Super funds should be putting aside 0.1 per cent of their annual investment return as a reserve to compensate members in the event that a major operational risk event occurs, according to Mercer.
In its first study on super fund attitudes towards operational risk reserves, which included 34 super funds representing 40 per cent of fund assets in the not-for-profit sector, Mercer found many funds were putting their funds and their members at risk by failing to stockpile sufficient cash should an event occur.
The consultant modelled three hypothetical cases based on its recommendation that a reserve should be at least 1.25 times the cost of the fund’s annual operations, plus extra reserves to cover the cost of outsourcing.
David Knox, actuary and worldwide partner at Mercer, said only a minority of funds had enough money set aside. Typically, the level of the reserve is between 0.2 and 0.6 per cent of assets or liabilities.
“A little more than half the funds’ had an operational risk reserve, but in some cases – probably more than half of those cases – we would have thought the reserve was too low,” Knox said.
“Basel II has put operational risk very clearly on the agenda of banks. What we’re saying is operational risk should be on the agenda of super funds, and we’re glad to see that more than half of the funds that responded already have such a reserve, but in many cases we think it should be a little bit higher.”
Knox said super funds with a reserve were generally sourcing it from the small profit they made on their annual operations or insurance contracts, or from their annual crediting rate or investment return.
“[Taking it from the investment return] is what we would normally suggest,” Knox said. “0.1 per cent is not a big difference in the fund’s return, but if you take 0.1 per cent each year over a period of three to five years, together with your operating impact, then you can normally build up a reserve to a reasonable level.”
According to the survey, super funds’ three biggest concerns were failure of an administration system (56 per cent), crediting rate errors (36 per cent) and unit pricing errors/arbitrage (35 per cent).
Of the respondents, 59 per cent agreed or strongly agreed that super funds should have an operational risk reserve or ready access to capital to increase member confidence in the fund’s operations, and 53 per cent agreed that such a reserve was important to protect the brand of the fund.