Retirement reform

Part 2 of an important policy and regulatory update by Pieter Koekemoer

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A private retirement system depends on a contract between a country’s government and its citizens. The essence of the deal is that the state is prepared to give you tax breaks if you save enough to be less of a burden on society when you become too old to work. Because of the tax breaks, they also tell you how you should invest as well as when and how you can get access to your money.

Income smoothing between your working and retired years literally covers a whole lifetime. The retirement system is also heavily intermediated, often not allowing individuals any agency in deciding how to manage their own affairs. All these factors mean this will always be the most intensely regulated component of the savings industry.

The current retirement reform process started in 2004 and is nearly complete. The original objectives were to increase coverage (less than 30% of adults are in the system), increase preservation (interrupting compounding, as most people do when presented with the opportunity, is the biggest pension killer of all) and ensuring fund members receive value for money (cue a big debate about optimising for the lowest system cost or the highest retirement income; this is also a big driver of the dramatic consolidation in the retirement fund industry).

The most relevant retirement reform issues of the day are the approaching deadline for all funds to comply with new default regulations (March 2019), and the ongoing debate about the phasing out of provident funds (or introducing compulsory annuitisation in the jargon).

The big idea behind the default regulations is to make use of a combination of giving fund trustees additional duties and nudging fund members to do the right thing through better system design. It tasks trustees with:

  • ensuring that default investment options are simple, appropriate and offer value for money;
  • offering their resigning members preservation options, and making it easier for them to move their assets to their next employer’s retirement fund;
  • recommending a retirement income plan for members; and
  • ensuring members receive good information before they get access to their benefits.

While it is too early to know exactly how the new rules will change behaviour, it is very clear that it will impact the market dynamics in the R500bn living annuity market and the R100bn preservation fund market. The presence of trustee-endorsed alternatives, better information flow and an occupational retirement system designed to preserve retirement capital when changing jobs mean that there will be less demand for individual advice given the presence of alternative supply. However, retirement income is the most complex and individualised area of financial planning, and the early indications are that many fund trustees will adopt a conservative and minimalist approach in setting defaults, leaving significant scope for continued value-add by financial advisers.

The other outstanding decision is whether all retiring fund members with retirement capital above a certain threshold will over time be required to use two-thirds of their fund value at retirement to buy an ongoing pension. This is technically still government policy, but the outcome will be dictated by political rather than technical imperatives. This is an issue that should be on all advisors’ National Budget Day watch-list as this change, if implemented, will have implications for all clients with assets in provident funds.

National Health Insurance (NHI) and Social Security Fund (SSF)

Government is also considering significant changes to our social security system. The current approach is to provide a variety of benefits, operating within separate legal frameworks that have emerged at different points in history, evolved at different rates and are in different states of operational and financial health. Government’s vision is to create a more cohesive system with the ability to provide better healthcare, risk protection and retirement benefits. The ambition of aiming to achieve a quality social safety net akin to the welfare systems in Western Europe is laudable. A society that cares about its weaker members is happier, more stable and fairer than one that does not. These values are enshrined in our Constitution. Unfortunately, good intentions are not enough. Grand plans often suffer from the defect of not being costed, nor having much thought applied to how they will be funded.

The higher-priority item now is the attempt to implement the NHI in South Africa. Its vision is to eventually become the single-payer for a range of prescribed healthcare benefits, provided by both public and private hospitals and medical professionals, that should be available to all, free at the point of service. This has the potential to displace at least some activities currently funded by private medical schemes if all citizens are required to contribute to the NHI (national health systems are normally funded through payroll taxes paid in addition to income taxes).

