Reforming the retirement funds industry is a welcome intervention that seeks to redress embedded inefficiencies and abnormalities by amputating entrenched privileges. This initiative will raise the ire of the present profiteers who, from a risk and reward perspective, disproportionately benefit from the industry.
A case in point is the way asset managers receive commissions.
Asset managers are employed by funds to provide expert advice on investments. Based on the advice, the assets of the fund are invested via the asset manager. Prior to the investment taking place, the asset manager’s commission is subtracted from the total asset value (that is to be invested) and the balance thereafter invested.
This is an abnormality – no worker is paid prior to performing a task? On what basis has payment been made? What measure is used to ascertain the validity of advice? Hence the emergence of inefficiencies when funds have been ill-advised. Poor investment performance is almost always blamed on the markets. Is it not the responsibility of the asset managers to analyse and predict market changes and engage in appropriate action? Failure to act timely negatively impacts on workers’ capital (retirement assets).With payments having been made up-front, what guarantees exist to ensure asset managers are accountable for the advice provided? Would a performance-linked payment structure not be a more efficient system?
The exorbitant cost of retirement savings is another example of abnormalities which probably led to the Minister of Finance highlighting the issue at the 2004 Nedlac Trustee Conference, where he also made specific reference to leakages.
High costs of retirement annuities Evidence suggests that the most expensive retirement saving vehicle is a retirement annuity (RA), with costs ranging from 13% to 60%. In the first few years, usually around two years, up to 60% of the monthly premium goes towards the costs of the RA. In addition there are other “˜hidden costs’ such as withdrawal costs, reduced contributions costs, etc which solely serve to benefit life-assurers. They adversely affect members, with some members having lost their entire savings.
Such costs border on criminal activity. They also demonstrate the unethical and immoral conduct of the life-assurers who have in recent months experienced a number of rulings against them by the Pension Fund Adjudicator.
The 400 complaints a month received by the latter serves as a barometer for the abnormalities and inefficiencies that prevail in the industry. The present high costs associated with retirement savings suggest a lack of competition among the service providers in the industry. It seems as though the service providers are setting prices, by acting like a cartel, turning retirement funds into price takers. To illustrate this point an analysis of a small employer (employing less than 20 workers) was done. It was found that a monthly fee of 11% of monthly contributions went to service the fund’s costs.
Government’s reform process welcomedTherefore Government’s retirement funds reform process presently underway, through the National Treasury is welcomed. History informs us that when economic abnormalities (oligopolies, etc) persist in sectors of our economy, the only way to introduce competition is by government itself becoming the competitor of the private sector.
This was successfully achieved in 2004 when government introduced the retail bonds. Prior to their introduction, the big four banks in the country paid around 4-6% per annum on fixed term deposits with marginal differences amongst the banks. However with the introduction of the retail bond which offered a much higher interest rate (9%), there was an almost immediate move by the banks to improve their interest rates, with some thereafter offering around 8%. The sole reason for this knee-jerk reaction was the migration of saving away from the banks to government bonds.
Hence National Treasury’s proposal to introduce the National Savings Fund (NSF) ought to distress life-assurers. Paradoxically life-assurers, proponents of the free market and competition, were quoted in the Business Day as stating that they believe there should not be “legislated encouragement of competition between the (private sector) funds and the national savings fund”.
On the contrary, the absence of competition in the private sector demands government intervention. Government intervention could take a number of forms. Regulation is the most obvious but this poses its own challenges. The Minister of Finance recently stated that for every loophole closed someone will find another to make money.
Nevertheless, government could introduce legislation to improve efficiencies within the industry by permitting consumers to vote with their feet, that is, retirement funds or members of RAs could change service providers, investment choices, etc without experiencing costs. This will force service providers to become more accountable and transparent. Introducing the NSF as a cost efficient, ‘no hidden costs’ fund, with good returns will most certainly result in a migration to it. This will hopefully lead life-assurers to improve their present business practices. It is time to remove the leeches from the retirement fund industry.
* Devan Pillay is in the Pension Funds and MNC Strategy unit at the National Labour and Economic Development Institution (NALEDI).