Issue: Oct 2010/Jan 2011
Back to Basics 5

Free-standing versus umbrella funds

David Weil

David Weil

In comparing the differences, David Weil of Independent Consulting & Trustee Services asks questions that imply a distinct preference.

In the retirement-fund industry, two structural options are available. The choices are between:

  • A retirement fund that is privately administered (i.e. a free-standing fund), and
  • Participation in a retirement fund underwritten by an insurer (i.e. an umbrella fund).

Several factors must be considered before deciding which of these two structures would better suit the employees. But let’s first understand these structures’ differences.

A free-standing fund that is not an insured fund is referred to as a privately-administered fund. These funds are administered by an administrator registered in terms of s13B of the Pensions Funds Act and are governed by this Act. The name of the fund is in the company’s name and only employees working for that company may belong to that employer’s free-standing fund.

An umbrella fund is one in which a number of unrelated employers participate as a collective. It may be set up by an administrator registered in terms of s13B of the Pension Funds Act. Upon setting up the umbrella fund, it could either be a pension or a provident fund.

This table summarises some of the most important differences:

FREE-STANDING FUNDS UMBRELLA FUNDS
More administratively intensive Simplified administration
Higher costs (as it is a personalised fund) More cost effective
Company’s own branding Product’s branding
Board of trustees
  • Managed by company-appointed and member-elected trustees
  • Have fiduciary responsibilities and duties
  • Legal liability
Outsourced trusteeship to professional trustees
  • Management committee to oversee fund (50% employer-nominated and 50% member-elected)
  • Legal liability is now limited
Increased costs due to member trustee elections and trustee training Usually no additional costs associated with member elections or trustee training
Time-consuming, onerous duties for trustees and principal officer  Saves time to concentrate on core business duties; principal officer appointed by umbrella fund trustees 
Fund-specific rules drawn up to reflect the trustee practice and registered with the FSB General set of rules; each participant in umbrella has special annexure (special rules registered with the FSB)
Auditors, bankers and principal officer appointed by the trustees (costs of which are in addition to administration fee) Auditors, bankers and principal officer appointed by professional trustees (costs of which are included in the administration fee)
Each fund must be audited annually Audited as a whole
Trustees to approve financial statements Professional trustees are responsible for the approval of the financial statements and the management committee is not involved
Total flexibility in the fund structure – i.e. trustees have responsibility and full flexibility in
  • Risk benefit design (death/disability/funeral structure) and choice of underwriters
  • Investment strategy
Limited but reasonable level of flexibility
  • Management committee decides on the risk-benefit structure within the parameters set
  • Menu of underwriter options available as specified by the umbrella fund trustees
Trustees responsible for communication, which again is at a cost additional to administration Designed by the umbrella fund and the cost is inclusive of regular communication

There are distinct differences, but ultimately the decision must be made on the basis of what’s best for employees. Is it the company or fund branding that makes employees feel special, or is it a case of employees wanting to save more for their longer-term objectives?

Would the decision be made solely on pricing, flexibility and the like, or possibly going further; for example, to ask whether trustees of free-standing funds want the increased risk and liability. Are the trustees of a free-standing fund prepared to accept those extra duties and responsibilities? Or would they prefer that their members join an umbrella fund and become part of the management committee, allowing professional trustees to make the necessary informed decisions?

....and then there’s the need for sound administration

There are many areas that the board of trustees (BoT) could examine in order to determine whether the fund’s administrator is complying with sound administration practices. Many of these control areas are set out in the Financial Services Board’s assessment questionnaire which is sent for administrators to complete.

The table below lists some high-level areas that can be examined: :

Possible question to ask Reason
Is the administrator licensed under s13B of the Pension Funds Act? Only those administrators that are registered with the Financial Services Board are allowed to conduct administration services. As a BoT, you do not want to enter into business with unlicensed administrators as there would be little protection afforded to you and your fund. Your members could view this as a serious breach of your fiduciary duties. The licence certificate should be requested as well as whether the auditors signed off the audit report for the licence.
Has the administrator had independent oversight of its controls such as an ISO or SAS70 review? This will provide additional comfort to the BoT regarding the control environment at the administrator. Request the administrator to present on the findings of this independent audit and request access to this report.
Has the administrator been denied any licences and is the administrator utilising licensed software? If the administrator has been denied any licensing arrangements, this could indicate potential weaknesses at the administrator. The denial of licences also extends to software licences as unlicensed software is not supported and data loss is therefore a risk. Enquire of the administrator whether any licences have been denied and request confirmation that all software is licensed.
What is the average number of years of experience that the administrator’s key management staff have? You want to deal with an administrator that has staff with the necessary skill to interpret and apply the various forms of legislation. This provides the BoT with some comfort in discharging its duties, knowing that there is sufficient depth of knowledge at the administrator.
Has the administrator outsourced any of its functions? The BoT must be aware of any outsourcing arrangements and the terms of the agreements. For instance, you do not want to have part of the administration outsourced and the terms of the contract do not allow for proper handover procedures on the cancellation of the contract.
Does the administrator train staff and how is this monitored? In order to keep up with the necessary changes, it is important that staff are kept up-to-date and regularly assessed. The BoT should ask the administrator about its training and how it is monitored.
How does the administrator ensure compliance with legislation as well as its own procedures? The BoT should find comfort knowing that there is a compliance officer as well as some sort of internal audit department that monitors compliance with applicable regulation and laws as well as procedures. Enquiries should be made of the overall results of any compliance or internal audits. In order to obtain further comfort as to the level of knowledge and skill, the BoT should also enquire whether there is an in-house legal department or whether this function has been outsourced.
How many financial statements are outstanding? This is vital. Failure to submit financial statements for funds could potentially indicate a problem with the administration services or systems.