In last month’s newsletter, we made reference to the ‘familiarity risk’ that NAMFISA discovered as the result of off-site inspections on a number of pension funds. NAMFISA directed these funds to consider this risk and to report back.

In last month’s newsletter, we made reference to the ‘familiarity risk’ that NAMFISA discovered as the result of off-site inspections on a number of pension funds. NAMFISA directed these funds to consider this risk and to report back.

Unfortunately the risk was not defined nor are we aware of any official guidelines. However in the relevant correspondence with funds, this risk is linked to the period for which service providers have been providing services to the fund.

The correspondence insinuates that service provider rotation mitigates this risk.

Let’s speculate and look at what this could possibly refer to and investigate each scenario.

1. A family or personal relationship exists between one or more trustees and one or more employees of the service provider.

   Firstly, personal relationships are not necessarily linked to the period over which the service provider has been engaged. Such relationships can develop over time and they can already exist upon the appointment of a service provider.

   Secondly where one is dealing with a board of trustees on the fund side and a company rather than an individual on the service provider side it becomes virtually impossible to avoid such familiarity either existing, arising or ending at any time.

   Thirdly, a relationship between a person on the fund side and a person on the service provider side will undoubtedly be diluted by the fact that it is a board of trustees dealing with a service provider organisation rather than two role players dealing with each other only.

   Fourthly, people come and go and are replaced by other people. So a relationship that has existed may end as the result of staff turnover but may also arise as the result of staff turnover.

   Fifthly, a family relationship does not necessarily constitute a personal relationship.

   Clearly, rotating the service provider will make no meaningful contribution towards mitigating the ‘familiarity risk’. Requiring role players to declare family relationships and maintaining a register is based on objective criteria, if narrowly defined, and should be a more effective mechanism to monitor and probe any decision. Other personal relationships would be based on subjective criteria that will essentially be impossible to define and would have to rely on the discretion of the person concerned. This in turn is better addressed in a code of conduct.

1. The processes, procedures, policies etcetera of service provider and the fund have over the years become so entrenched and routine that built in deficiencies are not uncovered by either party.

   Again deficiencies in processes, procedures, policies etcetera can develop over time or they can exist at the time of appointment.

   It is common cause that deficiencies in processes, procedures, policies etcetera are most likely to occur at the outset while they become ever more refined and better as time lapses. Track record is a very good indicator to what extent these have been improved over time.

   Clearly, service provider rotation will make no meaningful contribution towards mitigating any familiarity risk that may arise from this scenario. The more effective oversight and control is put in place by the Pension Funds Act by requiring the engagement of an actuary and an auditor and also by requiring a fund to be managed by a board of trustees equally representing employer and employees. Further effective mitigation can be achieved by unbundling the non-statutory day-to-day services to pension funds such as administration, risk re-assurance, asset management, asset consulting and employee benefits consulting.

Having dwelled on the possible risks of ‘familiarity’, every coin has two sides. So while ‘familiarity’ may present certain threats to the independence of judgement and could lead to leniency, complacency, loss of objectivity and lack of innovation that need to be considered  in perspective, service provider rotation entails serious risks that also need to be considered.

Service provider rotation will result in ‘short-termism’. ‘Short-termism’ has been shown to produce undesirable consequences in many walks of life. It can lead to a laissez fare attitude by employer and employee, fund and service provider, particularly when it comes to intangible or unquantifiable elements of service delivery and it can lead to arbitrage where the quantifiable elements are misused to divert the focus and measurement of intangible and unquantifiable elements.

In the case of pension fund administration, loss of information and of fund and member history normally occurs when a new administrator is appointed as the fund and member history is usually too extensive to be moved to the new administrator. Loss of fund history and information is also a serious risk when changing other service providers but mostly not as acute as in the case of the administrator. This risk is a lot more serious than changing your bank, car mechanic or your doctor as a fund has an infinite life and entails the history of many people. In all cases history and information will be lost and this could be very costly and even deadly, for an individual as much as for an organisation!

Dependence of one person on another person may well restrain the dependent person in freely expressing an opinion on the other person. The audit profession is the profession where the discussion on familiarity and the possible threat this may pose to the auditor’s judgement has become topical internationally. In the narrow sense of the word, an auditor is not a service provider as it is a statutory appointment with a public attestation function that a business is obliged to make. Internationally however, there is no consensus yet whether auditor rotation should be enforced. Some countries such as Australia and China have introduced obligatory auditor rotation. Others, we believe, like the US and England have stopped efforts to introduce obligatory auditor rotation while yet others like the Czech Republic who had introduced auditor rotation have removed this obligation. There has to our knowledge not been any discussion of the rotation of an audit firm where is serves a company in an advisory capacity only, serving a similar role to that of the consultant on a pension fund.

Finally, King IV, the ultimate measure of good corporate governance makes no reference to service provider rotation in the sector supplements for retirement funds.

Conclusion:

Although we evidently have a personal interest as a service provider to pension funds, we are convinced that service provider rotation with regard to non-statutory appointments of pension funds is ill-conceived. These appointments are not required to express an opinion on the fund they are servicing. Rotation will add no value, in fact it will add to the direct costs and indirect cost through loss of knowledge, information and history. It goes without saying that the application of good corporate governance principles by trustees must be the core of managing their funds. As long as these are observed in the course of appointing and reviewing service providers, the trustees have done their job and need not fear any intervention by the regulator.

Important notice and disclaimer
This article summarises the understanding, observation and notes of the author and lays no claim on accuracy, correctness or completeness. Retirement Fund Solutions Namibia (Pty) Ltd does not accept any liability for the content of this contribution and no decision should be taken on the basis of the information contained herein before having confirmed the detail with the relevant party. Any views expressed herein are those of the author and not necessarily those of Retirement Fund Solutions.