Selection of the providers of default products
Following our earlier newsflash on the KiwiSaver Bill (Bill), we now provide an update for those who are interested in becoming default providers. Our main observation is that, as the Bill will progress in parallel with the tender process, providers will be in the unenviable position of tendering to provide services while there is still uncertainty and a lack of detail in a number of key areas. We elaborate on this below.
1. What do I do to become a default provider?
The Ministry of Economic Development (MED) has indicated that a Request for Proposal (RFP) for KiwiSaver default providers will be issued in late April 2006, with a closing date for submitting a tender sometime around mid-June 2006. It is expected that the RFP will contain key information regarding the criteria for appointment as a default provider. In the meantime, the Registration of Interest document (ROI) recently released by MED contains some preliminary guidance (which we consider in more detail below).
MED requested that interested parties register their wish to receive the RFP by 7 April 2006. However, even if you have not registered an interest with MED, you will still be able to submit a response to the RFP (once available) by obtaining a copy from either the Government Electronic Services website (www.gets.govt.nz) or www.med.govt.nz.
At the same time as the tender process is taking place, the Bill will also be progressed. Public submissions on the Bill are due by 28 April 2006. The Select Committee will hear and consider the submissions and is due to report back to the House by 1 September 2006, although these dates could change at any time. The Act is due to be passed in October 2006 with a commencement date of 1 April 2007.
This means that, although the RFP will contain the key criteria for assessment of potential applicants, there will still be uncertainty for those entering the tender process as further amendments to the Bill can still be made. There is also the possibility of regulations being passed as there are extensive regulation-making powers in the Bill.
MED have stated that the tender process will involve interviews with potential providers, site visits (if considered appropriate), fee negotiations and due diligence.
In terms of numbers, there is no certainty as to how many default providers will be appointed. Under the Bill, there can be any number of default providers. It is expected that between four and six default providers will be appointed. However, regulations may be passed prescribing the maximum number of default providers (s194(f) of the Bill).
The long gap between the time by which tender submissions must be made (June) and the date of appointment (October) gives MED a long period to assess, choose, shortlist and then negotiate with applicants.
Providers of default schemes will be appointed by an instrument of appointment which will be entered into once the Act comes into force (around October 2006). Once appointed, default providers are expected to be ready to accept members who are allocated to them from the anticipated commencement date of 1 April 2007.
As noted above, default providers will be appointed by a formal instrument of appointment. Further uncertainty arises from the fact that this process remains subject to a number of further variables including:
- The Minister's power to make the appointment of default providers subject to such terms and conditions as he or she sees fit (s158(3)).
- The exercise of regulation-making powers to specify the information that must be contained in the instrument of appointment of a default provider (s194(g)).
It is to be hoped that the RFP will include any such terms and conditions, and any requirements that are intended to find their way into regulations, even though these will not have been formally adopted at the time the RFP is released. However, there has been no indication that this will be the case.
2. What is a KiwiSaver default provider?
A KiwiSaver default provider is a person who is appointed by government to provide:
- A default KiwiSaver scheme; and
- A default investment product within that scheme.
What are the criteria for being a default provider?
The Bill and ROI both set out criteria for qualification and selection for default schemes and default products. The RFP will contain much more detail on the criteria outlined in the ROI.
To qualify as a default KiwiSaver scheme, the scheme must:
- Qualify as being a KiwiSaver scheme under the Bill; and
- Have a trustee corporation as one of the trustees of the scheme.
To qualify as a KiwiSaver scheme, a scheme must:
- Be established and governed by a trust deed under New Zealand law.
- Have retirement benefits as its principal purpose.
- Be a defined contribution scheme.
- Have one independent trustee (a trustee corporation will fulfil this requirement).
We believe it is likely that default schemes will follow the master trust format, making a number of products available within the default scheme. The ROI states there needs to be a default product within the scheme and this will have a conservative risk profile. The RFP will include broad guidelines on the investment risk profile for the conservative product.
The ROI sets out key expectations for default providers. Providers are expected to:
- Meet new tax rules for qualifying collective investment vehicles (QCIVs) for the default scheme. A ministerial announcement about the new QCIV rules is expected shortly, and the proposed tax bill is expected to be released in May. This bill will also need to go through the select committee and legislative process and may not be passed into law at all. Currently it is expected that it will be enacted before the end of October – about the time when the default providers will be appointed. Until this yet-to-be-seen tax bill is passed into law, it is difficult to assess all the potential tax issues.
- Accept all members and contributions, regardless of the size of the contributions.
- Provide a complete business solution including trusteeship, administration, investment management and custodial business functions. It is also acknowledged that providers may wish to form a consortium to achieve this.
- Deliver competitive fees across the default scheme, and particularly for the default investment product.
- Demonstrate commitment and capability in delivering quality savings products.
- Have systems that will work with IRD's central administrator system. This has been identified as one of the crucial requirements for potential default providers.
- Provide a minimum level of information for members.
- Agree to a minimum level of service standards to run the default scheme.
While useful, the ROI expressly states that the list of expectations is not intended as an extensive, all-inclusive and exhaustive or complete list. Further detail on many of the ROI expectations above will not be available until the RFP is released.
2. What does it mean to be a default provider?
Automatic enrolment into default schemes
From 1 April 2007, all new employees will join a KiwiSaver scheme unless they choose to opt out. Employees will join a particular KiwiSaver scheme in the following order of preference:
- The employee's choice of KiwiSaver scheme; or
- Where the employee does not make a choice but the employer has a preferred scheme, then the employer's preferred scheme; or
- If neither the employee or employer make a choice, then a default scheme provisionally allocated by IRD.
