Savings pensions and some strange ideas

Robert W Vivian, Professor of Finance and Insurance at the University of the Witwatersrand, takes a look at the international practice and local experience in terms of social security and savings, and comments on some strange ideas in the proposals.

A key feature of the second edition of the National Treasury’s discussion paper on social security and retirement funding is that it is mandatory for all employed persons to save for retirement.

The theory that working people should save for their own retirement is correct. There comes a time, for all who survive to the point where they can no longer continue working, that they will need to have access to a pension. South Africa has been the only developed county that does not have a compulsory system, since the movement was started by Otto von Bismarck (1815-98) in the late 19th century.

International practice

In other countries, the mandatory “savings” takes the form of pay roll social security tax. Very few of these countries use the contributions as savings but rather adopt the Pay-As-You-Go system (PAYG). Current contributions are used to pay current pensions.

Most countries are announcing to those who have contributed and thereby provided pensions for previous generations, that when their turn arrives to receive a pension, they will not be getting the pensions promised during all the years they have contributed. This, understandably, has caused unhappiness. In some countries the state pension is paltry and probably out of line to what persons have contributed. The contributors did not get their money’s worth.

Local experience

Since about the middle of the previous century, South Africa has had a voluntary savings based system, as it became increasingly widespread for companies to offer occupational pensions. This resulted in South Africa having by far the highest contributions to “life” insurance companies.

These “life” insurance companies are not, in fact, acting as risk insurers and the term “life insurance” is probably a misnomer. Thoughts should be given to correcting this. These are actually pension fund administration and investment companies. The life insurance regulatory system does not fit. Having a mandatory contribution system probably will not introduce too much of a change in this regard.

The consequences

In South Africa, most savings are contractual savings. State involvement in private pension funds is new, so some movement from private schemes to the state scheme can be anticipated.

The current South African voluntary retirement system is fraught with problems and has been subject to more enquiries than one cares to recall, with very few, if indeed any, problems being solved. Although most persons understand they must save for retirement, very few succeed. Those who do not save are generally unable to save.

Case in point

To understand this, draw up a list of essential expenditure. Pretend, for example, your son or daughter is now planning to leave home and has never had to prepare a budget. Start with the most essential items and end with the least essential items – e.g. food, accommodation, clothing, transport, medical treatment and retirement funding. You will soon see the figure is about R10 000 per month or R120 000 pa.

This figure is important for two reasons. Firstly, it gives an indication of the level below which people cannot save for retirement because they do not have sufficient income to cover the essentials for life and, secondly, it is an indication of the monthly pension income required to survive while on pension.

Other way round

The Treasury proposal recognises that some who work cannot save and makes provision for a wage subsidy. This is strange. Government current income will be diverted into pension funds to provide a pension for those who cannot afford to save.

During their entire working lives, these employees will not benefit from this flow of government income. When they go on pension one day, the inflow stops and they get a pension from the accumulated government funded savings.

Why not the other way round?

We do not know if the accumulated savings, 30 years from now, will in fact be sufficient to provide a pension. Why not do it the other way round? Provide a pension for all working persons who do not earn enough to save.

In that way the current government expenditure will be used to provide a current income to pensioners. Why use government income to subsidise working people - what about the unemployed?

This second report will certainly provide food for thought.