Shining some sunlight into the workings of group retirement plans is surely a good thing in its own right. But if it also has the effect of reflecting some light into the murky world of segregated funds, that is even more beneficial.

Guidelines that recommend best practices for various aspects of capital accumulation plans (vehicles such as defined-contribution pension plans, group RRSPs and RESPs) were finalized in May 2004. Regulatory authorities expect CAPs to be in compliance with these rules by yearend. If plan sponsors are to meet that requirement, insurers are going to have to come clean about the charges the plans pay for seg funds, say pension consultants.

For CAP sponsors to meet their responsibilities under the new guidelines, they must disclose all of the fees charged to these plans, including commissions, research costs, investment fund management fees, fund operating expenses and administrative fees, among other things. To make this sort of disclosure, sponsors have to make certain they get full disclosure from various suppliers to their plans.

On that count, Greg Hurst, manager of pensions for Vancouver’s Heath Benefits Consulting Inc., suggests that seg funds may be a source of concern for some plan sponsors. Mutual funds already disclose all their fees as part of an all-in management expense ratio, but seg funds may not do so because they are organized differently. For plans invested under an insurance contract, members’ benefits are determined in relation to the value of a notional seg fund unit — unlike mutual funds, in which case the plan actually owns units, he explains.

Hurst has long worried that this structural difference creates a potential “black hole” for fees within these plans. While he has always had his suspicions about the existence of undisclosed fees in these plans, he couldn’t be certain until one insurer stepped up and disclosed it. He cites the forthcoming CAP guidelines as the reason for for the disclosure.

In one plan he has seen that has received this new disclosure, he reports that seg fund fees were an average 15 basis points higher than originally disclosed. That doesn’t sound like much, but it works out to $15,000 a year on a $10-million plan. And, Hurst suggests, the level of undisclosed fees may be much higher for other firms — up to 50 bps in some cases.

The added fees could also include operating
expenses that may be charged outside a fund and GST, which may not have been disclosed as part of stated investment management fees. Under the CAP guidelines, fund operating expenses that must be disclosed include audit, legal and custodial fees; costs for financial statements and other reports or filings; taxes; transfer agency fees; pricing; and bookkeeping fees.

Hurst suggests that these sorts of charges may exist without plan sponsors’ knowledge because of the way these plans are structured. Moreover, the insurers themselves may not know about them with any precision, because the underlying portfolio managers may charge expenses differently. Some of them cover operating expenses out of the management fees, while others don’t, he points out.

Hurst reports that, in his work as a benefits consultant, he has tussled with insurers over this issue in the past, demanding more disclosure from them for his clients. One insurer has so doggedly resisted the demand for full disclosure that his firm has stopped dealing with it, he says. He declines to name the insurer.

The relevant industry trade association, the Canadian Life and Health Insurance Association, declines to comment on the issue.

But the question of whether there are undisclosed fees being charged to group plans is something that plan sponsors and their advisors must consider. Ashley Crozier, an independent actuary with Crozier Consultants Inc. in Toronto, notes that some costs levied on top of management fees should not come as a surprise.

“Most people seem to appreciate the GST is on top of costs. When I buy something at a store that is priced at $100, I know I am going to pay [GST] on top of it,” he points out. “If, however, there are fees and expenses charged by the underlying fund managers in addition to the [management fees], then these definitely need to be disclosed.”

He reports that fees of this sort, if they have been charged, have not been disclosed to him or his clients in the past. “I will now be asking about them,” he adds.

@page_break@Whether seg fund fee disclosure in group plans emerges as a genuine issue or not, it highlights the larger issues surrounding the different regulatory treatment that seg funds enjoy compared with other securities. Independent financial industry commentator Glorianne Stromberg hopes that the fee disclosure issue brings more scrutiny to the world of seg funds generally. “I think fee disclosure is long overdue,” Stromberg says. “These segregated funds have operated as black boxes for as long as they have been around.”

She suggests that they are not well understood by most people, including plan sponsors. And that although they are effectively securities, they aren’t subject to the same disclosure requirements as apply to more traditional securities. Disclosure is one of the fundamental principles of securities regulation, she adds.

Stromberg says that the only reason seg funds aren’t considered securities is because insurance industry lobbyists have successfully convinced authorities that seg funds should not be treated as such. She chides regulators and legislators for not imposing the same standards on seg funds as they do on most other types of securities. “The Joint Forum of Financial Market Regulators have been working on [harmonizing requirements for mutual funds and seg funds] for years and have little to show for it except self-serving comparative spreadsheets and proposals for point-of-sale disclosure that result in meaningless disclosure for both types of funds,” she laments.

But fee disclosure is just one issue. Stromberg also points to the calculation and use of performance information, valuation practices and error correction techniques as other ongoing concerns around seg funds. Along with improved fee disclosure, she hopes that some of these other issues come to be addressed.

It remains to be seen just how much disclosure has to or will improve. Heath Benefits suggests that plan sponsors — most of whom, it believes, have no idea these additional charges may exist — are the ones who should be pressuring insurers for full disclosure. The CAP guidelines apply to the sponsors, not to the insurers, although the obligation may be starting to get pushed back up the food chain to fund manufacturers, too.

For plan sponsors to meet their responsibilities under the guidelines, they must ensure that their members are getting complete fee disclosure. Heath Benefits recommends that sponsors ensure they get this information from their suppliers; that they review whether the full scope of fees is competitive in the marketplace; that they devise a strategy for advising plan members of the fees; and that they explore the possibility that these undisclosed fees could represent a breach of its contract with an insurer. Hurst suggests that the issue could even be ripe for class-action suits against the insurance companies, depending on the magnitude of the problem and the terms of the contracts between insurers and CAPs.

But seg funds aren’t the only aspect of insurers’ businesses that are under pressure for more disclosure. Indeed, the industry is still feeling the echo of New York state Attorney General Eliot Spitzer’s assault against several dubious industry practices in the U.S., which began last fall.

In response to Spitzer’s investigations, the Canadian Council of Insurance Regulators and the Canadian Insurance Services Regulatory Organizations are looking at disclosure and conflict-of-interest issues as part of an effort to develop best practices in the area of insurance sales. A consultation paper was issued earlier this summer, and the regulators have just published a summary of the comments they received in early November.

Regulators report that 69 comments were received and that several common themes emerged, including whether the current level of disclosure to consumers is adequate and consistent across the various jurisdictions. The committee charged with assimilating the comments reports that some submissions say harmonization of disclosure requirements would be beneficial to both consumers and the industry.

“However, if an actual or potential conflict of interest cannot be managed adequately by disclosure, then it will be necessary to consider whether the underlying business activity needs to be regulated,” it notes.

The committee observes that voluntary guidelines or codes of conduct may be difficult to enforce and that consistency in disclosure requirements is also a concern. It pledges to consider options for using disclosure to manage conflicts of interest, noting that if any recommendations come out of it, they will go out for comment first.

Disclosure is the cornerstone of much financial industry regulation. And, while no one disputes its necessity, the question of just what constitutes adequate and effective disclosure is highly contentious, and can be a moving target. Like it or not, it appears the insurance industry is being dragged toward ever greater disclosure on several fronts. Hopefully, shining brighter light on a murky corner of the industry will be enough to keep consumers safe and the industry out of trouble. IE