Issue: June/July 2006
VICTIM OF SUCCESS
In biting the bullet, will Alexander Forbes still face a rocket? And what of the fallout for other retirement-fund administrators? National Treasury and FSB command a consumer army on the march.
‘The board supports the principles of transparency, ethical behaviour and honesty in all the group’s business dealings.’
Support is one thing. Practice is another. So here’s a challenge to the guys at Alexander Forbes once they produce their mea culpa on “bulking” and “secret profits”: Let’s see a representative sample of your consultants’ incentivisation structures.
That way, it will either allay or aggravate the main allegation against the Alexander Forbes “one-stop-shop” business model. If allayed, what a pleasure. If aggravated, well, Alexander Forbes does profess to be a market leader in risk management.
For it’s probably in the commission agreements of its consultants, not to be confused with salespeople, that the key lies to unlocking the accusations of compromised independence that favour group-related companies ahead of others. Should this be to the benefit of the company and the detriment of its clients, Alexander Forbes will have to answer for a lot more than the manner in which it operates money-market accounts and favours its “preferred suppliers”.
Not yet available as this TT edition went to press was the independent report from law firm Deneys Reitz and accountancy firm Ernst & Young into Alexander Forbes business practices. Its findings will doubtless impact on the group’s financial results, delayed until late-June, and have much broader ramifications for the industry as a whole.
With the proverbial having hit the fan (TT April-May 2006), Alexander Forbes finds itself in the front trench. Unenviably, perhaps deservedly, it’s a victim of its own success. But now the very model of that success is being challenged, obliquely by National Treasury in recently having issued a discussion paper on commissions, and explicitly by the Financial Services Board in public pronouncements. All retirement-fund administrators, many stabled in financial institutions whose competitiveness National Treasury has begun to question, are being held similarly accountable for proof of innocence.
Inevitably, it will lead to at least some of them biting the bullet as life offices have done with their intended R3 billion compensation package to policyholders in fees reversals. With that controversy hardly out of the way, they don’t need this. It’s not impossible that a variety of institutions – if complicit in practices considered by the regulators to be clandestine, conflicted and nefarious to consumer interests – could be forced to share culpability on this occasion, too.
A group the size of Alexander Forbes shouldn’t have too much trouble in swallowing a bullet, even if its magnitude equates to the larger proportion of last year’s R461 million attributable headline earnings. Its 2005 report showed total equity and liabilities of R91,7 billion, revenue of R4,6 billion and pre-tax headline profit of R705 million.
Although the group appears not to have provided for a contingency in respect of “secret profits”, of which “bulking” might only form part, a note to the financial statements recognises that it is “exposed to various actual and potential claims . . . relating to alleged errors and omissions or non-compliance with laws and regulations in the conduct of the ordinary course of its business”. It adds, perhaps now too comfortingly: “The directors are satisfied . . . that the group has adequate insurance programmes and provisions in place to meet such claims.”
Beyond the money is reputation, and beyond reputation is the robustness of the Alexander Forbes business model. Money is a bullet; the business model, to the extent that it is seen to rely on inter-group business referrals at client expense, is a rocket of potential litigation and regulation.
Why should Alexander Forbes be the primary target? Arguably, because of its kingpin visibility. Achievement begets attention, and the group’s influence is pervasive.
Throughout the retirement-fund industry, Alexander Forbes people are everywhere to be seen. They put a foot in the door and eventually they fill the room, a natural and convenient progression for all parties from a pitch to handle short-term insurance until the client is hooked into its whole gamut of retirement-fund administration, asset management, actuarial and related services that spare trustees the bother of searching for better arrangements and dealing with disparate organisations.
So hand it to the Alexander Forbes people. They’re generally considered in the marketplace to be sharper, faster, more aggressive and more on the ball than anybody else. A problem to be solved? You know whom to call. A new product or service on offer? You know who’ll call you. The compliment carries a catch. It’s a widely held belief that Alexander Forbes attracts top people because its sales incentives enable top remuneration. These incentives impact on clients, ignorant of the fees accumulated in each individual process of one-stop shopping and obscured from the machinations of internal bookkeeping. How a consultant can earn a commission from a buyer, ostensibly to act in its best interest, and be incentivised by the seller, simultaneously to enhance its shareholder value, begs explanation.
The crime with “bulking” is not, like fraud or theft, in the principle. It’s in the secrecy. Pick ‘n Pay, for example, “bulks”. Profit is made by quickly converting the cash from its tills to interest-bearing deposits at the bank. Consumers benefit by competitive prices that are readily visible. So it should be also with retirement-fund administration, requiring clients’ consent and allowing negotiation on fee packages, but it isn’t. When clients aren’t told, they don’t know.
‘The often conflicted relationship between the intermediary and the policyholder is a key contributing factor to the failure of the existing system to work in the best interests of the consumer. The triangular association – whereby the intermediary provides advice to the policyholder but is incentivised by the insurer, who then recoups such costs from the policyholder – is fundamentally flawed.’
So says National Treasury’s discussion paper, published in March, on contractual savings in the life-assurance industry. SA is not alone. Specifically on the pensions industry, a survey last year by the US Securities & Exchange Commission found:
In his seminal analysis, independent actuary Rob Rusconi calculated the minimum in administration costs for self-administered funds at 13,1 percent (excluding retirement-fund tax) of members’ annual contributions. At the extreme, he’s mentioned more recently, an astounding 43 percent of monies invested might be taken by the whole agglomeration of charges (TT Nov-Dec 2005).
Figures of the Pension Funds Registrar almost certainly understate administration costs because not all fees are disclosed; for instance, asset managers sometimes provide performance figures net of fees. There’s clearly a need for a uniform way of describing fund costs, without which they are impossible to measure accurately, and perhaps for Rusconi to drill deeper into the variety of costs for the assistance of National Treasury’s reform initiatives.
Amid all the brouhaha over Alexander Forbes, one might have expected clients to desert in droves; they haven’t. Or for its share price to have been pounded; it hasn’t. This speaks volumes for the ongoing confidence and trust the Alexander Forbes franchise represents.
Whether such stability will continue depends as much on the findings of the independent review as on the way Alexander Forbes handles them. To have commissioned the report was wise. To publish its warts-and-all content, rather than withhold it for internal digestion, would be smart. For it will come out, one way or another, like it or not.
A new swearword in the retirement-fund industry is “bulking”. In isolation, it should be neither new nor a swearword. In the context of “secret profits”, over which National Treasury has recently exhibited outrage, it assumes the unsavoury complexion it deserves.
“Bulking” is old as the hills, practised by almost everybody capable of practising it. Law firms do it. Accountancy firms do it. Banks do it. They take relatively small amounts of client money, which they agglomerate to achieve better rates than clients might earn individually. On the principle that wholesale prices are cheaper than retail, which is understood and accepted, there should be no objection when applied by fund administrators.
The stink is in the secrecy. Administrators are arguably entitled to the benefit, or to a share, because they do the bulking from which the benefit arises. If they didn’t bulk, there could be no benefit. But the monies they bulk do not belong to administrators. They belong to individual retirement funds that make possible the bulking and hence the benefit.
The issue is not whether bulking is inherently bad – it’s obviously good, because benefits are derived – but whether the benefits are properly disclosed by the administrators to trustees of affected funds. Without disclosure, the administrator can pocket for itself the entire differential between the wholesale and retail interest rate. Some kindly call it a “rebate”; others, less kindly, a “kickback” from some or other bank for the administrator having placed the bulked monies with it.
With disclosure, four options are open. Trustees can: