Issue: December 2012 / February 2013
Editorials

UMBRELLA FUNDS

A fit for all? Not necessarily.

Larger standalone retirement funds might be better off, from a costs perspective amongst others, remaining as they are. But they may well find themselves with little choice.

There’s a shutting of shops amongst larger administrators of standalone retirement funds. Unless the standalones can find suitable alternative administrators – smaller in size and relatively few in number, if not limited in systems capacity and experience too – the standalones might be virtually pushed into multi-employer arrangements.

Latest example of a bigger administrator is Old Mutual. After careful introspection, it says, it has decided to move away from offering administration services for standalone funds: “Instead, we will focus on maximising the benefits we offer through cost-effective umbrella funds, our pre- and post-retirement member support services and our industry-leading investment and risk solutions”.

The reasoning, probably not untypical of other larger administrators likely to follow, relates to a re-evalution of its business model. In plain language, it implies that insufficient profits are made from the administration service on its own. Better profits are from cross-selling of investment and risk products from within an umbrella fund’s sponsoring institution. Life offices, commonly the umbrellas’ sponsors, have these products in abundance.

Mutual, which plans to close its standalone-fund administration by the end of next year, explains: “The SA retirement fund environment has undergone significant shifts over the past few years, particularly in the areas of fund administration and regulation, and the future will undoubtedly bring even more challenges. The consolidation of retirement funds has been one of the biggest drivers of this change as the industry has had to come to terms with increased regulation and the rising cost of running standalone funds.”

Quite correct. Yet, for all the myriad advantages of umbrella arrangements, there’s also a flip side:

  • Even large funds, with sufficient scale and expertise to be at least as cost-efficient as umbrellas, could be forced to abandon their status should they be unable to find an alternative administrator in which they have confidence;
  • Umbrellas are run by boards of professional trustees, obliged to act independently in the funds’ best interests. But the funds’ sponsors, being financial institutions, can also enjoy first-mover advantage by the mere fact of sponsorship. Since trustees are appointed by the sponsor (although some umbrellas, Sanlam being one, provide for members to elect a limited number), a test of their independence will be in how they entertain competitive services and products from outside the sponsoring institution;
  • All things being equal in the eyes of the trustees, the sponsor can be in pole position when the investment manager, for example, is appointed. A manager not linked to the umbrella’s sponsor will perhaps find itself with a smaller asset allocation, if any, than a competitor which is linked;
  • Umbrellas may be unable to offer the same levels of contact and communication with fund members as effectively as standalones. Trustees of the latter are personally in the workplace, having direct employer-employee relationships which sensitise them to members’ needs. By contrast, umbrellas’ optimal communication processes with clients and members is basically formal. Although employers needn’t and shouldn’t abdicate their own interactions with employees, with umbrellas the hassle-free temptation of employers is to do no more than pay over the monthly contributions and premiums;
  • Standalones adopt their own investment-policy statements and mandates (including compliance with the Code for Responsible Investing and incorporation of environmental, social and governance criteria into investment decisions required by Regulation 28). Once standalones are subsumed, it’s the umbrellas’ interpretations that apply;
  • The Pension Funds Act sought better workplace representativity by stipulating that funds’ boards comprise employer-nominated and member-elected trustees in equal number. Whatever the flaws in practice, umbrellas undermine the purpose.
  • So much for the arguable downside. On the indisputable upside is the reality that, particularly for medium-sized and smaller funds, the umbrella concept introduces operational efficiencies and board capabilities not universally conspicuous amongst them.
  • On top of this, of course, the question of costs is central. The lower they are, the more money for fund members’ savings accounts. National Treasury and the Financial Services Board actively encourage cost reductions. There’ve been far too many smaller funds administered on a standalone basis with their own boards of trustees. This presented a number of problems in management and control of the funds:
  • 80% of the funds were small and costs were eating into members’ benefits (see table).
  • The authorities are looking for economies of scale in order that the average costs of running a fund reduce;
  • There were too many funds for the FSB to police (over 13 000 registered until quite recently). The number had to be brought to a manageable level;
  • Too many trustees, particularly of smaller funds, are not properly trained. At the same time, their duties in running a fund are increasingly onerous.

Trustees should be fully aware of all costs being charged to a standalone fund. On the following page there’s a checklist (which excludes asset managers’ fees because they’re separately deducted from investment returns) and a real-life practical case study (rands exclusive of vat) against which your fund can be compared.

If your standalone fund is extracting the maximum costs savings due to its scale, your service providers (including assets managers) are passing through the full cost savings, and the net costs are less than those of an umbrella fund, your fund (assuming it’s being run efficiently) is doing the best for its members.

But if your standalone fund has operating costs substantially higher than an umbrella fund can offer, you are effectively penalising the fund’s members as less money is going towards their retirement.

The umbrella fund should only have three costs:

  • Administration fees, covering all the above fund-running costs;
  • Asset management fees, where the umbrella fund should pass on to members any discounts it receives;
  • Risk-benefit premiums.

Advice to fiduciaries: Each year, every board of a standalone fund should conduct a line-by-line comparison of its costs against an umbrella to establish whether remaining a standalone is still the most cost-effective option for members.

These are the sorts of costs being paid from contributions in one form or another.
Administration fees Can be a rand per member per month or on a formula basis or both.
Actuarial fees Actuarial fees
Auditors’ fees  
Bank charges The fund will need its own bank account.
Fidelity insurance premiums Fidelity insurance premiums
Financial Services Board levy  
General expenses  
Professional fees Legal opinions etc.
Telephone and fax
 
Trustee training and expenses  
Consultancy fees  
Fees for additional services required by administrator or consultant Such as trustee elections. Additional advice or work over and above the service level agreement.
Where a broker/intermediary is appointed there will be commissions built in This can be an additional expense over and above the other costs.
 
  XYZ Standalone Provident Fund XYZ Umbrella Provident Fund
Costs Year to end-Dec 2008 Year to end-Dec 2010
  Rand amount p.a. Rand amount p.a.
Administration expenses 140 730 34 565
Actuarial fees 4 010 Included
Auditors’ fees 42 900 Included
Bank charges 712 Included
Fidelity insurance premiums 1 640 Included
Financial Services Board levy 2 759 Included
General expenses 536 Included
Professional fees 10 397 Included
Telephone and fax 3 791 Included
Trustees’ training and expenses 1 298 No fees (ManCo)
Consultancy fees 1 640 N/A
Participating employer fees N/A 12 000
Employer service fee* N/A 24 000
Total
R 210 413 R 70 565
As % of salary bill p.a. 2,50% (rounded) (0.84%)
The annual saving in fees is R139 848 i.e. 1,66% per member which can go towards his/her account.
Risk-benefit expenses:

Some umbrella funds force you to take the death and disability cover through the fund but many allow you to chose your own insurers. In the case of the first option, one may gain by obtaining a pooled premium rate.

But for many funds in the second option, the premiums would remain the same once you move to an umbrella fund.

* In the case of a broker appointment, the employer service fee should be substituted with a broker commission of R3 815,17 (per applicable scales).