Issue: May 2005
New Order Beckons
If recent RA rulings of the Pension Fund Adjudicator have produced pure drama, it's only an indication of the structural reform that awaits the retirement-fund industry. Too many malpractices have been hidden for too long. With new legislation being prepared, the industry should move of its own volition to repair its credibility.
For the financial-services sector, this is the best of times and the worst of times: the best, because its profits are riding the crest of a boom in consumer spending and JSE share prices; the worst, because its business practices and credibility are challenged. And credibility is the bedrock of financial institutions, for on it rests the preparedness of clients to entrust their money.
In New York, attorney-general Elliot Spitzer has exposed irregularities which ripped into the reputations of household names in American and world finance. They've paid huge amounts to settle his charges of having dealt for their own profit at the expense of clients.
In South Africa, Finance Minister Trevor Manuel set the scene for a consumer revolt with his observation last year about "horrendous fees taken by institutions from people who find that they have less than they paid" into retirementannuity (RA) funds.More recently, he expanded the theme: "It is my belief that, for far too long, the retirement-fund industry has lived off the fat of the land without having to be accountable to anybody" (TT March 2005).
What followed could hardly have been anticipated for sheer rapidity and magnitude. In a series of rulings unfavourable to life offices, Pension Funds Adjudicator Vuyani Ngalwana has upheld complaints from various RA investors over deductions made from their payouts, sometimes causing them to receive substantially less than they'd actually paid in.
The ripple can become a tsunami. Life offices are reportedly inundated with similar complaints.Were they validated, on the precedent of the Adjudicator's rulings, the life offices administering these policies could face top-up of payments amounting to an untold fortune. Foreseeing this risk, Sanlam – by no means the only assurer affected – has indicated that it intends to take on the Adjudicator in court.
Why are so many investors so suddenly up in arms? Mainly, no doubt, it's because of the forceful approach taken by Ngalwana in giving meat to the bones of Manuel's belief. Also, quite probably, it's because of greater disclosure and transparency of charges levied. Irreducible and irrecoverable commissions paid upfront to financial advisers form part, but only part, of these costs.
Note, however, that Manuel's comments relate to the retirement-fund industry as a whole. RAs have received headline attention because, unlike pension and provident funds, private individuals are in the front line with a handle directly on their individual contracts.With pension and provident funds, there's a perceived remove where costs and benefits are ostensibly not in the hands of private individuals but delegated down a faceless chain of trustees, consultants, actuaries and service providers where responsibility is offloaded to "somebody else".
The widespread outrage (sometimes feigned?) arises from a sense of rip-off (sometimes opportunism?) in the discrepancy between the amounts RA investors were led to believe they'd get when they bought the policies and the amounts they will get when payment falls due. For the Adjudicator's rulings are seen to open the floodgates. In context, though, there have so far been only four publicised RA rulings against life offices. Amidst the hundreds of pension-fund cases handled by Ngalwana's office, unpublicised is the number abandoned or dismissed.
Past practice, to which Manuel had referred, is nevertheless being turned on its head. Even in the event that Sanlam wins a test case for the life industry – where its claims to lower inflation giving rise to lower-than-illustrated nominal benefits but improved purchasing power are upheld – the performance of fund managers and the costs to investors will be scrutinised as never before.
Of immediate concern, in none of the four reported cases did the funds' boards of management submit a response to the Adjudicator. Instead, responses were filed by the respective underwriters.
Further, in terms of the Act, there is a duty on boards to act in the best interests of members. It is thus critical for the Adjudicator to hear from the boards themselves as to how the charging of all these costs is in members' best interests. It also should be emphasised that the RA fund is a pension-fund organisation; so all the provisions of the Act (including all the provisions to protect members) are as applicable to an RA fund as to any other pension, provident or preservation fund. Neither will the matter end here, for more cases are likely to come before the Adjudicator. One stems from a situation outlined in TT last month. An investor found that, on reducing his RA premium, the life office (not Sanlam) was to deduct from his payout the present value of management fees it would have earned on the higher premium to maturity of the policy. In other words, it was charging him a management fee for money not being managed.
On top of this is an annexure to the policy, to which the investor is supposed to have signed his agreement. On investigation, however, it was discovered that the investor had not previously seen this annexure and his signature on it had been forged. It is now suspected that this is not an isolated instance.
There could be a host of systemic consequences.
FIRST, potentially, is a string of claims against a number of life offices that administer RA policies. The extent to which the claims succeed will determine the extent to which the reserves and profits of institutions will be hit. Conjecture that billions of rand are involved, in claims to be made, might not be exaggeration.
SECOND is reappraisal of the industry's methods of operation. Assuming that specific instances condemned by the Adjudicator are illustrative of rife practice, the industry will itself need to enter the heart of its conventional business model. The easier profits of bygone years, when consumer protection was poor, face abrupt termination.
