High costs affecting retirement funds? Communication is the key to alleviating litigation

One of the more interesting trends that has recently emerged from the American retirement space is the practice of employees taking their employers to court over high costs associated with their pension funds.

Toy Otto, Head – Employee Benefits Consulting at leading financial advisory group GTC, believes this trend might well find its way to South Africa in due course.

“This may have serious consequences for the savings and retirement industry as we know it, if we do not adjust the way we report information back to our members.”

Otto believes this is a natural consequence of employees becoming more empowered about their retirement options and rights, and the changes in regulation over the past ten years (as well as draft regulations to be introduced in the near future) which will encourage greater interest in costs and benefits relative to retirement funds.

“We have increasingly seen that employees no longer merely accept their retirement outcomes.  Instead, members are now actively questioning whether the parties entrusted with their life savings continue to act in their best interests,” says Otto.

While it is definitely encouraging to see employees taking a more proactive stance in their future savings, Otto says that based on the American experience it may well catch some employers on the back foot.

“Often companies have not applied enough attention to the way retirement portfolio construction may change to keep up with modern developments, and if they have, they may not have adequately explained and disclosed this information to their members or employees.”

In South Africa all retirement funds are governed by a board of trustees who bear the liability for decisions made by the fund.

“In the US employees have scrutinised their retirement funds and often found that the governing bodies and employers did not always act in the best interests of the members and other beneficiaries of the retirement funds,” says Otto.

Examples include employers electing to invest the assets from their retirement funds in strategies which are inappropriate for their members’ level of risk tolerance, leading to adverse investment outcomes.

Legislation released late last year in South Africa calls on boards of trustees to address investment portfolios within their funds.  This could go some way towards curbing the issue of inappropriate investing.

“Fortunately South Africa also has regulations obliging trustees and board members to disclose their relationship with investment management providers, in an effort to prevent conflicts of interest and promote the best outcome for members,” says Otto.

“Another key factor is the cost of investment management. Globally, board members are required to apply much more scrutiny to the fees charged by portfolio managers, specifically comparing these to the portfolios’ performance and questioning the instances of consistent or long-term underperformance.”

He adds that each board will in future, have to demonstrate that they have considered both passive and active strategies in the retirement fund portfolio construction.

“We strongly suggest that the results of these investigations are shared with their members, detailing the rationale for choosing certain strategies. This will allay members’ fears that boards may not be acting in their best interests.”

Given South Africa’s advanced legal and financial services systems, he says it may not be long before we see similar actions in the local retirement fund arena, unless the communication to members becomes more transparent for disclosing information.

“It is crucial for boards of trustees – and by extension employers who appoint half of the trustees to stand-alone funds – to ensure they are always acting in the best interests of their members/employees. Within our business, we continually compare our solutions and costs relating to administration and investments to that of the market, to ensure we offer optimal solutions and are priced as competitively as possible,” says Otto. “We also undertake regular market assessments of risk benefits and premiums on behalf of the funds we administer, comparing costs and benefits to those available from other providers in the market, further ensuring the most competitive pricing and advantageous benefits for the members.”

“If there has been proper scrutiny of fees, charges and investment management options, it should result in the majority of the members’ monthly pension fund contributions making its way to the investment accounts, and not towards the servicing expenses,” he adds.

The engagement of a competent investment manager to design, implement and monitor the most appropriate portfolio for a fund’s membership remains one of the most important duties performed by a board of trustees.

“In the long run, communicating these methods to members will go a long way towards ensuring that they are comfortable knowing they are getting the best retirement results, and ensuring that employers and trustees are protected against potential future claims.”

For more information contact:
Toy Otto
Head – Employee Benefits Consulting
GTC
T: +27 (0) 10 597 6861
E: totto@gtc.co.za