Advice to Boards and Employers in an Evolving World
By Elrina Wessels, Head: Technical and Compliance
Remarkably, with the promulgation of the Pension Funds Act in 1956, South Africa became the first country to have a comprehensive act to regulate retirement funds. Globally it was deemed to be one of the most detailed regulatory tools at a time when other countries still relied on trust and income tax laws to govern retirement funds. In 1959 the local retirement industry had a modest membership of 675 404 and assets of R656 billion.
Fast forward to today, the Financial Sector Conduct Authority (FSCA) 2019/2020 Report indicates the total membership to be 17,5 million with assets totalling R4,5 trillion. In fact, the South African retirement fund system is ranked in the 2021 WTW Global Pensions Report as one of the largest in the world (top 22).
This raises the question as to why one of “the largest retirement fund systems in the world” does not translate into adequate savings for members at retirement, as it is well known that only a small percentage of people can afford to retire today and we are still faced with the difficult reality that 75% of our elderly population’s main source of income is the old-age grant. Where did the system fail them? Or is it a case of members not taking ownership of their destinies?
According to Homer, “A page in history is worth a pound of logic”, and I am a firm believer that to know one’s past is to understand one’s present. What are the learnings from the past and how can we use them to achieve better outcomes for our members?
When considering the question regarding poor retirement outcomes, the answer that comes to mind immediately is lack of preservation. I was therefore quite astounded to find that preservation of benefits (along with the role of state pensions/social grants based on a means test) was already heavily debated in the early 80s. Many papers were written on the topic, and all the signs of trouble to come given the ageing population and resultant increased pressure on the state were already there: “It is estimated that the number of elderly people in South Africa will double between the year 1980 and the turn of the century and will nearly quadruple by 2020. … These trends have far-reaching implications for state expenditure on the provision for the aged in South Africa.” – Dr Valerie Moller, Senior Research Fellow, Centre for Applied Social Sciences, University of Natal (1986).
In June 1980 a Committee of Inquiry appointed by Government recommended that, based on a specific formula (remember defined benefit funds were prevalent), accrued rights be preserved either within the fund, or by transferring them to another fund or special savings account upon resignation.
Unfortunately, the Preservation of Pensions Bill was not welcomed with open arms, specifically by workers who saw this as being denied access to their benefits.
Today the proof is in the pudding and one cannot help but wonder, had the Bill been promulgated, how different the retirement outcomes would have been for members who started their career in the 1980s, as many are expected to reach age 65 by 2025.
Back in the 80s the political scene was turbulent, and the stage was set for the creation of provident funds, as members and unions demanded to have access to their entire savings, not only upon withdrawal but also at retirement. At that point in time, a valid argument was that after retirement members would move back to rural areas where it would be difficult to access their monthly pension payments.
We also started seeing a dramatic shift in the 1980/90s from defined benefit (DB) to defined contribution (DC) funds. DC funds were initially popularised by the unions in the 1980s, given job/financial security concerns, the control employers had over retirement funds and the fact that DC funds were less complex and easier to understand by members. In the 1990s, however, the conversions to DC funds were driven by employers, who started seeing the benefits of conversion on their own balance sheets from a liability perspective.
The conversion wave in South Africa was the fastest in the world, faster than regulatory change, which meant that boards (and the employer) depended greatly on consultants and actuaries to guide them through the process.
From 1998 onwards a vast number of regulatory requirements were imposed on pension funds, such as equal provision for employer-appointed and member-elected boards (1998), the surplus legislation (2000), and Default Regulations (2019), just to highlight a few. This year alone we have had the implementation of the Protection of Personal Information Act (POPIA), and the Conduct of Financial Institutions (COFI) Bill, which is expected to have a far- reaching impact on the retirement industry, is awaited.
