Retirement funds: Reform of the continent’s largest pension industry brings opportunity

Amidst a period of market-led consolidation, the continent’s largest pension industry is now facing the prospect of wholesale reform of South Africa’s social security system. While the fiscal implications remain unclear, more inclusive retirement coverage has emerged as a key government priority, alongside health insurance reform (see Health chapter). With a move towards a twin regulatory structure with stricter control of market practice and the prospects of further consolidation into larger, more cost-efficient funds, the sector is facing significant change.

Uneven Coverage

The Treasury estimates that 2.7m, mainly low-income, workers do not hold retirement coverage aside from social assistance and grants. The government wishes to contain its spending on emergency assistance as part of its drive towards fiscal consolidation in the medium term. Despite the high rate of coverage of workers earning above the tax threshold, the level of financial security remains far below the looming demand. A 2012 survey by Alexander Forbes, a leading independent African retirement fund, revealed that only 26% of retirement fund contributors in South Africa would reach pension age financially secure. Lack of coordination among pension fee structures and a fragmented market of various fund types have compounded the low level of pension savings through formal channels. “Funds face two challenges: the low savings rates, particularly among lower-income earners, and mistrust of fund administrators and state pension schemes,” Seren Thomas, head of information and communications technology, direct loans and marketing at NBC Holding, told OBG.

Extend & Reform

Faced with the challenges of inadequate savings, unequal coverage, low preservation and portability of retirement savings, and high fee structures, the Treasury has announced its intention to reform the country’s social security system in early 2012. “While the full social security reform package has yet to be announced, the government appears to be forging ahead with pension reform with the aim of extending pensions coverage, improving the portability of pension funds and introducing penalties for withdrawing savings early,” Joan Stott, a consultant at NEDLAC and former advisor to the Treasury, told OBG. Elias Masilela, CEO of Public Investment Corporation (PIC), agreed with this. “Pension fund reform has slowed in the recent past, presumably owing to the growing uncertainty in the global economy, whilst there may actually be an economic case for firmer execution – as we have observed among OECD countries at the height of the financial crisis,” Masilela told OBG.

By the start of 2013 four of the five planned discussion papers framing pension reform had been released. The aim is to establish a low-cost structure of pensions that can be adopted as a default for all of the country’s pension schemes. The planned National Social Security Fund (NSSF) would consist of a pay-as-you-go defined benefit fund, backed by a 25% reserve requirement.

Benefits would be defined according to lifetime earnings adjusted for inflation based on an accrual structure. This harmonisation of fund structures would provide for uniform taxation, allow for flexibility of contributions for those with uneven incomes and improve preservation of funds by extending as-yet-unclear incentives. This standardisation is expected to lower costs, while also creating tax incentives for retirement saving. The proposals are for funding income above R13,000 ($1585) by 10%, split between employer and employee, with an additional 2% to the Unemployment Insurance Fund.

Going Forward

The move towards a mandatory retirement savings system will have extensive implications for the existing pensions industry. Sector reform and consolidation will impact the institutional investor class as a whole. More cost-efficient savings intermediaries should extend coverage just as they build more diversified investment strategies.