While all South Africans currently have retirement coverage through both private and the state pension scheme, the adequacy of this coverage - and specifically improving this adequacy - is one of the biggest issues facing Government and the pension fund industry today.
It has been widely reported that just 10% of South African retire comfortably. The consequence of this is a huge burden on the state welfare system and lower standards of living at pension age, which consequently leads to other problems like the inadequate provision of healthcare.
While Government has recognised this and is addressing the problems associated with the inadequacy of pension coverage through the proposed National Social Savings Scheme, Government has also been addressing many issues in the pension fund industry over the past few years, which could pave the way for a smoother, more efficient national scheme.
Quite simply, improving the adequacy of pension coverage for South Africans is mainly dependent on one main issue - reducing costs.
Costs reduce investment yields and it’s been estimated that an individual age 35 could lose more than 20% of his retirement nest egg due to cumulative costs associated with administration and investment management.
While reducing costs may appear to be a simple affair, the issues associated with reducing costs are complex. Adequately reducing costs means solving problems that have dogged the retirement fund industry for decades. Many of the pension fund reforms we’ve seen until now have been addressing these issues, but here is still way to go. Since 2005 pension fund reform largely centred on improving governance standards. Regulation like PF130 and numerous rulings by the Pension Fund Adjudicator are testament to this. But there is still some way to go. One of the biggest problems facing the private sector pension fund is that some 80% of SA’s 13000 pension funds have less than 100 members. The fixed costs of managing these costs are significant. The annual auditing fees can severely impair the returns of these small funds. One of the results of this has been the “one-stop-shop” approach to pension fund management where service providers often offer all services (investment management, consulting and administration). I believe that while this approach may be convenient, it could substantially increase fund costs in the long run because: (1) there could be hidden costs, (2) preventing cross-subsidisation of various service fees becomes nearly impossible, and (3) the basis for fair cost comparison diminishes when trustees look for new service providers, therefore, lessening competition.
While it will take some time for the architects of the national scheme to achieve its overall objectives, Government could do more concurrently to promote greater competition and eliminate unnecessary layers of cost in the pension fund industry today. For example, it could prescribe some mechanism that creates a basis for proper cost analysis when trustees look for new service providers.
This approach is useful, because despite the private sector having a mixed track record in retirement management, international evidence suggests that a well-designed and well-regulated system using public- private partnerships can be effective at harnessing the best of what the private sector can offer. And the private sector must step up to the plate.
For example, in SA it is estimated that it costs on average between 1 and2% of contribution to administer a fund per annum. Through economies of scale and technological innovation Metropolitan administers a large fund at a cost of 0,1%.
The costs of the proposed National Social Savings Scheme could be markedly lower depending on the complexity and scope of the scheme, the industry’s willingness to seek cost measures and Government’s ability to learn from similar models from around the world. For example, after the recent market collapse, the Australian national defined contribution system has come under sharp criticism as retiring members saw their benefits (and long-term financial security) significantly decline. The Australian system has also been criticised for an outcome where workers now typically belong to four or more separate retirement funding arrangements, which has multiplied the overall cost of administering the system.
Open funds, which allow individual choice, have proved to be expensive to operate in Australia, reducing overall investment yields by 2% per annum and more. Critics argue that the high advice and financial education requirements of such structures, together with the risk of things going wrong, make them an inferior option to the alternative of large, well governed traditional fund structures, which could cost as much as 75% less. Over a working lifetime, the impact of such cost differences can be vast.
From Government's perspective, addressing adequacy through the national scheme will ultimately be a trade-off between member choice and costs associated (in addition to regulation governing the scheme), so we are likely to a simpler model than the Australians. From the industry’s perspective, its relevance in the scheme will ultimately be determined by its ability to improve efficiency and reduce costs.
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