Looking ahead, we see the following areas as being key:
Member Education:
When considering the past learnings, with preservation being optional, and the creation of DC funds, where members ultimately took up the risk of possible poor retirement outcomes, we have to admit we simply did not do enough to educate our members. With umbrella funds reaching substantial sizes in membership, it is unreasonable to expect the trustees of umbrella funds to reach every member. Participating employers and consultants will have to play an active role in member education.
Leon Trotsky said, “Old age is the most unexpected of all things that happen to a man.”
It is frankly difficult for younger members to associate with the distant idea of retirement.
Research on saving behaviour has shown that if the idea of attaining a reasonable retirement income is remote, little effort will be made; however, if the approach to saving is concrete and the target seems attainable, then people are motivated to achieve it.
Instead of just providing members with net replacement ratios (NRR) and a projected lump-sum value at retirement (with which younger members cannot associate), should we not set achievable targets for every two or five years of a member’s working career, with the ultimate aim to have smaller goals that build up to a reasonable NRR at retirement? This would get members more engaged and create the positive impression that they are working towards a bigger goal and achieving something as they progress, and hopefully result in taking ownership.
Technology and gamification can easily be used for this purpose, or even just casting the net wider when it comes to retirement counselling and by pro-actively engaging younger members in discussions and actual retirement planning.
Interestingly, with COVID-19, certain countries such as the USA and Australia allowed members to access up to a certain percentage or amount of their retirement benefits. It was found that members who had a “target date account” (i.e. had a specific targeted pension amount they saved for) did not access their pensions as they fully understood the impact it would have on their retirement outcome.
Consolidation of Funds:
The consolidation of funds is expected to continue at a fast pace given the commitment from the Regulator and Treasury to substantially reduce the number of stand-alone funds.
According to the latest FSCA report, there are currently 1 528 (vs 11 102 in 1980) active funds, which is still well above the targeted number.
The shift towards umbrella funds highlights the importance of advice and education to be focused on members. We expect that there will be an organic shift from advice to board of trustees, to more direct advice to members of umbrella funds.
Governance:
This will become more onerous, and funds should allow for a proper governance budget. The COFI Bill will have far-reaching implications.
Transformation:
Boards will be expected to actively drive transformation.
Investments:
Boards will have to carefully scrutinise their approach to Environmental, Social and Governance (ESG) and impact investing, given the socio-economic circumstances and burning issues such as climate change. A high level of compliance will no longer be acceptable, and active ownership will be required.
When making investment decisions, boards must consider any factor that may impact sustainability from an ESG perspective, and it must be reflected in the Investment Policy Statement of the fund. It will be expected of boards to actively engage with asset managers. In many instances, the argument of impact on returns is raised when it comes to ESG factors, but high returns will have no meaning if the world people are expected to retire in is in shambles. We must be willing to ask the difficult questions regarding impact, infrastructure, and sustainability, and whether the company we invest in is adding value to society. Advisors to participating employers must empower them to ask the right questions to the trustees of an umbrella scheme.
Retirement structures:
There are many learnings from other countries when it comes to the structure of retirement funds. In the UK and now also the US, a distinction is made between short- and long-term investments, where a member may access his short-term account. In Europe, certain funds apply a smoothing approach to the collective DC, thereby safeguarding the members who are due to retire at the bottom of the market, and in Asia we see a return to a form of hybrid DB/DC funds to provide DC members with some form of guaranteed minimum outcome.
Locally, on the topic of preservation, government and Nedlac is in conversation regarding early access of retirement benefits. Although one is sympathetic to the need for access to funds in challenging financial circumstances, the long term implications must also be measured. Ideally if early access to retirement funds is allowed, it must be balanced with some form of compulsory preservation.
In conclusion, funds will face many challenges from a governance and compliance perspective going forward, and it is important to ensure you are partnered with the right consultancy house who has the necessary skills and technical support to provide guidance in navigating these turbulent waters.
Member education is more crucial than ever, both from the perspective of a board of trustees as well as a participating employer in an umbrella fund. Let’s make the changes now to achieve a better outcome for all our members, especially the generation that is due to retire in the next 40 years.