Some of the country's biggest pension fund administrators have been fingered as the main culprits in an undisclosed profit scheme, said to be costing thousands of pension funds members' millions of rands.

The victims of the scheme are pension fund members who received home loans facilitated by the administrators to either renovate or extend their houses. To access the loans, the members had to put up their pension fund benefits as collateral in the event they defaulted.

In many of these home loan schemes, pension fund members are charged interest rates that are unjustifiably exorbitant on what are essentially low-risk loans. On the other hand, administrators, who arrange the loans on behalf of the members, pocketed undisclosed profits and kickbacks.

Several industry insiders assisted City Press Business last week to lift the lid on this unethical practice. They said it will leave millions of South Africans relatively poor on retirement and perpetuate their dependence on state old-age grants.

Over and above earning income from the secret profits, the administrators charge the following fees on the pension fund-backed home loans:

• A once-off set-up fee;

• A once-off entry administration fee;

• A recurring administration fee to cover the cost of managing the book; and

• Credit insurance to settle the outstanding debt in the event of the death of the pension fund member, thereby protecting pension benefits from being seized by the lender.

While the above-mentioned fees are disclosed to a pension fund member, the secret profit earned from the interest charged by the administrator on the loan - which the administrator sells to the member on behalf of the lender - is hardly ever disclosed. This contravenes Section 13 of the Pension Funds Act, which clearly prohibits this action.

Will send shockwaves through the industry

The revelations about the scheme are likely to send shockwaves through the retirement fund industry, which is plagued by allegations of poor corporate governance, corruption, lack of disclosure and transparency and, in some instances, anti-competitive business practices.

The manner in which the administrators earn the undisclosed profit is interesting, simple and quite clever.

The administrator arranges the funds in the debt market in advance and uses the assets of the pension fund as collateral. Because pension funds are deemed low risk for default, the administrators are able to secure favourable rates from banks or the corporate bond market.

The loans are priced at the Johannesburg Interbank Agreed Rate (Jibar), the rate at which financial institutions lend to each other.

On average, Jibar is 200 basis points below prime. The pension-backed loans are usually priced between Jibar + 0.25% and + 0.5%. The size of the loans through this facility range between R500m and R2bn.

The administrators then negotiate the interest rate they will charge for providing the home-loan facility to the pension fund members. The interest rate is usually set in the range between prime rate -1% and prime rate +2.

The higher the rate the administrator is able to secure from the pension fund, the more interest income they stand to make. This is the portion of the income they do not disclose to the pension fund trustees and members.

The administrators pocket the secret profit, which is the difference between the low interest rate paid from borrowing in the corporate bond market and lending to pension fund members at higher rates.

"Worse than bulking scandal'

Pension fund members could save significantly on their repayments if administrators offered them more competitive rates and disclosed the profits they stand to make.

A pension fund adviser, who did not want to be identified, said: "In my opinion, this practice is insidious and worse than the bulking scandal. At least, pension fund members benefited from bulking because the administrators negotiated a higher interest rate.

"But this 'interest rate arbitrage scheme' that is perpetrated by the administrators helps them to make more money because they negotiate the worst possible rate for the members of the funds."

The Financial Services Board, which regulates pension fund administrators, said it had received several complaints from pension funds about the scam.

Jurgen Boyd, the FSB's deputy executive of retirement funds, said: "I am aware that there have been complaints by pension funds that the administrators have set up arrangements with the banks, in which they earn secret profits without the knowledge of the pension fund trustees. If this is an industry-wide practice, a full investigation is needed."

But Boyd appeared to concede the problem of secret profits and excessive rent-seeking by the administrators was bigger than the FSB could handle alone. He said the 'one-stop shop model' employed by the pension fund administrators created fertile ground for unavoidable conflicts of interest and lack of disclosure, and by extension secret profit- making.

Under the model, administrators own a number of divisions that provide services ranging from risk management, investment advice, actuarial employee benefits and now home loans.

While most of the above-mentioned businesses are supervised by the FSB, the home loans divisions at the pension fund administrators fall under the jurisdiction of the National Credit Regulator (NCR).

'Conflicts of interest'

So far the home loans units at the administrators are set up as joint-ventures with the banks.

For example, NBC Future Guard is a joint venture between NBC Holdings and Absa bank, while HomePlan Financial Solutions was a partnership between Alexander Forbes and Absa.

Absa was recently bought out by Alexander Forbes as a 50% shareholder in HomePlan. Both Home Plan and NBC Future Guard are registered with the NCR.

More than two years ago, Home Plan and NBC Future Guard raised R2bn and R1bn respectively from the corporate bond market.

The funds were used to provide home credit to members of pension funds, most of which are advised and administered by the companies.

Industry insiders estimate that HomePlan and NBC Future Guard earn secret interest incomes of no less than R40m and R20m a year for Alexander Forbes and NBC respectively. These figures do not include the administration costs.

Boyd said: "The one-stop model or the whole concept of cross-selling introduces conflicts of interest. We will act harshly against the administrators if they are making secret profits. But I don't have the powers to investigate the joint ventures because they don't fall under my jurisdiction."

Actuarial consultant Donald Molema said: "In instances where a fund administrator derives income and secret profits from a fund without the permission of the board of trustees, the administrators fall foul of both the Pension Fund Act and the Financial Institutions Act, especially when interests are not fully disclosed to the board of trustees."

- City Press