Issue: September/October 2007
Edutorials
Liberty Life

RETIREMENT REFORM: AN INSURERS VIEW

Ian Maron and Bevan Heslop of Liberty Life suggest that, in pursuit of the most desirable objectives, National Treasury still needs to address some particular South African characteristics for optimal success.

Building better lives, alleviating poverty and implementing a comprehensive social security system for the benefit of all South Africans are commendable and critical steps in nation building. Few would question these objectives. But since reform requires more than advocates, a great deal of work has yet to be done to create this holistic framework. Although international examples abound, the challenge is not to imitate them. Rather, it is to learn from them and adapt their best features in the construction of a solution for the very unique South African social, political and business landscape.

Earlier this year, National Treasury published its second discussion paper on Social Security and Retirement Reform. The main proposals may be summarised as follows:

  • The first tier is an old age grant, funded from general state revenues, with little or no means testing and essentially providing a safety net against poverty in old age;  
  • The second tier is a national social security fund, funded by compulsory contributions. All employed people will contribute a defined percentage of earnings, up to a given earnings threshold. The system will provide basic retirement, death, disability and unemployment benefits;
  • The third tier is an additional mandatory contribution, for earnings above the threshold. This may be directed to either an individual or private occupational scheme;
  • The fourth tier allows for additional voluntary savings with tax incentives capped at a certain earnings level;
  • The final tier consists of community and state non-cash support that enhances the well-being of the elderly.
These proposals are broad and represent a starting point for the definition of the detail underlying the model for the future. The issues facing reformers are not all uniquely South African and much can be learnt from international cases, although the combination of issues makes for a challenging task. Some major considerations include:
  • Our labour market which is characterised by high levels of unemployment, protracted periods between employment and irregular incomes;
  • The high number of deaths prior to retirement, largely as a result of HIV-AIDS, is contrasted against a rising longevity among retirees;
  • The high number of deaths prior to retirement means that income for young dependents is a critical concern;
  • The existence of an effective skill set as well as retirement and risk benefit administration and delivery infrastructure in the private sector, which is not matched in the public sector;
  • Affordability for individuals, employers and government currently and on a sustainable basis;
  • The challenge in introducing a savings culture into an environment where current personal savings levels are negative;
  • The task of balancing tax incentives on savings with the costs of administering a compulsory system; Determining an optimum balance between “Pay as you go” type savings and a fully funded benefit model.

In considering the current voluntary retirement savings framework, two key observations can be made:

  • There is a relatively high level of coverage among the employed and self-employed;
  • Other than those who exit funds early and don’t preserve their benefits, members generally enjoy a real return on investment.

Government’s perception of this model is that it is expensive by world standards and that it offers inadequate protection for individuals as demonstrated in instances of poor governance and conflicts of interest. Retirement saving is prone to “leakage’ when members fail to preserve their benefits and take them in cash. Tax incentives are viewed as inconsistent with social policy. In addition, the existing social security framework is seen as fragmented and not aligned with retirement provision.

The private sector holds the view that retirement fund administration is not profitable on its own and costs are exacerbated by low asset build-ups as a result of low income levels and high staff turnover. The latter factor also creates high administration activity rates. There is also a complex, inefficient and expensive compliance demand placed on providers. Group risk benefits offer cyclical profitability and the number of deaths pre-retirement must not be underestimated when designing a framework for the entire population.

Commercial considerations include the recognition of our developed capital markets, funded to a significant extent by pension fund assets which have historically enjoyed a real return on investment after costs. During the period of implementation of a national social security fund, these markets must not be destabilised.

The private retirement savings industry, while fragmented, involves a well developed and expert range of providers. These include asset managers, administrators, insurers and financial advisers. Reregulating and redefining this value chain must not be allowed to introduce inefficiencies and increased costs, which ultimately reduce the benefits to fund members.

A multi-pillar retirement system potentially increases the demand for advice, as does the introduction of voluntary membership of schemes in respect of the proposed earnings thresholds. The latter also brings additional administrative complexity and impedes the ability to provide non-underwritten risk benefits.

Forming a view on the private sector’s role in a reformed framework requires careful analysis of the South African situation, some aspects of which have been detailed in this article. A collaborative approach that engages all stakeholders throughout the process of research, model construction and debate is therefore critical. This would certainly be preferable to an approach that sees stakeholders arrive at the negotiating table to debate their vested position.

As an insurer we are encouraged by government’s recognition of the strengths in the current private system. We support the objectives of improving the depth and breadth of retirement savings and building a holistic framework for social security.