Balancing savings with diversity
The keynote speaker at this year’s Sanlam Employee Benefit Symposium was Dr David McCarthy. An internationally acclaimed authority on pension economics and the financial implications of actuarial practices, McCarthy is also a Senior Lecturer in Finance as the Tanaka Business School at Imperial College, London. He was invited to share some of his insights on government’s National Social Security System (NSSS) and perhaps provide some pointers for government and industry players as they put the finishing touches to the plan.
In today’s newsletter FAnews Online takes a look at some of McCarthy’s comments on issues like forced savings and diversity, national versus individual needs and the best way to implement a system that works for everyone.
Understanding the domestic environment
Any analysis of a country’s retirement fund environment is incomplete without a basic understanding of the incomes, geographic dispersions and ages of its people. McCarthy used the “lifestyle measures” developed by the South African Advertising Research Foundation (SAARF) which divides South Africans into LSM 1 to LSM 10. The questions asked to determine which category an individual belongs to are not financially based, though it is possible to create a broad range of salaries for each category. LSM 1 to 4 will survive on gross incomes of less than R2 000 per month. LSM 5 will typically enjoy R2 674 per month with LSM 6 moving up to R4 400. The top category on the LSM scale is the family earning R19 974 per month. And it’s worth noting that only 25% of the country’s population slots into the LSM 7 to 10 range.
When building NSSS we have to understand the channels that are available for saving and how families in different LSM categories use them. These channels include formal savings through the financial markets, general savings through an investment in the family home, investing in children’s education and community savings. McCarthy observed that while the channels available to families across the LSM measure are the same, the importance of a particular channel will differ vastly. Thus a saver in LSM 1 to 4 might ‘invest’ heavily in schooling for their children, while a saver in LSM 7 to 10 would be more intent on paying their primary residence off earlier.
National objective versus individual needs
The range of income through LSM 1 to 10 highlights one of the main difficulties in building an effective NSSS. Government must ensure that the final solution accommodates the widely differing needs and expectations of a diverse population. But before these diversities can be tackled government is faced with another balancing act. They have to distinguish between what is in the national interest versus individual needs. Existing systems like the Social Old Age Pension (SOAP) or a national health care system are clearly in the national interest. However, if government chooses to target a macroeconomic factor like the national savings ratio or Gini-coefficient, their ultimate strategy would be inappropriate for (and even alienate) thousands of savers.
Perhaps the best compromise, raised by McCarthy early in his presentation, is to focus on individual South Africans and what they need. McCarthy said that the NSSS should be formulated on the concept: “What is good for South Africans is good for South Africa!”
The ultimate social security fund
McCarthy concluded his presentation with a list of principles which (if applied) should guarantee a successful NSSS. Top of his list was to give people exactly what they want: a cheap, portable and accessible way to invest. If you can sell the system to people in a format they agree with then you’ll ensure much greater buy-in than by any amount of coercion. Government should also “accept that lower LSM’s will not participate, and for sound reasons.” McCarthy covered these reasons in detail during his presentation. Reasons include the large number of people in informal employment and the fact that the existing SOAP was high compared with existing salaries.
For the system to work properly there must be sensible default options and proper incentives to maximise preservation. The challenge for government and other NSSS stakeholders is “how to encourage people to participate in the scheme without making it compulsory” and, by extension, how to encourage people to preserve funds while still allowing some form of emergency withdrawal. There was also a need to ensure various checks and balances to prevent “moral hazard” in both private and public sectors.
And the last appeal was to all stakeholders in the industry. Charges have to be kept to the absolute minimum. Because each 1% in charges can reduce the final pool of funds available for retirement by some 30%.
Editor’s thoughts:
Most of the NSSS presentations we’ve attended in the last 18 months have emphasised the importance of a solution with low administration fees. The Chilean system which is often offered as an example for SA to aspire to included costs of only half a percent. Do you think the South African retirement fund industry could offer a solution at a similar cost? Add your comments below, or send them to [email protected]
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