How the draft default legislation will impact trustees

In July 2015, National Treasury released draft proposals aimed at lowering charges and improving market conduct in the retirement industry. These proposals represent positive steps, but trustees need to be aware that they are in for an increased burden as they carry out their duties.  

While this article does not provide detail on the draft proposals, it will provide a brief summary and  comments around some issues that have emerged.

The draft proposals provide guidance on three broad topics within the context of defaults in the retirement system. Default options are automatic choices made on behalf of members who do not exercise their choices in a given situation.

In general, trustees will need to review their current strategies to determine where changes are necessary. They also need to make sure they have a sound communication policy to ensure they do not confuse members before, during and after implementation.

Default investment  portfolio states that:

• All defined contribution retirement funds, including retirement annuity funds, must have in place a simple, cost-effective and transparent default investment strategy into which the retirement savings of members that do not make any investment choice should be invested.
• Trustees must consider specific factors that include:
  • appropriateness
  • communication
  • simplicity, and
  • passive investments.

This proposal suggests that trustees must now consider, if not already, age, aggregate savings, term until retirement as well as pensionable salary. This means that defaults for members of the same age could potentially be different and trustees must factor this into the design of the default investment strategies.

Trustees will need to review some smoothed bonus portfolios, portfolios that incorporate performance fees and any other complex fee structures. They may need to force changes to existing fee structures or complete changes to providers. However, the previous structures can remain as options for members not going into default solutions.  

Disclosure requirements on the impact of fees and charges will increase the reporting burden on trustees. They will need to prepare themselves for the practical implementation of this requirement.

The introduction of the need to consider passive will impose a requirement on trustees to undertake the exercise of formulating a clear view on passive investments as well as why they choose to use them or not.

Default preservation and portability states that:

• All retirement funds into which members are enrolled as a condition of employment are required to have a default preservation strategy.
• Guidance is provided on ‘paid-up’ members as well as the treatment of charges in the process
• The rules of the retirement fund must also make provision to accept ‘paid-up’ certificates on transfer.
• A retirement benefit counsellor must be available to consult with prior to any withdrawal taken or benefit transferred.

Retirement funds will now need to make provision to preserve exiting member’s retirement benefits. Trustees will also need to make similar considerations to the above in deciding on an appropriate default investment portfolio/s to preserve exiting member benefits.

Dealing with the administration of ‘paid-up’ members, will be a difficult task for most funds as some of these functions may be outsourced.  But trustees will need to ensure all service providers act in the interests of members, as they may still ultimately be liable for any undue outcomes.

Trustees will also need to consider how best to implement the envisaged retirement benefits counsellor. Further clarity is still required on this and will come forth as the comments stage comes to completion.

Default annuity strategy states that:

• All defined contribution retirement funds, including retirement annuity funds, will be required to have in place a default annuity strategy
• In addition to the guidance outlined above, the proposals provide for flexibility in how funds can structure the defaults.
• Funds must also make retirement benefit counsellors available to members on retirement to assist them in understanding the default annuity strategy.

Previous comments on the investment preservation defaults will apply to the annuity defaults insofar as disclosures, benefit counsellors and fees are concerned. Trustees will need to prepare themselves for the administrative burden of making sure all funds rules reflect reality.

The various options for how trustees can provide the default annuity strategy will challenge trustees to spend time familiarising themselves with a sphere of the retirement industry to which they may not have previously applied themselves. They will need to structure defaults such that they are able to justify clearly that the defaults into which members end up are appropriate. The additional burden of monitoring members after retirement will be something new to most trustees in the defined contribution environment.

Should the fund decide to offer pensions payable from the fund, the trustees will need to consider the additional requirements of running such an approach and additional service providers required to ensure it runs efficiently.

National Treasury’s draft default proposals have clearly created a lot to consider for trustees. Trustees need to weigh the additional ‘burdens’ against the benefits that National Treasury is aiming to impart upon members. The hope is that the benefits will outweigh the consequences and this will be another positive step in the retirement reform journey.