Issue: April/May 2007

Better protection but higher costs on the way

Retirement funds are meant to be custodians of people’s retirement savings. To the extent that these savings vehicles are less than effective in their primary objective, the burden of welfare provision will fall back onto the state in the form of state old age pensions – a cost which the state cannot afford, and which government’s proposal for a compulsory earnings-related social security sytem will help to address.

As a nation, we have a disturbingly low savings rate. It’s aggravated by the savings lost by leakage when people change jobs and thus gain access to their retirement fund nest eggs. It is generally agreed that very few people will be able to survive purely on retirement benefits received from their funds.

This scenario is further aggravated by ongoing developments in the industry. Some issues that have attracted considerable media attention include:

  • “Bulking” practices of certain fund administrators, resulting in “secret profits” being earned by the fund administrators and thus ultimately reducing the returns which the affected funds could have earned for members;
  • Status of the surplus-apportionment scheme submissions where a number of schemes have not met the Financial Services Board (FSB) deadline. Certain boards of trustees and their advisors have been identified as trying to “hide” such surpluses, and the related costs incurred, in undergoing these surplus-apportionment exercises;
  • The build-up of unclaimed benefits in various funds where boards of trustees, together with their fund administrators, have been unable to locate past members to pay out benefits due;
  • The number of Pension Fund Adjudicator determinations which have gone against boards of trustees for poor governance practices, i.e. for not having discharged their fiduciary duties to fund members.

Reforms to be expedited

There can be no question that reforms in the retirement fund industry are long overdue. National Treasury (amongst others) recognised this with its first discussion document on reform. After reviewing the submissions received from industry role players, a second discussion paper was issued recently. In addition to the mandatory national social security system, which the second paper discusses in some detail, results of these reform efforts will include:

  • A new Pension Funds Act, the present Act having been around for over 50 years;
  • Revised ‘prudential investment’ guidelines, the current guidelines being ineffective given the array of investment instruments available in the market;
  • Clear demarcation of regulatory powers between the Registrar of Pension Funds and the Registrar of Insurance (for example, on pension products underwritten by insurance companies);• A more holistic approach to the provision of retirement fund savings including the tax treatment of the various retirement savings vehicles, with retirement funds tax having been abolished in the latest Budget;
  • Accreditation for fund members to be appointed as trustees, including the need for trustee training;• Industry consolidation, with reduction in the number of standalone funds due to ongoing cost pressures. Such consolidation will result in greater prominence of umbrella and industry-based funds;
  • An increase in the costs of compliance as the regulatory environment changes to become more onerous.

For sure, in this industry it will not be business as usual. It is an industry which is increasingly under the spotlight of the Regulator. Trustees and service providers have been feeling the heat that flows from poor governance practices. Members of retirement funds are now more aware of their rights and what they can expect from their boards of trustees, and are not averse to using the Pension Fund Adjudicator’s office for complaint resolution.

The end result of these reforms will see the emergence of an industry which is more transparent. There’ll be increased regulatory and compliance requirements, thus offering better protection to members of funds. But this will come at higher cost to the members, ultimately in their accumulated credits at date of retirement in defined contribution funds.


With the lifting of the audit-exempt status of underwritten funds, the FSB classified these funds as ‘large’, ‘small’ and ‘mini’ (based on the respective sizes of their memberships and the fair value of of their investments). These thresholds are used in deciding whether the fund in question would need a full-scope audit or a limited assurance audit carried from their 2006 financial year. The classification of funds and their related thresholds are:

  • Large – these funds have total annual contributions of more than R350 000 and total assets of at least R6 million. Such funds require a full-scope audit;
  • Small – these funds have total annual contributions of less than R350 000 and total assets of under R6 million. Such funds require a limited assurance audit;
  • Mini – these funds have total annual contributions of less than R150 000 and total assets of under R500 000. Such funds will not be subject to audit but will require certification by the principal officer, chairperson, one trustee and the fund administrator.

Once the first-time audits of the funds for 2006 financial year are complete, the FSB will need to review and raise these thresholds as the limits are simply too low and the costs associated with the requirement for a full-scope audit or limited assurance audit are too high – thus significantly eating into the returns earned for such funds and their members. In these instances, the audit costs will seem high as there is a base cost for an audit regardless of the size or the nature of the fund being audited. This is because International Standards of Auditing apply to all assurance engagements. The only way to compensate, clearly, is by raising the classification thresholds.