It is anticipated that many employees will be allocated to a default provider because they will not act to opt out of the KiwiSaver scheme, choose a scheme themselves, or their employer has not selected a preferred KiwiSaver scheme.
If you are appointed as a default provider, new employees who do not opt out, join an employer’s preferred scheme or select a scheme themselves will be allocated to your default scheme as follows:
- All new employees will be given a KiwiSaver information pack from IRD via the employer.
- The employee is provisionally allocated by IRD to a default scheme on a sequential basis (as between the default providers). IRD notifies the employee of the name of the default provider and default product and sends an investment statement for the default product.
- Automatic deductions will be made from the employee's wages via their employer and held by IRD for three months.
- In general, if, after three months from the date of the employee's first contribution, IRD has not been notified that the employee is part of another KiwiSaver scheme, the employee becomes a member of a default scheme.
- Automatic membership in a default scheme creates a membership contract between the member and the default provider without the need for a default provider to complete a contract with each individual allocated to them.
- IRD will notify the employee of that fact.
The automatic contributions continue unless the member elects to take a contributions holiday, permanently emigrates or a case can be made for withdrawal of funds on the grounds of serious financial hardship. It is possible for the provider and IRD to agree on a minimum threshold for the payment of contributions, with IRD holding the funds until they reach that threshold.
The Bill provides that a person can only be a member of one KiwiSaver scheme at a time. They can, however, have more than one account or investment product within a KiwiSaver scheme. From a provider’s point of view, there may be administrative and cost advantages to placing a limit on the number of products members are allowed to participate in at any one time. There is nothing in the Bill that prevents the provider from doing this.
As a default provider, you can market the default scheme as a preferred KiwiSaver scheme to employers, or as an investment choice to the public. If employees actively choose your scheme, you will be responsible for notifying IRD and providing the applicant with an investment statement, not IRD.
The Securities Act will apply to KiwiSaver Schemes, meaning that an investment statement will need to be provided.
- A default provider will need to supply IRD with investment statements for their default product. IRD will send these to employees allocated to that default scheme. Employees will be treated as having received an investment statement for the allocated default fund if IRD has sent one (which is an exception to general securities law, made to deal with the effects of automatic enrolment and default allocations).
- You need to supply an investment statement for a default product to an employee if he or she contacts you directly.
3. Key issues for default providers
The power to make regulations is a major area of uncertainty. Section 194 of the Bill states the purposes for which regulations may be prescribed. The list is extensive and covers items that are significant for providers. In particular, regulations may be prescribed which will have a significant impact on system requirements and fee subsidies. These items alone have a significant impact on system development costs and pricing. This is coupled with the political risk that if there is a change of government in the next election, that new government might repeal the KiwiSaver Act. In short, this means that prospective default providers are faced with some hard decisions as a new system will need to be in place by 1 April 2007.
The cost in changing/developing systems to comply with new QCIV rules has been identified as one of the key issues for default providers, as the new rules have not been released and the timeframes to achieve compliance are very short.
Importantly, default providers can operate funds which do not have QCIV status in order to provide investor choice and not limit providers to one type of investor.
Like many in the industry, we will be keeping a close eye on developments in this area, particularly with the upcoming ministerial announcement and tax bill on the subject. We will be in touch again as soon as any further information is available.
Investment statement cost
There is no way of knowing how many employees will be allocated to default schemes, creating potential unrecoverable costs in supplying investment statements to IRD for distribution.
Treasury has also shown a desire that KiwiSaver providers ensure their investment statements are ‘succinct’. However, investment statements are currently required to be concise and understandable, so unless there is intervention with the making of specific regulations for investment statements, there will be no difference from the current requirement.
The Bill does contain a power to make regulations that vary requirements of the Securities Regulations in relation to KiwiSaver investment statements, and it is possible that this power will be used. We strongly support any proposal for simplifying investment statements and making products more readily comparable and will be making a submission to the select committee considering the Bill on this point.
Once members in KiwiSaver schemes have paid contributions for 12 months, they can apply to take a contributions holiday (the minimum period of which is three months with the maximum being five years). There is no limit on the number of holidays that can be applied for, so contributions could be halted indefinitely resulting in KiwiSaver accounts with little activity and low balances.
If a KiwiSaver member cannot be located, trustees of schemes are required to hold the money in the member’s account until that member is at least five years older than the qualification age for New Zealand superannuation (currently 65). While there is relief for providing information to the member, this would still leave default providers with the burden of maintaining dormant accounts.
A member may apply to withdraw funds if they meet financial hardship withdrawal requirements defined in the draft KiwiSaver rules attached to the Bill. As the administration of these ‘serious financial hardship’ applications under the Bill is left to the trustees of a scheme, this creates potential administration costs for default providers dealing with low income earners who apply under these provisions.
Power of the Court
The Bill contains a power for the High Court to order providers and trustees of default KiwiSaver schemes to act or stop acting in a way that the Court considers would breach the terms and conditions of the instrument of appointment. This power of intervention could potentially create legal and compliance costs.
The short deadlines and parallel activities in the tender process, the taxation review and the commencement of KiwiSaver, together with the uncertainty of the final form of requirements that KiwiSaver will impose on default providers make it difficult for providers to properly assess the risks they may face in deciding whether to become a default provider. We will keep you updated as further information is released.
We also encourage you to contact us with any queries you may have about becoming a default provider or about the KiwiSaver initiative in general.
This publication is intended as a first point of reference and should not be relied on as a substitute for professional advice. Specialist legal advice should always be sought in relation to any particular circumstances and no liability will be accepted for any losses incurred by those relying solely on this publication.