Retirement reform costs - the expensive elephant in the room?

Who will end up paying the costs?

Retirement fund and related reform in South Africa has been the subject of serious debate for many years. As complex as it is, few question the social imperatives that drive the need for reform. This concern has resulted in various bits of incremental legislation over a number of years, with the industry largely in “wait and see” mode. Recent months have seen a sharp increase in legislative and regulatory reform initiatives, forcing a new concentration of minds.

Until now, most of the industry costs associated with making the necessary benefit administration, investment administration, communication and marketing changes have been borne by funds, insurers, administrators and asset managers. This was all well and good – until now. Looking at all the adaptations needed, now and in the near future, the question has to be posed “how will this all be funded?”

Clearly, part of the ongoing debate on reform has been the need to drastically reduce the cost of retirement funding, as this impacts directly on the amount available for a member to retire on (the so-called Net Replacement Ratio). But how feasible will this be in practice?

The most recent draft of legislative changes promises to be a real game changer, from both the perspective of needed reform and the impact on costs to the industry.

We note here some of the changes that the industry has been asked to respond to:

1. The Financial Services Laws General Amendment Act No 45 of 2013 (effective from 28 February 2014), introducing some 15 changes to the Pension Funds Act (PFA), and five other Acts administered by the FSB
2. The Taxation Laws Amendment Act No 31 of 2013, with a dramatic change to the tax treatment of retirement fund contributions and benefits (effective from 1 March 2015)
3. Regulation 28 (with ESG replacing SRI requirements) and its reporting regime
4. The Treating Customers Fairly Bill (TCF)
5. The Protection of Personal Information Act (PoPI)
6. The Promotion of Administrative Justice Act (PAJA)
7. The Code for Responsible Investment in South Africa (CRISA)

We will not address the need for such reforms here, as these have already been comprehensively aired in many different fora, and few will contest them. As usual, the devil is in the detail, and we do want to address the real impact on costs, directly or indirectly – as well as the effect these might have on retirement benefits for members.

Costs will be increased by, inter alia, the following factors:

1. The need to investigate and amend (often complex) administration systems and procedures
2. The need to train and retrain staff in the many changes
3. The need to communicate the changes to participating employers, members and beneficiaries
4. The need to fund personal advice to members. Fund-sponsored advice has to be paid for in some way
5. Increased workloads on trustees and Principal Officers (at least for the next two years) as they make the necessary changes and respond to member queries and concerns
6. Increased workloads on investment administrators and asset managers
7. The need for more (expensive) legal and actuarial advice
8. The need for more professional and independent trustees (at appropriate fees)
9. Increased compliance costs all round, including audit fees (already expensive)
10. Increased need for trustee training (when elected / nominated and ongoing)
11. The many costs associated with administrator and fund amalgamations

Each fund will have to proactively determine how increased costs impact on them and their members. Even where they can negotiate for service providers to absorb some of the costs, these are likely to filter through as increased fees over time.

To offset these increased costs, pro-reform commentators have offered the following sources of potential cost savings arising from reform:

1. Larger funds (100 000 members or more) – assuming there are actual economies of scale, but are these adequately proven and quantified?
2. Vastly simplified (and easier to administer) benefits
3. Default options on withdrawal and retirement
4. Preservation of retirement accumulations to retirement
5. Compulsory auto-enrolment of members
6. Negotiated mass annuity products (leading to better pensions)
7. Fewer paid trustees, as funds amalgamate

There are other potential risks to consider, for example:

1. Loss of mass individualisation and choice
2. Loss of a personal service touch (funds too large – members just a number)
3. The use of inappropriate defaults and life stage models, with all the associated opportunity costs
4. Concentration of investment choices by very large funds, leading to lack of competition and a threat to smaller asset managers
5. The over-use of unproven passive investment models: how well do these offerings really track and how passive are they in practice? What are the true net costs?
6. The ongoing constraints of Regulation 28 of the PFA: the costs of compliance have already been onerous and there is a long-term opportunity cost in limiting equity exposure
7. Lack of involvement of sufficient member trustees (due to more onerous qualification requirements and umbrella arrangements)
8. Possible fixed (and uneconomic) fee levels determined by the Regulator
9. The loss of jobs in the industry as funds and administrators merge
10. The damage to the principle of stimulating small businesses (many small administrators and asset managers could go out of business and active asset managers will see pressure on their fees and viability as passive investment models get promoted)
11. The barriers to industry entry will be too high for most small players, including the sheer volume and cost of staff now required to interpret legislation

Regarding point 8, one is reminded of the economically ruinous platinum mine wage negotiation where the CCMA admitted they made (unsuccessful) wage recommendations - without any reference to the financial situation of the companies concerned.

The real impact of all these changes on costs to the industry could well be the (very expensive) elephant in the room that nobody wishes to openly acknowledge. It is time for a serious attempt by the Registrar and the industry to quantify the real net cost impact of reforms and how this will be funded. Industry bodies such as ASISA, Batseta and the IRF can all play a role. It can be said with confidence that trustees and principal officers will need a great deal of objective assistance to identify and quantify the cost drivers unique to their funds and to determine how these can be offset or funded.

Our concern is that the reform initiatives could lead to even higher costs for members, and/or serious structural disruption in the retirement funds industry? A long-term detrimental impact on the retirement benefits of members will have defeated the laudable objectives of all the retirement fund reforms.

The 2014 Sanlam Benchmark Survey indicates that a Net Replacement Ratio of around 60% is required for mere survival and around 75% to maintain current lifestyles. Average Net Replacement Ratios are currently around a woeful 40% of final remuneration. Nothing can be allowed to push this in the wrong direction. We can’t wait another twenty years to find out whether this has happened.

Will this elephant crush both members and industry players before we have acknowledged the problem and found satisfactory answers?