Gordhan gets tough on pensions

Finance Minister Pravin Gordhan is trying to ensure that citizens can retire comfortably. (David Harrison, M&G)

Finance Minister Pravin Gordhan is trying to ensure that citizens can retire comfortably. (David Harrison, M&G)

The treasury is taking a tough stance on the retirement industry, which it believes has costly fees and is not doing enough to assist people with saving.

This week it was announced that Finance Minister Pravin Gordhan would meet soon with life insurance industry leaders to discuss costs. This would contribute to a retirement fund reform document that would be released in the next few weeks and draft legislation by the end of the year.

Gordhan made the announcement on Wednesday during his 2013 budget vote. David McCarthy, a retirement policy specialist at the treasury, said South Africa has very high cost structures for retirement funds relative to the international benchmarks.

"South Africa ranks very poorly when compared with other countries," he said.
A survey by the treasury looking at reduction in yield – a measure of how much charges reduce the annual rate of return on retirement annuities invested – shows that South Africa's figure is close to 2.5%, which, over a 40-year period, can reduce the reduction in yield by half. This is compared with 1% in an average United Kingdom personal pension plan and 1.25% in an Australian personal pension plan.

"South African retirement funds perform poorly when their reductions in yield are compared internationally, although international comparisons are difficult because retirement institutions around the world differ in how they function, how mature they are, or what their underlying investments are," he said.

"In Sweden, for instance, their system is centrally administered in all respects except asset management, which is performed by private-sector providers. In Chile, all functions are centralised."

One retirement expert warned that a sudden reduction in retirement fees could have serious financial repercussions for the sector.

David Gluckman, head of Sanlam employee benefits future position and research, said: "A sudden reduction in retirement fees will be more than the financial services industry could withstand in the short term."

The retirement and insurance giant Sanlam believes a sudden reduction in fees relating to retirement funding could see an average 14.3% capital loss in JSE-listed financial companies.

This would also have an effect on the retirement funds' members, as 11% of South Africa's retirement assets is invested in the financial services sector, which is said to have a market capitalisation of R1-trillion. The retirement sector currently has about R2.7-trillion assets under management.

Gluckman, who was generally positive about the treasury's overall reform proposals for the sector, said there would need to be cost-cutting in the financial services sector before fee cuts could be introduced to mitigate the losses. He also felt that the sector had already seen a reduction in the number of funds registered. This, he believed, was a result of increasing competition and changes in legislation due to the move away from defined benefit funds.

"In 2005 there were 13 000 registered retirement funds and now there are only between 2 000 and 3 000," said Gluckman. "The market is sensitive to charges and there is a strong chance that competition will drive costs lower over time. I don't want to be alarmist, but a large cut in fees will have negative repercussions," he said, adding that government had indicated that it was sensitive to the sector remaining viable.

Survey findings
The 2013 Sanlam Benchmark Survey found that retirement fund administrators and investment managers rated charges among their top considerations when conducting business for their funds.

Gluckman did admit that transparency in cost structures would need to be introduced to see a significant change in the costs. "The products are complicated, but the industry would need to establish a method to standardise products so that some kind of comparison can be made."

He said this was tricky, which could be why the Association for Savings and Investments South Africa has been grappling for some time with a single cost-declaration structure.

McCarthy said at an association conference that the more complicated the product, the higher its costs were likely to be and the more likely it was that it would be sold through an intermediary.

Also, many retirement products had multiple layers of fees, such as administration and investment management charges, as well as brokerage, adviser and performance fees, making comparisons across product channels very difficult.

The cost of investment management, in particular, has been found to be high. McCarthy said that South Africa was not unique in reviewing its pension fund structure.

Changes to UK's regulation of defined contribution pension plans
"The United Kingdom has made substantial changes to its regulation of defined contribution pension plans, partly to reduce costs, and are considering more changes," he said. "And Australia has just completed a review aimed at reducing the cost and complexity of their retirement system. The costs of [defined contribution] plans in the United States have also been a concern for a long time, and disclosure requirements there were recently strengthened in a bid to reduce costs."

In reviewing the retirement landscape, the government is hoping to encourage saving and to offer less complicated and more cost-effective ways for employees to save for retirement in a way that enables them to maintain their preretirement standard of living. Research by the treasury revealed some serious flaws in the current retirement system.

Apart from low disclosure levels and the shifting of fees from upfront charges, which consumers are more sensitive to, to recurring charges, which appear smaller but have a much greater effect in the long run, the system has been found to have little protection for employees at the point of retirement.

This, treasury said, left consumers at the mercy of the "retail market" where they were exposed to poor advice or high fees that could see them outliving their capital or seeing their retirement income being eroded by inflation. This was not an unreasonable concern. The Sanlam Benchmark Survey found that 64% of pensioners interviewed had to cut back on expenses after they retired and 31% had to carry on working after 65 to survive.

As Gordhan said this week: "A central proposal is that pension funds should transfer members' balances into a preservation fund when they change employer, as the default option, and should also identify suitable retirement annuity products for the years beyond retirement."

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