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The dark side of group schemes

The dark side of group schemes

A blasé attitude today may result in major financial consequences in future

By Andró Griessel

20 March 2021

Most people in a formal working environment are members of a pension fund, a provident fund or corporate annuity, hereafter collectively referred to as a “pension fund”. My experience is that it gives these employees (and employers) a great deal of assurance that, provided they have started contributing early enough, they can expect to enjoy a dignified retirement from the proceeds of the funds one day.

My recent interaction with two such funds reminded me that unfortunately this sense of reassurance is not justified. Let me start by saying that the problems I will briefly be referring to, are found mainly in smaller schemes (in small and medium-sized businesses), but not exclusively so.

Group Scheme 1 at Insurer A, (34 members):

My experience with the insurer in question is that what is on the “label” is often not what is going on inside the can. In this client’s case, both the group insurance (which I do not have a problem with) and the retirement provision (with which I do have a problem) are with the same insurer.

The easy way to test whether the promises that are being made with regards to returns and funds are the truth, is to ask for an internal rate of return (IRR) calculation. This calculation is like standing in front of the world naked and without any make-up. It is harder to hide your “mistakes” here compared to other ways usually used to conceal them. The IRR calculation, or in other words the actual returns of the employees that were members of the fund, has shown the following:

  • The main member and approximately 40% of members have already been contributing to the fund from the middle of 2011. All these people’s yields have been lower than inflation over the past nearly ten years.
  • Not a single member who has been invested since 2014 has been able to achieve a positive return over the seven-year period. In other words — after seven years of contributions, they have less than what they have put in.
  • I compared my own contributions to our work’s “pension fund”, in the form of a corporate annuity done at a well-known investment house, to the returns earned by the members of this fund. On average, it was 6.75% better than these members’ returns per annum.

A projection made with the assumption that this underperformance will continue indicates that some of the new members to the fund, who have yet to contribute for many years, will end up with as much as 70% to 80% less than what they should end up with.

Group Scheme 2 Insurer B (approximately 500 members):

The problem at this scheme is not so much the performance of the funds. The problem is that 20% of the premium is being spent on risk coverage and costs and that only 80% of the member’s premium is ultimately invested for retirement.

The likelihood of the client indeed reaching retirement age is better than any of the other nasty things that could come your way. But ultimately, when you must enter your retirement with just your pension fund portion, you very soon realize you simply don’t have enough wind in your sails to reach your destination.

In this case, R175 159 has already been deducted from the member over a period of six years and paid over to the scheme, while his fund balance stands at only R112 619! Suppose he were to resign from this employer today and move on to a new one, he simply gets the R112 619 to transfer to a preservation fund or his new employer’s scheme while having to obtain risk coverage elsewhere again.

Repeat this process several times and you can see where its heading.

There are several other hiccups regarding employer schemes that I would like to address in a few points below.

What do you have to do as an employer

If you have already taken the important first step to offer your employees group benefits, you need to go one step further to make sure they are in a scheme that will enable them to one day retire comfortably or that the benefits are appropriate for when an undesirable event like death or disability strikes. We see the following problems regularly:

  • Members’ investments are often in a default option that is usually the insurer’s own product. These funds are often expensive and perform relatively poorly compared to their competitors. Make sure your employees understand what the different investment options are. Many people are also invested too conservatively because of these default options.
  • There are often no beneficiary forms and when an employee (especially in the case of blue-collar workers) dies, a fierce fight breaks out over who should receive the benefits. Intestate inheritance (because they often do not have wills) is a major problem where there are several children with various spouses.
  • There is never a determination of actual after-cost returns, causing people to keep going with contributions to a scheme as in the first example.
  • Think carefully about the so-called targeted retirement-age investments. I don’t agree that investments should be automatically taken out of the market as you approach retirement.

For example, think of a case where someone has been taken out of the market recently over the last four years of his or her work life. You would have gotten almost no returns from 2016 to 2020 and then been out of the market for the massive recovery that has followed over the past 12 months. The impact on the member’s total retirement fund would have been catastrophic.

What do you have to do as an employee

  • If your retirement benefit is projected in future value, ask the adviser of the scheme to express it in today’s purchase value, and ask what type of income you will be able to receive (in today’s purchase value) from it. This will make the extent of your shortfall clear very quickly.
  • Important: Ask for an internal rate of return calculation on your pension fund contributions since inception, as well as what inflation was over the corresponding period. If your return does not exceed inflation by at least 4%, raise alarm!
  • Make sure your employer has a beneficiary nomination form on record in case you die while you are still working.

Contrary to popular belief, your home is not your biggest financial asset, but rather your pension fund (or provisions for retirement). In general, I experience a very blasé attitude about what exactly is going on within these funds (on both the working employer and the employee’s part). It will benefit both parties to change their attitude on this.

Andró Griessel is a certified financial planner and director of ProVérte Wealth and Risk Management. Contact him at info@proverte.co.za.

Although all possible care was taken in the drafting of this document, the factual correctness of the information contained herein cannot be guaranteed. This document does not constitute advice and anyone planning on taking any financial action based on this document, is strongly advised to first consult with their personal financial advisor. ProVérte Wealth & Risk Management is an authorised financial service provider with FSP no. 5966.

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Samuel Rossouw CFP®
(BCommHons; Adv PGDFP)
Wealth Manager
Director

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True to company culture, Samuel strives to build solid long term relationships with clients and has a meticulous way of identifying needs, defining goals and compiling an executable plan to reach one's goals. He firmly believes that one has to be a specialist in one's field to be able to add value, and continuous training & education is therefore paramount. To be objective and to have an independent approach to a client's planning is critical to make a difference.

Born & bred on a farm in the Montague region, Samuel matriculated in 2001 from Montague High School. He completed his BComm Honours degree in Business Management as well as his Postgraduate & Advanced Diploma in Financial Planning. Samuel is a CFP charter holder. Apart from a short stint at an agricultural company Samuel has spent his whole working career with ProVérte. Samuel is a shareholder and valuable member of the board of directors of ProVérte.