The background
Section 30 (2) (u) of the Pension Funds Act 1956 stipulates that a policy of insurance be effected to indemnify the pension fund against losses owing to the dishonesty or fraud of any of its officials or such other indemnification as the Registrar may allow. Other than this, there is very little clarity on what insurance a fund is required to have.
There have been a few pension fund circulars from the Financial Services Board with the first draft guideline released in 1996 based on an American Honesty Index. According to the Honesty Index the minimum amount of fidelity insurance cover that a fund should have, is the aggregate of 20% of the assets of the fund plus 10% of contribution income applied to a prescribed table. As an example, a fund with assets of R30 million and a contribution income of R1.7 million should have a fidelity exposure index of R6.17 million. This exposure when applied to the Honesty Index prescribed table would translate into a minimum cover of between R450,000 and R500,000.
Industry raised concerns that the basis upon which the Honesty Index was developed in the United States was not clear and its relevance in the South African context was questioned. Also, criticism was that the Index prescribed the same level of minimum cover for all funds. A joint industry workgroup that consisted of the FSB, the Institute of Retirement Fund (IRF) and the Pension Lawyers’ Association was formed to reassess the draft guidelines.
On 26 May 1997, the joint industry workgroup circulated their recommendations on both the scope and extent of cover in respect of delegated administration arrangements. The workgroup realized that it was not possible to eliminate or fully protect the fund against fraud. It was recommended that systems and controls be put in place to either detect fraud at an early stage or to make it difficult for fraud to be perpetrated.
The recommendations were accepted by the workgroup meeting held at the FSB’s offices on 15 October 1997. It was agreed that these guidelines be endorsed and issued in the form of a PF circular. In January 2007, fidelity cover was removed from the agenda of the Joint Legal and Technical Committee of the IRF/SARS/FSB as it became clear that the FSB no longer intended to issue a circular in this regard.
Where do we stand now?
There is still no clarity on the limits of indemnity and sufficiency of cover remains the trustees’ decision. On an annual basis, the auditor of a fund will need to confirm that the insurance is in place.
How much cover should we have?
Current industry suggestions for the quantum of cover include
1) Two times the largest death benefit; or
2) A percentage of assets (2% plus 10% of annual contributions); or
3) A minimum of R1 000 000 insurance
What should we do as trustees?
1). Trustees are to take into consideration the size of the fund. Umbrella Funds can buy a policy but may need to take a higher level of cover.
2). Consider the risk profile of the fund and assess the capability of the board of management
3). Ensure that your fund’s service providers have service level agreements in place
4).Ensure that the rules of your fund have indemnity provisions
5). Ensure that the fund’s risk management polices and procedures are in place
6).Ensure that the fund complies with PF 130
7). Consider the cost of the cover and remember cheaper is not always better. The policy terms and conditions would need to be taken into consideration.
8). Remember the limit of cover is an annual aggregate limit and should include legal costs in defending claims.
Consider the fidelity policy
The insured in the fiduciary policy should cover the fund, trustees, committee members and the principal officer. The fidelity cover should cover the following events
1). Negligence - includes claims against the fund/officer resulting from the wrongful act committed by an officer. The definition of officer should extend to include all third party service providers to the fund, such as administrators, actuaries and consultants.
2). Fraud and dishonesty – includes loss of monies belonging to the insured or for which the insured is responsible. This includes monies stolen or any direct financial loss suffered by the insured as a result of fraud or dishonesty by an officer of the fund.
3) Computer crime – includes loss resulting from a fraudulent or dishonest entry or change of data elements within a computer system utilized by the insured and committed by an officer of the fund.
Some typical claims in South African pension funds
1). Transfer of funds and section 14 applications
2).Negligent administration of funds
3). Lack of disclosure to members
4). Imprudent investment of assets and non compliance to Regulation 28 of the Pension Funds Act
5).Conflicts of interests
6). Breach of fiduciary duty
7). Death benefit payments
Conclusion
Trustees should request disclosure of conflicts by service providers especially if the board is acting on their recommendations. If there is need for separate special committees to discuss fund issues, it is advised that independent opinions be sourced. Trustees should ensure that service providers have adequate professional indemnity cover. If a service provider’s performance is sub standard, trustees are encouraged to address this. It is important for the investment policy statement of the fund to be reviewed annually in accordance with the membership profile of the fund. Lack of disclosure to members is the highest reason for fidelity claims and it is therefore important for trustees to communicate with members. Trustees are to ensure that fidelity insurance renewal commences two months prior to renewal date and that their cover is placed with a reputable insurer.
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