Is compulsory retirement savings viable in South Africa?

Experience in countries such as the United Kingdom (UK) and Australia illustrates that the introduction of compulsory retirement savings is very beneficial for the industry if an open model is adopted and members could gain from reduced administration costs so that more money is devoted to savings.

This was very true for these markets, however there are two fundamental differences between the UK and Australian models and the model currently proposed in South Africa (SA), namely the risk benefit underpin planned for SA and the fact that the UK and Australia already had a social pension underpin. If one looks at the first item, the SA model includes not only retirement fund savings but certain risk benefits such as death and disability.

If SA opts for a model where anyone can opt out, and the healthy and/or wealthier members of the population elect to do so, which is highly probable, as they could potentially get better risk rates outside of the scheme, leaving more of their contribution available for savings, the risk cost to the scheme would then become more expensive as higher claims are received. It is therefore unlikely that the legislators will want to go for a full opt out basis as they would want to make sure that the risk pool contains as many people in it as possible

We can only hope that a two tier model will be selected where a person will be able to place the retirement funding portion of the contributions in a open market scheme leaving the risk portions behind to create a wider risk pool.

In terms of the second difference, a large part of the UK and Australian population had to contribute to a social-based scheme and could then switch this to a private scheme. In SA the majority of the population do not have to belong to any scheme and don’t in many instances.

As a result a 10% to 15% reduction in a house holds income, when they are compelled to pay to a scheme, will hit the poorest house holds hardest, even if a tiered contribution rate is put in place, or a government contribution is put in place, both of which may be deemed inequitable. Alternatively if employers are expected to fund this, the impact of a 10% to 15% increase of the company’s salary bill would also be an unpopular move and could in itself lead to a slow down in job creation.

While the idea of creating a pension net for everyone is commendable and probably a future necessity, to move from a zero base to having 100% of the population contributing to a social pension would not be achievable in a single step, and would more likely need to be introduced over a long period of time.
In terms of making the industry more competitive, it actually has the potential to destroy it. At the current suggested maximum level of contributory salary, almost 60% to 70% of existing retirement fund members would cease to contribute to their current funds.

Unless there is a joint government/private sector initiative on the administration of these schemes or a two tier opt out mechanism this could be the single biggest threat to face the industry in its history.

We have only mentioned a few of the issues facing retirement fund reform, there are many more, and the government is at an early stage of considering how it could implement a national retirement fund, and will receive input from a number of stake holders, including unions, administrators, insurers, investment managers and the public at large, all of whom could have very different agendas and ideas on the subject.

Given the impact of the retirement fund reform initiative, it is more likely that it will take ten or more years to implement and will probably need to be done in steps so as not to create more havoc than the good that is intended.

By Tim Rutherford, director, Insurance and Retirement funds
at Ernst & Young