THIRD, financial advisers stand to be held accountable as commission-driven agents. Paid by service providers, there is an inherent conflict in their duty to the clients they advise.
FOURTH, the life industry as a whole will need to recover from the battering to its image. This will not be a function of slick public relations, but in the longer-term delivery of client value. It will have to come out fighting, admitting liability where it must and presenting counterargument where it can, or the public trust on which its business is based will be riddled with an ongoing scepticism which defeats it.
At the centre of it is not merely the sum total of charges, which affect final value, but in the complexity of the charges themselves. All of these charges are not always disclosed. What's coming to light with RAs might well hold more broadly for pension and provident funds, too. National Treasury's discussion paper on retirement-fund reform would have had empirical evidence to justify its contention:
"The costs of the products and services sold by service providers in some instances have been disproportionately high in relation to their value. Sometimes these costs take the form of commissions or rebates paid by product providers to consultants or administrators who influenced the purchase of products by the retirement funds. These fees should be disclosed … but it is possible that some will not be or that such disclosure will be done in such a way as to minimise the chance of negotiation of the fee.
"For example, administrators are able to obtain lower asset management fees by ‘bulking' the assets of a number of funds into a single portfolio administered by the asset manager.Many do not pass on the savings to the funds or even disclose that the administrators or consultants are deriving financial benefit from the difference."
In her paper to the March conference of the Pension Lawyers Association, corporate law adviser Rosemary Hunter submitted that retirement funds incur more "costs" than they probably realise. "These take the form of special profits drained out of them by service providers in the form of benefits they derive from the management of the affairs of the fund," she said, noting in particular:
At the Pension Lawyers Association conference in March, Pension Funds Adjudicator Vuyani Ngalwana said he expected the unit's backlog of 956 cases to be cleared by the end of that month.
For the future, he promised a turnaround time of four months:
There is little the Adjudicator can really do with a respondent who says nothing in the face of a complaint, except perhaps invoke contempt provisions under the Pension Funds Act. This makes it difficult to resolve a complaint, and the complainant is left with no expeditious service that the Act promises him.
Insurers commonly pay, as commissions to fund consultants, a percentage of the premiums paid by those funds for insurance policies that underwrite funds' liabilities.While consultants are required to disclose these commissions, this disclosure is sometimes done in a somewhat "minimalist" fashion and is not accompanied by an explanation as to why the commission isn't paid instead to the fund itself;
Some fund administrators, or sponsors of umbrella retirement funds, receive "rebates" from asset managers. These are commissions paid by the asset managers as a reward to the administrators or sponsors for directing a certain volume of business to them. These commissions should be disclosed, too;
Some service providers also take a share of the interest paid by a bank for having deposited fund monies with that bank. A bank might pay interest of eight percent, for example, but the service provider will pass on to the fund only five percent and keep three percent for itself;
A number of umbrella-fund sponsors have entered into joint-venture agreements with banks. The sponsors ensure that the umbrella funds only grant housing guarantees to those fund members who obtain housing finance from those banks. In return, the banks give the sponsors a share of the profits they derive.
"To the extent that these benefits are not disclosed and agreed with the fund," states Hunter, "they comprise ‘secret profits' and in law must be paid back to the fund whether or not the fund could have obtained the benefit of the arrangement for itself."
The amounts potentially pale against the amounts disputed over RAs. Practices which would curl the toes of Spitzer seem commonplace in South Africa, and stand to be addressed with a rewrite of the Pension Funds Act.
Just as financial institutions thought they had their ducks in a row after their widely praised empowerment deals, to make life cushy into the future, comes this structural shakeout.
It will be accompanied, to be sure, by exacerbated pressures from the Public Investment Corporation and the trade unions for more influence over funds' investments. Not to mention that other little matter of ways for the hitherto uninsurable to obtain life cover . . .
This is transformation writ large.
FROM HEALTH TO WEALTH
You only have to go back 50 years – less than that – when health to most people was a mystery: the doctor was a god and whatever he did was right and never questioned, the prescriptions were in Latin and the medicine was delivered in dark bottles.
But that has changed dramatically. Today, you can go to your doctor armed with more information than your doctor – and that's exactly what patients are doing. So, why isn't that going to happen to the wealth-creating system? It is going to happen. It's just lagging behind.
People have never really taken any real interest in their pensions and investments. They buy stuff but most of the time they have no idea what it's doing. What will make people change their habits? One reason is scandals. The health industry was altered by scandals such as the thalidomide tragedy in the 1960s. Likewise, the wealth industry is altering as scandal after scandal undermines the trust between investors and fund managers.
Sir Richard Sykes, retired chairman of drugs giant GlaxoSmithKline and now chairman of business think-tank Tomorrow's Company, quoted in the Financial Times.