Choice in­creases risk

Finweek English Edition - - Retirement fund trustees - COPY: Shaun Har­ris AD­VER­TIS­ING: Lisa McCal­lum

IN­CREASED MEM­BER CHOICE was one of the in­her­ent ap­peals when the drive from de­fined ben­e­fit to de­fined con­tri­bu­tion re­tire­ment funds started about 15 years ago.

Choice is good. But it needs to be ac­com­pa­nied by far higher lev­els of un­der­stand­ing among mem­bers and trustees, oth­er­wise the flex­i­bil­ity of­fered by mem­ber choice be­comes a mine­field.

This ap­plies not only to mem­ber choice of in­vest­ment op­tions but also to the al­lo­ca­tion of con­tri­bu­tions to re­tire­ment sav­ings ver­sus death and risk ben­e­fits.

Pro­posed changes to leg­is­la­tion are go­ing to make th­ese ar­eas in­creas­ingly “dan­ger­ous” for trustees, who face per­sonal li­a­bil­ity and pos­si­bly even le­gal ac­tion from fund mem­bers.

Though the per­for­mance of the lo­cal stock mar­ket has been far from “nor­mal” over the past three years, it could pro­vide am­mu­ni­tion for fund mem­bers who feel trustees placed them in overly con­ser­va­tive in­vest­ment port­fo­lios.

The Pen­sion Funds Ad­ju­di­ca­tor has been scru­ti­n­is­ing in­ap­pro­pri­ate de­ci­sion mak­ing by trustees, par­tic­u­larly de­ci­sions re­gard­ing in­vest­ments, notes James Louw, head of im­ple­mented con­sult­ing at ac­sis, an in­de­pen­dent as­set con­sult­ing and fi­nan­cial plan­ning com­pany.

“The in­her­ent volatil­ity of in­vest­ment mar­kets cou­pled with po­ten­tial fi­nan­cial losses have left re­tire­ment fund trustees search­ing for struc­tures to guide their in­vest­ment de­ci­sion-mak­ing pro­cesses. They have thus adopted what is re­ferred to as the age-based or life-stage band­ing approach to pro­vide such guid­ance.”

Louw says this is largely due to the cur­rent Reg­u­la­tion 28 of the Pen­sion Funds Act be­ing “in­nocu­ous and vague”, re­sult­ing in a one-size-fits-all approach with lit­tle at­ten­tion to mem­bers’ ac­tual ob­jec­tives and needs.

Louw’s prob­lem with this approach is that it de­ter­mines a risk profile for a fund or its mem­bers based on the in­di­vid­ual’s time to re­tire­ment. “The fo­cus is there­fore on the risk profile in­put and not on whether the amount will ac­tu­ally be enough to sus­tain the mem­ber through­out re­tire­ment.”

A big con­cern with age-based strate­gies, he says, is that mem­bers’ in­di­vid­ual needs are not taken into ac­count. In­vest­ment de­ci­sions are based purely on time and in­vest­ment risk, and mem­bers banded into a par­tic­u­lar in­vest­ment may not un­der­stand the con­se­quences or im­pli­ca­tions that the trustee’s de­ci­sion has on their re­tire­ment needs.

“It is there­fore crit­i­cal for mem­bers’ choices to be made holis­ti­cally, tak­ing into ac­count their per­sonal pre- and post-re­tire­ment in­vest­ment and ex­pen­di­ture pat­terns, as well as their spe­cific needs.”

There’s even more con­cern with the age-based approach in funds where mem­bers don’t have in­vest­ment choice. Tra­di­tion­ally, mem­bers are moved into a low-risk port­fo­lio, such as a money mar­ket fund, about five to 10 years be­fore re­tire­ment. But Louw says that while it may be prefer­able to move into safer in­vest­ment op­tions at times, the band approach could see mem­bers “sac­ri­fic­ing sig­nif­i­cant po­ten­tial in­vest­ment growth that could be vi­tal for their fi­nan­cial well-be­ing dur­ing re­tire­ment”.

The out­come could be a “sit­u­a­tion where a mem­ber chal­lenges and po­ten­tially tries to sue the trustee board for lost growth due to the board de­fault­ing that mem­ber’s in­vest­ment into a par­tic­u­lar in­vest­ment port­fo­lio”.

Louw says ir­re­spec­tive of whether a fund of­fers mem­ber in­vest­ment choice, mem­bers should be en­cour­aged to look past re­tire­ment. “Re­tire­ment should be viewed as a sin­gle point in time and mem­bers se­lect­ing low-risk port­fo­lios be­fore and dur­ing re­tire­ment may ex­haust their sav­ings be­fore death.”

Fur­ther com­pli­ca­tions around mem­ber choice re­late to the in­creas­ing cost of risk ben­e­fits. In de­fined con­tri­bu­tion funds, the amount al­lo­cated to re­tire­ment fund­ing has of­ten de­creased ac­cord­ingly, af­fect­ing mem­bers’ fi­nal re­tire­ment ben­e­fits.

“Greater flex­i­bil­ity and choice in the al­lo­ca­tion of con­tri­bu­tions is there­fore the clar­ion call: ba­si­cally how much goes to re­tire­ment sav­ings, ver­sus the cost of death and other risk ben­e­fits?” asks Wayne van Rens­burg, prin­ci­pal con­sul­tant at Glen­rand MIB Ben­e­fit Ser­vices.

“Some trustees are al­low­ing mem­bers to choose the level of death ben­e­fits they would like to en­joy, thereby al­low­ing them to choose what por­tion is al­lo­cated to their re­tire­ment sav­ings, and what por­tion is al­lo­cated to costs.”

Van Rens­burg says “choice” has to be premised on ap­pro­pri­ate in­for­ma­tion and an un­der­stand­ing of po­ten­tial con­se­quences. “Ex­pe­ri­ence shows that mem­bers of­ten make emo­tional de­ci­sions if al­lowed wide lat­i­tude in this re­spect, par­tic­u­larly when those de­ci­sions are based on lack of knowl­edge and so­phis­ti­ca­tion.”

Mem­bers should be en­cour­aged to look past re­tire­ment. James Louw

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