Smaller funds lack op risk reserves, says survey

Mercer survey on operational risk shows diversity in attitudes and practices between funds

LONDON & NEW YORK - A recent survey by consultancy Mercer polled superannuation fund executives on their attitude and approach to setting operational risk reserves. The survey shows there is widespread support for having an operational risk reserve, even though there is no regulatory obligation for funds to do so. It also revealed that, although a growing number of funds are establishing operational risk reserves, smaller funds either don't have an appropriate reserve amount or don't have a reserve at all.

An operational risk reserve is created by a super fund to compensate members if a unit pricing error, system failure or fraud occurs. Typical levels at funds are 20 basis points and 60 basis points of assets or liabilities, the survey found. Based on a recommendation that reserves should be 1.25 times the cost of fund's annual operations plus extra reserves if using services from an outsourced provider, Mercer found super fund reserves are not large enough.

The electronic survey was sent to the senior executives of 68 industry, public sector and corporate superannuation funds in late 2008. Some 34 executives completed the survey, a response rate of 50%. The responses covered each type of fund, and a range of different fund sizes. The total net assets of those funds responding totalled about $180 billion, which represents around 40% of fund assets in the not-for-profit sector.

While some themes were consistent, the results also revealed diversity both in attitudes and practices. More than half the funds had either a specific operational risk reserve or a general unallocated reserve, but the items that gave fund executives most concern in respect of a future operational risk event were the failure of the administration system, errors in crediting rates and errors or arbitrage in respect of unit prices.

More than two-thirds of the respondents disagreed with the statement: "the development of an operational risk reserve is unfair as some members do not receive their 'fair' share of the fund". But most fund executives agreed with the statement: "The existence of an operational risk reserve is important to protect the brand of the fund".

These and other findings will be explored fully in a report to be published soon.