| Article
3:
Protect
your Pension: When ‘commission’ becomes a dirty word
In the wake
of recent revelations concerning the pension fund industry in South
Africa. this week I take a look at practices surrounding home loans
and typical conflicts of interest.
Home
Loans
There are two types of pension backed home loan schemes; ‘direct
loans’ and ‘indirect loans’. In the former, the
fund grants a loan to the member directly, applying its own capital
and using the member’s share in the fund to secure such loan.
In this arrangement, the administrator must recover any fees for
administering such a scheme from the fund and the fund in turn may,
or may not as it may decide, recover the fees from the borrower
i.e. the pension fund member. Since this is a service provided by
the administrator directly to the fund, its remuneration is usually
set in terms of its service agreement and should be pretty transparent.
The interest rate applicable to these loans is currently set at
16% in terms of the Pension Funds Act and in most schemes we know
of, the member actually pays himself or herself the interest, so
not even the fund gains anything at the expense of the member.
The ‘indirect
loan’ scheme is usually funded by a bank and is administered
either also by the bank or by the fund administrator. Since the
scheme is essentially administered without involvement of the participating
fund, the participating fund plays no role in the determination
or recovery of costs or fees, or the determination of the interest
rate, and may not be fully appraised of all remuneration components.
This arrangement also affords the administrator to arrange preferential
interest rates with the bank which are mostly not passed on to the
borrower - in principle fine, as long as the client is fully aware
and can evaluate the economies of the scheme for the fund and its
members.
Typical
Conflicts Of Interest
Some pension fund service providers – mostly brokers, administrators
and insurance companies - offer a wide range of services directly,
or indirectly through associated companies. Typically this covers
services such as fund administration, fund consulting, actuarial
consulting, investment consulting, group reassurance, asset management,
banking, dependents’ trust management, short-term insurance
etc. Each of these individual service components entail the payment
of one or other form of remuneration when they are placed with a
particular service provider. Particularly companies chasing perpetual
growth of their business are under substantial pressure to find
new ways and means to better ‘exploit’ their client
base, one of which being to place business ‘in the family’.
A prominent instance was reported in South African news media some
4 years ago where one large service provider also controlled an
asset manager and incentivised its consultants with substantial
‘commission’ payments (or name it what you like), every
time a consultant managed to convince his or her clients to have
the ‘family’ manage the client fund’s assets.
This may evidently result in the client being given biased advice.
Since every transfer of assets involves significant costs, each
such transactions will, as a matter of course, have been at the
expense of the fund and/or its members and pensioners and the surviving
dependents. I hear the argument that cost is only one part of the
equation, investment returns being the other and this outweighing
costs by far. Yes, could be in hindsight, but who will be so preposterous
to claim that manager A (family) is going to outperform manager
B (non-family)? Evidently this may put trustees in an awkward position.
What
you can do to prevent abuse
The problem with these ingenious practices of ‘exploiting’
your client base and finding new ways of generating revenue for
the administrator is, for one, that the service provider is in a
privileged position of possessing confidential information. He is
also providing a professional/semi-professional service to a layman
who places his or her trust and confidence in the advice received,
and is remunerated for his expertise (ingenuity). Expertise is sold
in units of hours and the higher the expertise, the more one has
to pay per hour and the more ‘value add’ one should
expect as the client. It is certainly not a product where the market
will determine the price and ingenuity will determine the profit
margins of the product provider.
To prevent abuse, consider the following, in addition to the other
mechanisms referred to previously:
Unbundling:
It is advisable not to place too many parts of the fund’s
business with a single service provider. One should particularly
try not to place such parts with a single party where there can
be any conflict of interest.
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