Edition: Sep - Nov 2014
Crunch for umbrella funds
Now is the right time to review the model, believes Sanlam Employee Benefits special projects head David Gluckman.
Retirement fund reform is essentially a quest for a new and better retirement funding model that better serves the majority of employed South Africans.
SA has made significant progress since this journey started around a decade ago. The National Social Security System theoretical debate has evolved to the point where more practical shorter-term measures to improve outcomes for members have come to the fore e.g. harmonisation of retirement funding vehicles, appropriate use of defaults, measures to increase preservation and to decrease charges.
Retirement fund consolidation has been the key trend over the past decade, just as conversion from defined-benefit to defined-contribution funds was the previous trend. The number of active retirement funds has radically reduced, and the multi-employer commercial umbrella fund market is substantial with assets and members now probably in excess of R150bn and 1,5m respectively.
National Treasury acknowledged the potential benefits of umbrella funds in a paper released with the 2014 Budget: “It is not economical for every small employer to have their own employee fund. Rather, small employers and their employees should benefit by joining multi-employer schemes of one kind or another.” It went on to highlight such governance concerns as ill-trained trustees and conflicts of interest.
National Treasury also indicated that, to try further improve the model in the interests of members, it would embark on a consultative process with umbrella funds. The industry seems to agree that the time is now right for such a review.
But I question whether the road to the optimal model lies in trying to adapt the model within the context of a 1956 Pension Funds Act. Maybe completely new back-to-basics thinking is required?
The 2014 Sanlam Benchmark Survey indicates many positive signals for the umbrella fund industry:
- Employers appear to follow sound decision-making processes in choosing an umbrella fund, the top three reasons for joining being cost savings, better administration and better expertise;
- Charges continue to move in the right direction with operating expenses (all charges other than asset-management fees) falling from 0,90% of assets in 2013 to 0,71% of assets in 2014;
- A quantum improvement in employer awareness of charges (albeit from a low base) since we started measuring this indicator in 2010;
- Much more regular market testing of the competiveness of charges via umbrella fund rebroking exercises;
- High levels of clients’ satisfaction both with the financial strength and ethics of their chosen umbrella fund sponsor.
But scratching beneath the surface also indicates some significant challenges with the existing model:
- The market is increasingly dominated by five major providers that today collectively comprise an approximate 80% market share. Concerns therefore can be expressed whether the optimum benefits from competitive forces will be harnessed;
- Significant new entrants do not appear to be entering the market;
- The Benchmark Survey results lay to rest any thoughts that commercial umbrella fund trustees are truly acting independently as regards investment strategies (40% of surveyed employers stated that investments are automatically placed with the fund sponsor and 72% of available investment portfolios are managed by the in-house investment manager).
Further, the existing legal framework does not appear to adequately protect members. One long-running dispute over alleged administration errors resulted in the Pension Funds Adjudicator ruling two years ago that four umbrella fund trustees make good R20m to members. There are perhaps too many parties involved to expect any other outcome here other than the blame game. We are now in 2014 and still the legal arguments are unresolved.
Compare this to the Toyota worldwide recall of 7,3m vehicles for malfunctioning power-window switches in 2012. Customers in that case had the problem fixed before they were even aware there was a problem!
So maybe instead of trying to force a new retirement funding model to fit a 1956 legislative framework, we should take a lesson in client centricity from the motor industry and come up with a completely new and improved legislative framework for umbrella funds.
I believe there are more serious concerns about the trustee model in this environment than those concerns identified by National Treasury. The umbrella fund model is essentially about creating scale and efficiencies so that these can ultimately be passed onto members in the form of better retirement outcomes.
It means that growth is imperative for any commercial umbrella fund. At present boards of trustees typically have skill sets covering aspects such as investments, insurance, law, communication and governance. But these are not the skills sets required to achieve growth Marketing, distribution and product development skills are required, not to mention access to capital. It is clear to me that boards of trustees are in no position to achieve the necessary growth to benefit members without the support and leadership on an institutional sponsor.
The Benchmark Survey results clearly indicate that clients regard umbrella funds as products. Perhaps herein lies the solution. Let’s not focus reform efforts on upskilling trustees to perform conventional governance better when this is in any event not sufficient to achieve the desired outcomes for members.
I suggest we rather focus energies in ensuring the industry becomes even more competitive e.g. a legal requirement that every umbrella fund participant must obtain three competitor umbrella-fund quotations at least once every three years. To my mind, this will clearly benefit members much more than training trustees. Obviously, standard disclosure methodologies are also essential for this to work.
To make it work, the legal framework must be completely rethought. It’s a new model and it requires new thinking. The role of the institutional sponsor is key and should be clearly defined in law.
And rather than asking boards of trustees to take accountability for issues beyond their natural skills sets, let’s rather get them to focus on their core role of representing the members in interactions with the institutional sponsor. In this product model, the institutional sponsor then takes the final decisions on product structures and also stands behind the umbrella fund if anything goes wrong.
So now is truly is the crunch time for umbrella funds. We should work together to put in place a new and improved model that builds on the good that has already been achieved, simultaneously tackling the cracks in the model that have become evident.