed, had no more defined benefit members, or had not disclosed their VBI on the basis they are government funds.

ASIC was pleased to note that more than 70% of trustees of funds with a funding shortfall disclosed the shortfall to members in the trustee’s annual report. Most remaining trustees did not disclose their fund’s funding shortfall on the basis that the employer has agreed to a suitable rectification plan to bring the VBI back to above 100%.

Connected with Stronger Super reforms, recent draft reporting standards released by the Australian Prudential Regulation Authority (APRA) propose that APRA collect and publish VBI data for defined benefit funds from July 2013 onwards. ASIC notes this may affect the disclosures that trustees choose to make to their members, as trustees may wish to provide explanations for their financial position to members who would otherwise get the data from APRA.

Further, APRA’s proposed Prudential Standard SPS 160 Defined Benefit Matters requires that trustees set a shortfall limit below which the trustee must arrange for an interim actuarial investigation. While this prudential standard is still to be finalised, trustees should consider whether disclosure of, and reporting against, the shortfall limit for the fund is appropriate.

For those trustees with open defined benefit funds, disclosure of market risk can be important information for members to have at the point at which they join the fund – that is, in the product disclosure statement (PDS). ASIC strongly encourages trustees to provide information in the PDS about the fund’s financial position and shortfall limit, the effect of market risk on the fund, and any shortfall rectification plan, if appropriate.

In the unlikely event a PDS is still being issued to new members when a fund becomes insolvent or the trustee doesn’t have a reasonable expectation that a shortfall will be rectified within an appropriate timeframe, ASIC expects the PDS to clearly explain the fund’s financial situation.

Where a fund becomes insolvent or a shortfall will not be rectified in an appropriate timeframe this represents a material change or significant event affecting the fund. ASIC expects trustees of funds in this position to make appropriate and timely significant event disclosures to their members.

ASIC is contacting each defined benefit trustee who has given information to ASIC in relation to this review in order to provide feedback about their disclosure practices.

Background

Defined benefit funds

A defined benefit fund is one with at least one defined benefit member. A defined benefit member is one whose superannuation entitlement is determined by a formula typically based on the person’s age, salary, and period of service. This contrasts with an accumulation member whose entitlement is made up of contributions and investment returns (positive and negative), minus fees.

In the past, members in defined benefit funds have, in many cases, not been affected by market conditions as contributing employers have made up any funding shortfall. However, this may not always be the case – either because of an employer’s own parlous financial position or because, in a prolonged market downturn, employers may not agree, or be unable to make extra contributions. Unless a fund’s trust deed says otherwise, there is no requirement or guarantee that employers will top up a defined benefit fund. As a result member benefits could potentially be reduced in a market downturn.

Vested benefits index (VBI)

A defined benefit fund’s vested benefits index (VBI) is a ratio which represents a fund’s ability to pay vested benefits to members if all members were to voluntarily leave the fund on the same day. A fund’s VBI should generally be above 100% to meet its vested benefit liabilities. A fund with a VBI of less than 100% means it has assets insufficient to cover all of members’ vested benefits.

This index is one of the actuarial ratios used to assess whether or not a fund is in a satisfactory financial position and, specifically, it helps assess the short-term financial position of the fund.

ASIC notes that there are significant differences between a fund being in an unsatisfactory financial position and a fund being in a state of technical insolvency. A fund will be in an unsatisfactory financial position if their VBI drops below 100% and the fund has a shortfall. Technical insolvency means that the defined benefit fund's net realisable assets, after setting aside the amounts for payments to former members of the fund, are insufficient to pay the minimum requisite benefits of the fund's current members.

Minimum benefits are generally the member financed benefit and the mandated employer-financed benefits that make up the components of the members defined benefit interest. Vested benefits might include more than just the minimum benefits.

ASIC notes that other ratios, including in relation to accrued benefits, also exist and can assist in assessing the financial circumstances of the fund. Accrued benefits is the proportion of a prospective benefit entitlement based on current salary or average salary which might be considered to have accrued in respect of membership or service completed up to a given date.

For consumers, more information on defined benefit funds and superannuation generally is available from the MoneySmart website.