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Umbrella funds: should we be concerned about governance?

18 March 2013 Fiona Zerbst
Fiona Zerbst, FAnews Online Editor

Fiona Zerbst, FAnews Online Editor

As standalone retirement funds dwindle, simply because it costs a lot of money to run them, big insurance companies are increasingly shepherding their clients into umbrella funds knowing full well that it is difficult to move to other funds once members a

Umbrella funds are essentially single retirement funds that multiple employers join in order to provide employees with access to a group fund. The employer selects the fund and signs up the employees, though employees can participate in the decision making process.

Employers are in favour of them because responsibility falls on the shoulders of fund administrators and trustees – but this should perhaps also be a point of concern, since in many cases employers are not paying close enough attention to these funds. Why should they be paying attention? Umbrella funds may be an excellent solution for companies, but some of their legacy problems have caused costly administrative hiccoughs, and in some cases governance issues have had unintended consequences for members.

A worst-case scenario

Take, for example, Dynam-ique Consultants and Actuaries umbrella funds. Member values had to be recalculated when it was found that Dynam-ique had mal-administered its funds – in its letter to members dated 23 September 2011, chairman John Rollason and principal officer Lindy Wingrove-Gibson noted: “The irregularities that were discovered related to the administration of the Funds prior to 31 January 2008 and included things such as contributions not being allocated properly, contributions being invested into the incorrect investment portfolios and payments paid out of the wrong Fund’s bank account. There is currently no evidence of fraud or misappropriation of member’s moneys.”

Auditors were appointed to rebuild the funds’ data and records but that wasn’t the end of the story, because the fund and its former trustees were found to have unlawfully deducted R20m from its members’ funds to pay for this rebuilding.

The Pension Funds Adjudicator ordered the fund to credit its members with 2.5% fund value to compensate for this. Aon Hewitt took over the administration of the funds on 1 February 2008, evidently without conducting proper due diligence, inheriting the mess and leading to the FSB’s suspending Aon Hewitt from taking on new retirement fund business (this suspension was lifted in July 2012).

Financials not submitted

Is this case the exception rather than the rule? The sad truth of the matter is that fund governance is often lacking (though, in fairness, this also happens with standalone funds). According to the Financial Services Board’s website, there are currently 430 registered umbrella funds, with a combined membership of just over six million members and assets in excess of R1 633 000 000. Of the 430 funds, 19 are new and have not yet had to submit financials, while 41 funds (representing 198 711 members) had the last financials submitted for year ends prior to 1 January 2010, which means they have two or more financial year-ends outstanding. Some 268 funds submitted their last financial returns late (including the 41 funds more than two years behind). This suggests an administrative morass pointing to poor governance.

What is the alternative, though? Companies aren’t pension-fund experts; it’s not their core business. They simply don’t have the time, expertise or resources to run their own funds. On a cost-benefit basis, it makes no sense.

“A commercial arrangement seems a lot simpler, in which you replace employee trustees with professional trustees, avoiding any personal liability if you make a mistake as a trustee,” says Steven Nathan, chief executive of 10X Investments. “You’re plugged into an existing infrastructure and you don’t have to duplicate costs. In theory, the trustees of umbrella funds know a lot more about regulation, which is useful. But where funds can fall down is in the commercial arrangement, since they may not always have members’ interests at heart – and this is, of course, breaking the law,” says Nathan.

Exercise caution

According to Steve Tennant, of Tennant Life Benefits, umbrella fund trustees are less likely to challenge a sponsor who is also an administrator, leaving some question marks over how members in these funds will fare. And the March issue of Today’s Trustee has this to say: “The perceptual risk is that trustees who don’t oblige the sponsor can be put out on their ears. Better to go softly on independence than sacrifice the remuneration commensurate with their time and experience.”

While Tennant says he is not ‘against’ umbrella funds, he is very much for exercising caution when it comes to employers’ offerings to employees. Independent trustees with a sound industry reputation are in the safest hands (though the ‘independence’ requirement may be more difficult to gauge than the ‘fit and proper’ requirement). An intermediary who is an agent for a company will obviously give a glowing account of a fund, so an independent financial advisor specialising in retirement benefits is probably best.

“The fact is, some products are great, and some are horrendous,” says Nathan. “The same applies to RAs. You just have to do a lot of homework before you join a fund.”

Take the following into account:

* Employers should make sure that they don’t abdicate their responsibilities simply because they hand over responsibility to fund administrators or trustees. They should interact with trustees and find out how members can gain access to education and information regarding the fund.

* It may be that trustees are so loyal to a sponsor (an insurance company or, a fund administrator) that even when something goes awry (the principal dies, fraud is committed, and so on) they neglect to put members’ interests first. They may neglect to appoint another administrator, for example, and thereby prejudice members, says Tennant.

* Find out how much flexibility there is in terms of getting components of employee benefit programmes from other service providers. Although a fund will say it has made all the components more affordable by packaging them together, is the administration fee really lower? Or is the fund using risk benefit costs and asset management fees to subsidise the administrative component of the business, which is not profit-generating in itself? No company will say outright that administration runs at a loss and profits come from cross-selling the products offered by the fund’s sponsors.

* Umbrella funds are generally considered to be cheaper due to economies of scale, but this is not necessarily true. Often, it is difficult to unpack costs and charges are often linked to assets rather than fees based on salaries or contributions. It may be that the initial fee will be attractively low but increases over time as assets increase and this is not disclosed. “Fee disclosure tends to be opaque. Trying to find out the total cost can be close to impossible,” says Nathan. “Some employers have been told it’s cheaper to move from a freestanding fund to an umbrella fund, but it actually proved to be more expensive. The fact remains that investment managers have commercial interests, which is why they push their own products.”

* Leaving an umbrella fund can be difficult and costly, which is why employers often stay put. It can take six months or longer to transfer to another fund under section 14 of the Pension Funds Act and members would be charged administration fees in both funds whilst waiting for the transfer to be approved. TCF should ensure that you do not face any barriers when you want to change a product or switch providers, so perhaps it will make a difference here.

* Advisers should be sure not to let a client enter a fund if it hasn’t submitted its financials. There may be a governance problem that could be costly for the client.

“This is not an industry that’s demonstrated strong concern for investors,” Nathan admits. “You actually need to go in as a sceptic and ask the right questions. You won’t necessarily get a better deal either way – you have to do your homework and also understand the value proposition. Far too often, companies don’t invest enough time in choosing and monitoring a fund, but it’s necessary to do this. Analyse the service provider and don’t just opt for a fund because it’s been recommended or you think it looks good.”

Editor’s thoughts:
The Financial Services Board (FSB) was previously keen on reducing the number of registered funds in South Africa, which has now been achieved. However, the suggestion that they are better governed than standalone funds does need to be interrogated; as we’ve seen, this isn’t invariably the case. Benefit administrators like umbrella funds, and intermediaries are also pushing for employers to go this route. But the golden rule, as always, is to do extensive research first. Let us know how you feel about umbrella funds – comment below or email fiona@fanews.co.za.

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