Umbrella funds need tougher scrutiny
Pension pots should open up to costs and conflicts of interest
The steady growth of members in umbrella funds is likely to accelerate with a government-led drive to consolidate retirement funds, making the need for improved oversight of these funds all the more pressing.
A seasoned pension lawyer speaking at the annual conference of the Pension Lawyers Association this week highlighted the inadequacy of the Pension Funds Act to deal with the multiplicity of legal issues arising from the increasing use of umbrella retirement funds.
However, umbrella retirement fund providers argue that the industry has become more competitive and this, together with a growing awareness among employers of their duty to interrogate whether funds are suitable for their employees, has led to funds improving their offerings.
Umbrella funds, which offer a number of employer groups the opportunity to save in a single retirement fund, have been growing rapidly but there are no specific provisions in the Pension Funds Act dealing with these structures.
In last week's Budget Review, the Treasury stated that the financial services regulator, the Financial Services Board, has been mandated to reduce the current 1651 active funds to "preferably less than 200".
This, together with other onerous requirements that retirement funds must now meet, is expected to accelerate the trend towards smaller retirement funds moving their members into commercial umbrella funds.
Umbrella fund costs may appear attractive, their boards have expert trustees some of whom are independent, and they often offer a wider investment choice to members, but many large funds are sponsored by large financial institutions.
Jonathan Mort, of Jonathan Mort Inc, says conflicts arise because funds typically use many for-profit services from the sponsor and the costing of those services and the independence of trustees from the sponsoring financial institution are problematic.
Mort, a former president of the Pension Lawyers Association, has served as a steering committee member of the International Pension and Employee Benefits Lawyers Association, advised both the Treasury and the FSB and is an independent trustee on numerous retirement funds including umbrella funds.
He says umbrella funds' service agreements with sponsors are not concluded at arm's length and trustees do not have a discretion to substitute these arrangements with others from independent third parties. Independent trustees are in the minority and can be removed by the sponsoring financial institution, he says.
Mort believes it is questionable whether all or some of these arrangements, such as a costly array of investment choice, are necessary or appropriate.
However, John Anderson, the head of group client solutions at Alexander Forbes, says effective umbrella funds need sponsors who will invest in the infrastructure, systems and support.
While this does create a conflict of interests, experienced professional trustees whose reputations are at stake and sufficient checks and oversight of administration and other services can counter-balance this.
The FSB provides good oversight and regularly audits umbrella funds, he says.
In addition, the umbrella fund market is extremely competitive, and employers have the ability to move their member employees to other funds, he says.
David Gluckman, head of special projects at Sanlam Employee Benefits, says the umbrella fund market has gone far ahead of what the drafters of the current legislative framework envisaged. Tweaking fund rules and governance structures is not enough. The act requires a complete rethink.
The role of the sponsor should be defined in law as it is in Botswana, he says.
Mort says usually umbrella fund contracts are effectively concluded between the employer and the sponsor, and the trustees of the fund are not party to any negotiated fees to which the employer agrees.
Umbrella funds are typically served by an independent financial adviser who may charge up to 7% of members' contributions and employers typically do not pay attention to the reasonableness of this fee because the cost is included in the umbrella fund's administration fees, he says.
Mort says fund costs are not completely transparent and the fees charged by other umbrella funds do not provide adequate benchmarks for these costs because all the major umbrella funds engage service providers in negotiations that are not at arm's length.
It is also not clear whether some employer groups cross-subsidise the expenses of other employer groups - a very large employer may subsidise the costs of a smaller employer or vice versa, he says.
Anderson says the trustees of the large umbrella funds are often significantly more aware of the costs of services and the conflicts of interest and therefore interrogate the fees stringently and take more steps to ensure these are appropriate than the average trustee board.
He says in his experience adviser fees are separated from the other fees.
Anderson says one problem is that different providers quote fees in different ways, making it very difficult to compare charges. Putting standards for fee disclosure in place would be an important step, Anderson says.
The Association of Savings and Investments South Africa is working on extending its effective annual cost measure introduced for retail investments to umbrella funds.
Mort says the administration of umbrella funds is complex. Administration errors are not uncommon, and members are prejudiced when it comes to the costs of such errors.
Few umbrella funds would pass muster in terms of governance.
Usually at least half of the trustees are employed by the sponsor and the board is not truly independent or able to rigorously oversee the services supplied by the sponsor, he says.
But Anderson says many of the larger umbrella funds have taken governance seriously through independent trustee representation and engagement with members and employers.
Eight recommendations from Jonathan Mort to tighten up oversight
Funds pay for each service, including that of the adviser, and not the administrator.
Fees are independently benchmarked periodically, for example, every three or four years, and justified.
The costs involved are itemised and disclosed to the members and the employers on an annual basis, as part of the member benefit statement.
If possible, there should be an analysis of the extent of cross-subsidisation among the employers.
The Registrar of Pension Funds should guide employers on appropriate due diligence and the role of the adviser in that exercise.
There should be strict rules around the treatment of administration errors and their disclosure.
Funds should not be locked in to arrangements to utilise the services or products of the sponsor.
Boards of the funds should comprise a majority of independent trustees.