Holes in the funds in which your retirement savings are held expose you to serious risks.
Umbrella retirement funds, which manage the retirement savings of hundreds of thousands of people, are becoming more fashionable, but a lack of legal protection is leaving many members of these funds exposed.
Umbrella retirement funds ostensibly offer (but not necessarily so) a cheaper and more administratively friendly way for small employers to offer retirement fund benefits to their employees. Umbrella funds are mainly sponsored by financial services companies - particularly the life assurance companies.
An umbrella retirement fund permits numerous employees of different companies and organisations, or members of industrial organisations or unions, to have their retirement savings placed in a single fund. This frees each individual employer or organisation from having to manage its own stand-alone fund.
However, umbrella retirement fund structures side-step significant protection offered to members by the Pension Funds Act, most notably section seven, which stipulates that at least 50 percent of a board of trustees must be elected by the members of a fund.
In terms of their current structures, umbrella funds could also probably side-step the new investment strategy requirements that are currently being finalised by the regulator of retirement funds, the Financial Services Board (FSB).
The problems with umbrella funds have been highlighted in:
- The latest report of John Murphy, the Pension Funds Adjudicator, which stated that recent court findings "bring to light the workings and pitfalls of umbrella funds, revealing unsatisfactory protection they afford to members";
- The placing of the umbrella fund of the South African Commercial, Catering and Allied Workers' Union under curatorship following the exposure of irregularities, including significant conflicts of interest between the union and the fund; and
- Claims made about the management of umbrella funds at the annual conference of the Institute of Retirement Funds (IRF) last year.
Dube Tshidi, the deputy chief executive at the FSB in charge of retirement funds, says he is concerned about the situation, and the FSB is investigating ways of improving the protection offered to these members.
An investigation by Personal Finance reveals the following areas of potential abuse in the management of umbrella funds:
- Conflicts of interest
In almost every major umbrella fund, the sponsor of the fund controls the decision-making process. Most of the trustees, the principal officer, the administrator, and the advisers on both investment management and group life assurance are appointed from within the ranks of the sponsoring company. The sponsor also manages the fund's assets and supplies the group life assurance cover.
In response to Personal Finance questionnaires, most fund sponsors argued that the way their funds are managed does not give rise to any conflicts of interest. Yet, in almost every case, the trustees appointed by the financial services company have employed their companies' staff to provide the fund's services.
Tshidi says the FSB is considering a number of measures to improve member protection, including steps that will ensure that at least 50 percent of the trustees of umbrella funds are independent of the financial services company sponsoring the fund.
He says that where conflicts of interest arise, such as the sponsoring financial services company appointing trustees from among its employees, the people concerned should declare their conflict of interest and refrain from voting on decisions involving the sponsoring company or its associated companies.
This, in effect, means that trustees employed by sponsors should not vote for, or consider, their own companies as potential service providers to their funds.
Tshidi says there is a rule of natural justice that is well-articulated by the Latin phrase Nemo Judex in sua causa, which means "you cannot be a judge in your own case".
- Lack of representation
Members of umbrella funds have virtually no say in how their retirement savings are managed. This is particularly the case with open funds, where most decisions, including the choice of umbrella fund and the investment choices, are concluded by the participating employer and a financial adviser, and there is no legal requirement to consult members and/or potential members.
- Churning
A significant number of members are being switched from one fund to another. Financial advisers are being offered high commissions and other inducements to obtain umbrella fund business - to the potential significant loss of fund members.
Every time a stand-alone employer-sponsored fund is closed and the members are switched to an umbrella fund, or members of existing umbrella funds are switched to another fund, members can lose up to eight or nine percent of their retirement savings. These losses are made up of initial costs, and a significant portion goes towards commissions, which are included in the overall costs and are paid initially and annually as a percentage of the remaining value of the retirement fund.
Although Personal Finance has been unable to establish any proof of these practices, at last year's IRF conference allegations were made that some financial advisers were paying employers kickbacks from their commissions to either convert to an umbrella fund or to switch from one umbrella fund to another.
However, Personal Finance does have individual cases of proof of churning between funds to the apparent disadvantage of members of umbrella funds.
Replies received from financial services companies also indicate that churning is taking place, and that there is a significant move from stand-alone retirement funds to umbrella funds.
Tshidi says an interesting debate is taking place over the legality of umbrella funds, which are established in terms of regulations and not legislation.
He says some industry stakeholders, "who today are trying to exploit the umbrella scheme to frustrate the provisions of the Pension Funds Act, are arguing in the case of retirement fund surplus regulation that what is not in legislation cannot find existence in or through regulations".
Overall, however, Tshidi says he accepts that there is probably merit in creating umbrella funds, because small employers with few employees need to club together to control the costs of running retirement funds.
He says the other arguments being put forward to support the case for umbrella funds include: "Employers and employees do not have time to waste on retirement funds; they want to get on with their businesses"; "many employees in fact do not want to be involved, they are just happy they have employment"; and "it is cheaper to belong to an umbrella fund than a free-standing fund".
Tshidi says many of these excuses are aimed at perpetuating "the old atrocities" of excluding members from a say in how their most important savings are managed.