Will umbrella funds become the default in retirement fund management?
New ‘default’ regulations create additional responsibilities for fund boards
The case for the boards of trustees of standalone retirement funds to consider an umbrella fund strategy as an alternative has been strengthened by the recent introduction of the “default” regulations.
These regulations came into effect on September 1 2017, with implementation from March 1 2019 for all retirement funds registered before March 1 2018.
The regulations aim to ensure the protection, preservation and consolidation of retirement benefits as well as the sustainability of post-retirement benefits paid to members.
Regulation 37 deals with occupational, defined contribution pension and provident funds excluding retirement annuities, preservation funds and defined benefit assets. Occupational retirement funds (pension and provident funds) are dealt with by Regulation 38, including paid-up fund members. Regulation 39 deals with annuities.
All three sections require that funds make appropriate default options available to members and that all related fees and charges be simple to understand, reasonable, transparent and competitive considering the nature of the portfolios.
Funds will have to provide regular and adequate communication to members about the composition of assets and performance. Investment portfolio design will have to consider both active and passive investment strategies. Members will be allowed to opt out of default portfolios, which, along with investment strategies, will need to be reviewed regularly.
From a pre-retirement perspective, default regulations will have less of an impact given that most defined contribution funds already have a default life-stage investment model.
Such a model ensures that the requirements for an appropriate default portfolio are met. The longer the investment horizon of a member to retirement, the greater his or her exposure to growth assets and affordable investment risk.
The life-stage model should also cater for both active and paid-up members of a fund. Member communication prior to retirement will be critical in helping members select the most appropriate investment strategy, depending on their choice between a living annuity or a life annuity for retirement income.
The post-retirement implications of these new default regulations are more significant given that retirement funds’ boards will now also need to cater for living and life annuity options. Retiring members will have to opt into the default annuity solution. Counselling for members will have to be considered at retirement together with an analysis of the fund’s membership and their credits. The board will also need to reasonably ascertain the level of income protection granted to beneficiaries in the event of death.
With regards to life annuities, funds will have to consider who will provide the annuity – the fund itself or an external provider. Boards will therefore need a thorough understanding of the annuity products available in the market.
Default options for living annuities will be limited to four portfolios, which must meet the requirements of Regulation 28. Where a living annuity is to be paid by the fund or purchased in the fund’s name, the sustainability of the rate of income by retirees will need to be ascertained from a retirement capital perspective.
This means funds will need to implement an appropriate post-retirement life-stage model, which considers the amount of retirement capital available, member longevity, investment and inflation risk, and the income or drawdown rate.
These variables will inform the design and most appropriate asset allocation and de-risking strategy for default annuity portfolios. The post-retirement investment strategy will need to be aligned with the pre-retirement strategy to avoid market timing risk and unnecessary portfolio trading costs.
Finally, the board of a fund will also have to ensure that all aspects relating to the fund’s default options, pre- and post-retirement, are comprehensively covered in the fund’s investment policy statement. Other stakeholders in the retirement industry such as consultants, administrators and the providers of investment products and annuities will also need to consider how they can help trustees fulfil their increased fiduciary responsibilities.
This article was paid for by Sasfin.