‘Bulking’ in the Insurance Industry: briefing by Financial Services Board

FINANCE PORTFOLIO COMMITTEE
19 June 2006
‘BULKING’ IN THE INSURANCE INDUSTRY: BRIEFING BY FINANCIAL SERVICES BOARD

Acting Chairperson: Mr K Moloto (ANC)

Documents handed out:
Financial Services Board Presentation on ‘bulking’
Financial Services Board: Memorandum
National Treasury presentation

SUMMARY
The Financial Services Board said that ‘bulking’ was when pension fund administrators ‘bulked’ the accounts to maximise the interest they could garner from the accounts, rather than having each account stand on its own. They negotiated a higher interest rate for the ‘bulked’ accounts than would have been the case for each individual fund with the banking institution. What was important was that this arrangement was between the administrator and the bank, to the exclusion of the fund’s members.

Some administrators argued that they could keep the money as they had ‘disclosed’ what they were doing to their trustees. To the FSB, disclosure could never be a defence against the fiduciary duties of an agent in respect to his/her principal.

MINUTES
Adv D Tshidi, the Financial Services Board (FSB) Deputy Executive Officer of Pensions, began by explaining what ‘bulking’ was. In terms of the Pensions Fund Act, a privately administered fund was required to have an account with a banking institution. It was through this account that money flowed from the employees, to the employers, to the administrators of the pension fund. Section 5 of the Act stated that the assets of a registered pension or provident fund belonged to that fund to the exclusion of all persons, including the members of that fund.

However, section 7(c) of the Pensions Fund Act said that the control of the assets was in the hands of the trustees. Given this power, they could outsource the function of administration of the fund to other persons. The trustees had to act with due care and diligence, in good faith, avoid conflicts of interests, and act in the best interests of the members of the fund.

The same responsibilities were passed on to subsequent administrators, with there being an agent/principal relationship between the trustees/members and the administrators. To explain what some of the administrators had been doing, Adv Tshidi used the example of the Alexander-Forbes case.

They had approached banking institutions on behalf of their 950 privately administered funds. They then ‘bulked’ the accounts to maximise the interest they could garner from the accounts, rather than having each account stand on its own. They negotiated a higher interest rate for the ‘bulked’ accounts than would have been the case for each individual fund with the banking institution. What was important was that this arrangement was between the administrator and the bank, to the exclusion of the fund’s members. The bank would then pay the administrator the extra interest, that is, the amount garnered from the higher interest rate less the amount that would have been due to the funds if the interest had been levied on the individual funds.

Administrators held the view that they were entitled to the extra amount as they had done the ‘work’ of negotiating the higher interest rate. However, when the trustees outsourced their powers to the administrators, all the parties agreed that a monthly fee would be paid to the administrators from the fund. It was as if the administrators were alleging that negotiating a higher interest rate was an added responsibility on them for which they had to be compensated. The FSB said that this was wrong. The administrators always had to act in good faith, avoid conflicts of interests, and act in the best interests of the members of the fund.

Some administrators argued that they could keep the money as they had ‘disclosed’ what they were doing to their trustees. Alexander-Forbes said that they would only pay back money to the extent that they did not disclose. To the FSB, disclosure could never be a defence against the fiduciary duties of an agent in respect to his/her principal.

Mr L Wessels, the FSB Senior Legal Advisor, added that fiduciary duty of the administrators was premised on a relationship of trust. The administrator was the agent and the content of their agency was the agreement underlying their relationship with the fund. This agreement set out things that the administrator could or could not do. Pension funds were very vulnerable and it was often difficult to discover abuse. Therefore, a heavy onus had to be placed on these administrators. There was no legal justification available to those who abused this fiduciary relationship.

Discussion
Mr B Mnguni (ANC) asked when the FSB had found out about ‘bulking’ as he had only heard about it through the media. If it was a while ago, why had it taken so long for this issue to come before the Committee?

Adv Tshidi replied that ‘bulking’ occurred outside the realm or ambit of the Registrar, auditors, and the members of the fund. It was difficult to identify ‘bulking’ quickly because the fund usually gets the interest rate it was supposed to get, with the banks then paying the administrators separately. Auditors and the Registrar would never spot this. Therefore, the only way to discover ‘bulking’ would be through a disgruntled employee of the administrator ‘blowing the whistle,’ which was exactly what had happened with Alexander-Forbes. This is how the media and the FSB found out. However as the Registrar, the FSB has to act according to the law, relying on facts. Therefore, while the FSB was busy investigating the matter, the media ran with the story.

The Acting Chairperson asked what the extent of the problem was in the pension fund industry. Was ‘bulking’ illegal? If it was not, at what point did it become illegal? What legal remedies could the FSB propose to handle the matter?

Adv Tshidi replied that to determine the extent of the problem, the FSB had to investigate 200 licensed administrators. This was impractical financially and would take too long. They decide to invite administrators to show their commitment to good governance and fair practice. About 60 of the larger administrators responded, with most admitting to ‘bulking,’ with the response that they deserved the money.

‘Bulking’ per se was legal, and in fact was good business practice. Two of the submissions the FSB had received showed that some administrators were in the same group of companies as banking institutions. Here the administrator would not engage in bulking as they would be taking money out of the group. This would equate to a ‘sin of omission’ with the administrator not acting in the best interests of the fund.

One of the remedies that the FSB proposed was issuing a directive about disclosure and how trustees should deal with the issue of ‘bulking.’ Education was also important. They had to be educated enough to be able to take total control of their funds. However, this would take time given the lack of education and skills among many of the trustees. The FSB forced Alexander-Forbes to divulge how much they had made through ‘bulking’ since they had begun doing so in 1996 [until October 2004], and made them demonstrate their level of remorse by making a contribution to an education fund for trustees to prevent such practices from occurring again. There was resistance at first, with them only wanting to contribute R5 million which the FSB said was too low. The compromise figure was then set at R12 million.

Ms L Mabe (ANC) said that the pension fund industry was worth billions so she wanted to know how much Alexander-Forbes had made from ‘bulking.’

Adv Tshidi replied that they had made R380 million which they had to return to the Registrar. This did not include the R12 million they had pay to the education fund.

The meeting was adjourned.