Rotten retirement ranking shakes SA financial planners to the core

Financial advisers who have been struggling to explain the country’s lacklustre retirement outcomes may have found the perfect scapegoat in the latest Mercer CFA Institute Global Pension Index (GPI), in which South Africa places 27^th out of 39 countries for its retirement income system. The 2020 GPI and its accompanying report provided the underpin for the keynote address to the inaugural Allan Gray Retirement Benefits Conference.  David Knox, the lead author of the report, said that retirement reforms remained necessary to address the low trust that savers had in retirement systems. 

The basics of retirement income systems

Mercer uses  the World Bank’s Five Pillar Framework as starting point for its retirement system comparison, eventually ranking countries based on objective statistics sourced from the Organisation for Economic Cooperation and Development, United Nations and World Bank. Additional information and insights are provided by Mercer’s in-country resources and partners. 

It has been some time since we reflected on the theoretical design of retirement solutions, so we thought it appropriate to share some of the basics. Pillar 0 and Pillar 1 are in the public domain. The bottom pillar is described as a public pension provided by government and either paid to all citizens or to those citizens who satisfy a means test. South Africa’s State old-age pension, a means-tested basic amount paid to all citizens over 60, is an example. Pillar 1 is a contributory social system from which government pays contributors a pension at retirement. Example of Pillar 1 systems include the super annuation solution operated in Australia or the opt-out workplace pension scheme currently available in the UK. 

Pillar 2 and 3, which lie squarely in the private sector space, will be familiar to South African retirement savers. Pillar 2 is a compulsory or mandatory system that must be fully-funded from contributions and investment returns of its beneficiaries, and can exist as either a defined benefit (DB) or defined contribution (DC) arrangement. The South African pension fund environment is dominated by Pillar 2 arrangements, with the bulk of these being in the DC space. The third pillar is described as voluntary savings that exist outside of Pillars 0-2. And the final pillar, Pillar 4, recognises retirement funding that takes place outside the formal pension funding arena by way of financial support from families or other organisations or sources. 

The three non-negotiables for success

The overall GPI rating is calculated by combining three component scores, namely: adequacy, sustainability and integrity, which are weighted 40%, 35% and 25% respectively. These, according to Dr Knox, are the three non-negotiable components that ensure a retirement income systems’ success. Mercer assesses approximately 50 indicators in determining scores for each of the components, per country. Over the next few paragraphs, we describe and unpack each of these components from a South African context. 

The adequacy score is based on the minimum pension available in a country; the level of pension that low, mid and high earners achieve after working for 20 years; the coverage of a country’s occupational pension system; and the level of household savings in a country, among other factors.  The Netherlands, Denmark and Germany occupied the top three slots in the 2020 GPI on the adequacy measure, with South Africa sitting at a rather lacklustre 35^th. Our shortcomings included an abysmal level of minimum pension for the poor, an inability to keep retirement contributions invested in the retirement system and rather disappointing net replacement values. 

Our Pillar 0 support comes in at a low 17% of minimum wage, way below the optimal level of between 25-30%. And our failure to preserve our retirement capital when changing jobs is the stuff of legends. “South Africa must focus on preservation to make sure that all contributions towards retirement are saved,” said Dr Knox. “There is too much leakage from workers’ retirement pots during their working years”. 

Finding enough cash to pay pensions

The sustainability of a retirement income system hinges on whether or not the level and penetration of a country’s existing pension liabilities can be maintained over time. It is based on factors such as the proportion of working class communities covered by the system, the proportion of accumulated retirement fund assets as a percentage of GDP and demographics, such as population age. Retirement age has become an important influencer in the sustainability debate too. “If you work a bit longer, not only can you save more but you shorten your years in retirement,” said Dr Knox. The Netherlands, Denmark and Australia featured in the top three on the sustainability front, with South Africa at a more palatable 22^nd out of 39 countries. According to the 2020 GPI, only 23% of South Africa’s working age population belongs to a formal retirement fund, with this fact made worse by there not being mandatory contributions to retirement savings of any kind. 

Finally, integrity is determined by the governance and regulation of the system. Mercer considers the requirements put on fiduciaries and trustees as well as the regulatory protections built in for members of the various retirement funding instrument, among other factors. They also focus on the communication that is provided to members and the impact of costs on retirement outcomes. Finland, Norway and the Netherlands came out tops for integrity, with South Africa mid pack. 

Aiming at the correct target

South Africa’s performance on the overall 2020 GPI, at 27^th out of 39 countries, is hardly surprising given our well-publicised, poor retirement savings outcomes. We attend countless employee benefits and retirement funding conferences each year… And at each of them, the industry trots out the oft-repeated claim that only six-in-100 savers achieve a comfortable retirement. The number is probably inaccurate; but it is indicative of a system that is failing. How can South Africa improve its retirement income system and rank alongside A-rated countries such as Denmark and the Netherlands? 

Many of the answers have been provided in the text. Another, not yet discussed, is to achieve better economic growth. The index reveals a strong correlation between per capita GDP and the success of a retirement income system. It would also help if stakeholders in the local retirement industry could give more thought to the current system design. “You need to have an income focus,” concluded Dr Knox. “An ideal retirement income system cannot just focus on the provision of lump sums; it must provide an income in retirement”. He suggested better coverage; an increase in the state pension age; and preservation as three quick fixes. 

Writer’s thoughts:
The best advice from Dr Knox’s presentation was for South African savers, and their financial advisers, to focus on income in retirement rather than the accumulation of a lump sum at retirement. This make sense given how many savers in formal retirement funds blow through as much as a third of their nest-egg when they reach retirement. Do you agree that a focus on income in retirement, rather than capital accumulation, would yield better retirement outcomes? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts [email protected].

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