Is this how we solve the retirement crisis?

How is it possible that despite regulation, stellar long-term market returns, pressure on fees, education campaigns and product improvements, the majority of South Africans are still not in a position to maintain their standard of living in retirement?

It is a complex problem that has plagued the industry for decades.

According to the 2018 Sanlam Benchmark research, the average net contribution rate for standalone funds is 13.61% and 11.75% for umbrella funds. These are the total (employer and member) contributions after admin and risk charges were deducted.

While averages have their limitations, the numbers suggest that contributions are not the main issue.

At these rates, a 20-year-old who starts work today and who retires at age 65 could expect to replace between 70% and 80% of her final salary in retirement (the replacement ratio).

Yet, even though there is still room for contributions and costs to improve, for 90% of 20-year-olds, something goes “horribly long” along the way, says Viresh Maharaj, head of client solutions at Sanlam Employee Benefits.

As one radio listener recently summarised his experience: I was told that if I save 15% of my salary for 40 years, I would get 75% of my last salary in retirement. That has not been my experience at all….

At issue is a wide range of challenges, which include cashing out retirement benefits when changing jobs, inappropriate investment choices and asset allocation, high fees and investment products designed to benefit the investment house, rather than the member, to name but a few.

One of the issues highlighted by the research is the lack of fee transparency. Only 7% of consultants surveyed, said investment management fees were very transparent. More than three times as many said fees were not transparent at all.

Maharaj says almost all consultants now want the total expense ratio (TER) as well as the total investment charge (TIC) disclosed when the investment portfolio charges are quoted.

In a recent analysis, one asset manager claimed to offer an all-in fee of 50 basis points. The 0.5% fee quickly became a TER of 1.75% and a TIC of almost 2% once everything was disclosed.

“It is not just good enough that fees must fall – they must also be transparent.”

With regard to replacement ratios, two-thirds of standalone and about a quarter of umbrella fund participants indicated that they used a stated targeted pension to help align the decisions taken by the parties involved. The majority also had a default contribution rate in line with the stated targeted pension.

“Yet, the jury is still out on the use of replacement ratios, with a third of standalone funds and two out of five umbrella funds expressing significant scepticism over whether or not replacement ratios are an appropriate measure,” Maharaj says.

Respondents argue that it is difficult for ordinary members to understand and that the measure is very sensitive to changes in the assumptions.

Maharaj says the criticism is valid, yet in their view the replacement ratio is the most scalable practical measure to help influence individuals to take better decisions.

With regard to investments, 60% of consultants said they would recommend a life stage model as the default investment portfolio.

Maharaj says the principle of the life stage model is that you attempt to manage investment risks at the appropriate life stage in order to optimise salaries in retirement. It is not to get a big number the day before you retire.

“Our view is that the investment strategy pre-retirement should closely align or match your investment strategy post retirement in order to minimise what you call an asset liability mismatch risk.”

“If the cost of your annuity increases and the assets you have don’t increase to the same extent, stay the same or fall, then you’ve got a mismatch and that is what we as an industry are exposing many of our members to because we find that 50% of respondents either do not explicitly align their pre-[retirement] investment strategy with their annuity strategy or are unaware of whether it is aligned or not and that is not good enough either.”

What is also quite worrying is that 40% of standalone funds and 28% of umbrella participants invest or transition into 100% cash, building up to retirement, he adds.

“Cash does not align with any of the annuity strategies available.”

Default regulations

In an effort to address the problems members experience on their way to retirement, National Treasury published the final default regulations for retirement funds in 2017. Defaults are automatic choices made on behalf of members who do not exercise their choices in a given situation.

As a result of the regulations, funds have to implement a default investment strategy, a default preservation strategy and a trustee-endorsed annuity strategy by March 1 2019 and make retirement benefits counselling available to members.

Although 55% of trustees, principle officers and consultants who participated in a more recent survey, were positive about the impact that regulations would have, David Gluckman, head of special projects, says there is some scepticism in the industry about whether the regulations will achieve the desired results.

While consultants saw the impact of retirement benefits counselling – particularly where members don’t have access to financial advice or where they have to make decisions around preserving their benefits – two-thirds believed that their clients would choose to do the bare minimum to comply with the regulations.

“I think that will be sad for the industry if that is all we can achieve.”

Gluckman says it is clear that funds will not only have to implement the defaults but will also have to start measuring their effectiveness in future. It would not reflect well on trustees if they put defaults in place and only 0.5% of members make use of it.

“We’ve got to not forget – in trying to implement this legislation – this is not a tick-box compliance exercise. We’ve got to try put in place something that actually improves retirement outcomes for members.”

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