Social security reform: the impact on your business

The financial intermediary has been subjected to a raft of changes in the past five years. One of the inevitable consequences of increasing regulation is that profit margins at individual practices have come under significant pressure.

Although compliance requirements imposed by the FAIS Act have been welcomed, they add to the cost side of the business equation. To illustrate this we quote from a recent LUASA submission to National Treasury on the draft proposal for commission regulation. They suggest that the average financial intermediary business (with a single key individual) spends between R2 000 and R5 267 to secure a single client.

Incomes dwindling

Under normal business conditions a company will raise the price of its goods and services when faced with such cost escalations. But instead, financial intermediaries face the prospect of dwindling incomes due to a combination of National Treasury proposals. Incomes are at risk from the draft proposal to modify commission structures. Changes such as the reduction of upfront commission, an extension of the 'claw back' period and commission portability will have a severe effect on commission and cash flows. It is likely some intermediaries will experience income instability for as long as 36 months. And new entrants to the industry could be severely curtailed.

Between a rock and a hard place

With incomes under pressure the only alternative will be to increase business volumes or add product lines. To accomplish this intermediaries will have to work longer hours, hire additional staff (more costs) or reduce service levels (ill advised when considering the requirements of the FAIS Act).

Unfortunately the objective of boosting business volume may run foul of another National Treasury obstacle. Government's eagerly anticipated social security reforms are lurking in the wings and must be close to implementation by now. While the final solution has yet to be outlined the one certainty is that cash flows to the retirement industry will change significantly.

The worst-case scenario is that government channels between 12% and 18% of gross salaries (up to a certain wage limit) away from the private sector into a publicly administered fund.

Extensive impact

What will this mean for the financial intermediary ? It's not easy to give a uniform answer. Masthead's chief executive Peter Dempsey notes that retirement annuity dependency varies greatly from practice to practice – with some relying almost entirely on retirement annuity business – and others having no exposure to the product at all. In 2007 Masthead conducted a survey among approximately 450 of its member practices to determine the impact of National Treasury's commission interventions on practice income. Using this data Dempsey estimates that the average intermediary business earns between 10% and 15% of its income from retirement annuity sales.

Proactive steps

It is essential that intermediaries consider the possible impact of social security reforms on ongoing retirement annuity income (in addition to the pending commission regulations) when completing cash flow projections.

How much to budget for will depend on the product mix in each business. If a practice sells no retirement annuities – then no worries! If retirement annuities make up only 15% of the business it can probably close the 'gap' by replacing retirement annuity business with collective investment products (unit trusts). Of course the practice will have to write slightly more of these products by value to compensate for the lower commissions earned.

Intermediaries whose business consists 100% of retirement annuities will have to seriously consider some form of product diversification.