It is important to note that there is still significant uncertainty about where this process is headed. While a framework bill that, if passed, will enable the NHI was published in 2018, so much of the detail is still outstanding that it is very unclear what, if anything, will eventually be implemented. Tellingly, the NHI has not been formally costed (some private-sector estimates put the cost of what is on the wish-list at around R500bn or more than 40% of the total tax take in 2017/18). There is no fiscal headroom to extend either government spend or the tax load any further without doing significant damage to an already fragile economy. And while it may superficially look like you can just redirect current medical aid assets to achieve different objectives, this strategy will not work well. The 8.9-million members of medical aid schemes will revolt against a fundamental policy change that will impair the quality of their care. And it is just not possible to provide similar levels of care for six times the amount of people on the same budget currently being spent for the benefit of medical aid members. Something will have to give. This has the potential to become a significant political issue, like the union revolt that led to the delay in the implementation of compulsory annuitisation mentioned above. Oh, remember that R500bn cost estimate? The total medical aid contribution credit granted in the last four tax years was around R20bn annually, while the public healthcare budget is around R200bn.

Treat anyone telling you with high conviction how the healthcare funding landscape will unfold with some scepticism.

Given the massive funding and implementation challenges in healthcare and the operational challenges impacting the payment of social grants, proposed social security reforms have moved onto the back-burner. It does remain official government policy though.

The plan here is to expand the Unemployment Insurance Fund (UIF) and the state old-age grant into a more comprehensive set of unemployment, death, disability and retirement income benefits. Well-designed benefits will provide an improved social safety net, but affordability is unsurprisingly a significant challenge. South Africa has a low labour force participation rate, making it very difficult to fund equitable benefits across both the formally employed, informally economically active and unemployed. If this is implemented, it is likely that the system will be funded through an increased compulsory contribution by all salary and wage earners. Currently the UIF contribution limit is set at 2% of the first roughly R180 000 of earnings. A future social security contribution may be set at up to 12% of this amount. Given that this will displace existing private savings into defined contribution retirement funds, the implementation barriers are high: retirement fund members will require much convincing that it is worthwhile moving their contributions from a proven employer or union fund into an untested government scheme.

Fit and proper: training and CPD requirements

All financial service providers are subject to fit and proper requirements. This partly deals with ensuring firms have appropriate business infrastructure such as adequate capital, control and governance systems, but also with ensuring that individuals employed by these firms have the requisite skill and character to be allowed to handle other people’s money. These regulations have recently been updated with additional training and knowledge requirements.

All financial planners have been required to pass regulatory examinations since the early 2000s. These exams deal with the rules of the game. The new requirements include a second set of formal learning requirements, dealing with class-of-business knowledge (eg investments or retirement benefits) as well as product-specific knowledge. The implementation approach here is different to the first round of exams. Where all existing advisors were required to pass the original exams, only new industry entrants are required to pass class-of-business and product-specific training. While class-of-business training requires structured tuition and examination, the rules for product-specific training allows for self-guided learning and online examination. Many product suppliers are putting in place mechanisms to simplify this new compliance burden. Several investment product providers are working with the ASISA Academy and other partners to find ways to enhance the quality of training available and to provide a variety of centralised training platforms for the benefit of independent advisers.

FPI members will be familiar with continuous professional education requirements. This has now been extended to all licensed individuals, with specific regulated CPD rules set. The most significant implication of this is that there is now more emphasis placed on evidencing attendance at events or completion of online. Think more cumbersome signing in and out requirements at industry events and conferences, and the need to complete a quick test after reading or watching something online. Advisors should also ensure that they keep proper competency registers for compliance purposes.

Conclusion

The world of policy and regulation can seem complicated, cumbersome and sometimes even scary. But the principles are simple. When the focus is firmly on agreeing on clearly defined objectives, aiming to find the right balance between rules and freedom through a robust and fact-based discussion where the social partners combine ideas and perspectives, it becomes much more likely that reasonable outcomes will be reached. This also requires an honest recognition that there are rarely easy wins; that you are trading off costs, benefits, winners and losers; that outcomes are always uncertain and often unintended. It is therefore better to proceed cautiously, make sure you have good data and evaluate outcomes continuously. Above all, it is important to remember that very few things have life-and-death consequences. Many policy intentions do not make it off the drawing board, and the final product in most cases ends up looking materially different after consultation. Taking time to understand the facts and evaluate the implications always leads to better decisions than being overwhelmed by an urge to take immediate action. 

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