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Weaving a national safety net

South Africa has one of the most developed retirement fund industries in the world, and perhaps the best established in the developing world.
There are 10m members of pension funds. More than two thirds of employees belong to occupational schemes despite it not being compulsory for companies to offer pension funds or for people to preserve their retirement benefits. Assets in retirement funds total ZAR1.5trn (€156bn), equivalent to 63% of GDP.

One of the reasons that the private sector has been so successful is the lack of a national safety net. There is a non-contributory state old age pension that gives ZAR870 a month to 2m people aged over 65 on a means-tested basis. This is enough to live on in some rural areas, but most people in the developed ‘first economy' are obliged to save through occupational or personal schemes.

There is no second pillar mandatory national scheme yet. Instead, there are 13,500 pension funds, although 80% of these have fewer than 100 members and the 88 largest private sector funds account for 73% of member and pensioners.

A third of the assets are accounted for by the Government Employees Pension Fund (GEPF), which includes teachers. It is not quite as dominant as the government funds in neighbouring Namibia and Botswana, which account for more than 70% of pension fund assets in their countries.

Historically, life insurers dominate the pension fund sector, carrying out administration, asset management and group life on a one-stop basis. Underwritten funds, in which the assets are held on the balance sheet of the life companies, still account for 20% of the industry's assets, but more than 40% are in self-administered funds, with the balance in the GEPF and some other state funds.

The South African employee benefits market contains a number of peculiarities. One is the dominance of DC funds. DB was always unpopular in South Africa as on changing jobs some people were given very low payouts, sometimes as little as their own contributions plus 5%, even when transferring into another fund.

The first main category of DC funds was the union-sponsored funds that emerged in the early 1980s. Many of the black union members had not previously belonged to pension funds or had been put into inferior black funds with very poor benefits.
The unions did not want to set up their funds on a traditional DB basis as they wanted their members to be treated equitably, whether they stayed on to retirement or left early. Almost all the union funds were structured as provident funds, which provided a lump sum on retirement.

Jan Mahlangu, pensions spokesman at the Congress of South African Trade Unions (Cosatu), says that there was so little trust that pensions would be paid - relatively few black workers had their own bank accounts in those days - that workers preferred to receive the benefits up front.

More recently, however, there has been a recognition that it is more responsible for people to receive a monthly pension after retirement and Cosatu supports this move.

 

he next wave towards DC came in the mid-1990s when consultancies led by Alexander Forbes encouraged companies to go further than simply closing their DB schemes to new members, as occurred in the UK. Pension funds also gave members the opportunity to move from a DB scheme to a DC scheme, offering as a sweetener to enhance the value of the accumulated benefits by anything from 25% to 40%.
They were able to pay this out of accumulated surpluses both from money which was not paid out to the early leavers from the funds and because the investment performance had been substantially ahead of actuarial calculations.

"There was far less resistance to the move to DC than in the UK as it took place during a bull market," says Graeme Kerrigan, CEO of Alexander Forbes from 1998 to 2002. "People doing the sums on a back-tested basis saw that they were actually better off in DC thanks to the strong markets."

But despite the sweetener some people chose not to convert to DC and most funds maintain a small DB membership.

The GEPF is one of the few DB funds left in South Africa but almost all the private sector pension funds only offer DC to new employees, as do some large state schemes, like that of giant transport utility Transnet.

There was some unhappiness in 2002 and 2003 when markets went south, but few are complaining about the move after four exceptionally strong years in which the Johannesburg Stock Exchange rose more than 200%. The average balanced fund gave a 31.5% return in the year to end-2006 and an annualised 30.3% over the previous three years.

 

nother South African peculiarity is that because of the isolation during the years of apartheid and sanctions, service providers, whether in asset management, administration or consulting, are almost all home grown.
Even when it comes to offering non-South African assets to pension funds, the main suppliers are the international offices of the local shops such as Old Mutual, Investec, Coronation and Allan Gray, which has a sister company operating as Orbis.

Only the two large US multi-managers, Russell and SEI, have persevered and established a respectable foothold in the South African market. Firms such as Alliance Capital, Franklin and Flemings failed in their attempts to set up domestic asset management businesses in South Africa.

South Africa has a well-developed financial services sector and the local financial brands have a loyal following.
Prudential Portfolio Managers, owned by Prudential UK., is the only internationally owned asset manager in the top 11 firms, but it plays down its international origins and is staffed entirely by South Africans.

South Africa has been a net exporter and acquirer in the institutional market. Alexander Forbes acquired the UK actuarial firm Lane, Clark & Peacock and set up a subsidiary of its Investment Solutions multi-
manager.

There are few international firms in consulting and administration. Aon Consulting is the only multinational active in this area. Barclays ultimately controls Absa Consultants & Actuaries, part of the Absa banking group, but the UK bank inherited it through acquisition and it is non-core.

London insurance broker Sedgwicks used to own the second largest consultancy, Ginsburg, Malan & Carsons, but on Sedgwicks' acquisition by Marsh in 1998 it decided that South Africa was too small, remote and risky. Ginsburg was then sold to Alexander Forbes, already the number one firm, which now has what some consider an unhealthily large share of the retirement fund consulting and administration business with 70% of the JSE top 100 companies its clients.

There was a scandal last year around the issue of bulking. Forbes and some of its competitors negotiated with banks for attractive interest rates on their pension fund clients' current accounts but breached their fiduciary duties by not disclosing they were taking a cut. Forbes had to pay back ZAR680m to clients.

 

he private sector, which is on the back foot following a 2005 scandal around the high termination charges for personal pensions, faces a threat from the new national social security scheme proposal. This foresees the first ZAR750 of a monthly pension fund contribution going into a new compulsory national fund to be launched in 2010, the year South Africa hosts the football World Cup.
Even those who are already members of occupational funds would be obliged to contribute to the fund under the current proposals. As 15% of salary is tax deductible for pension contributions it means that about half the people who are now members of retirement funds would in future
contribute all their pension savings into the national fund. Union funds could lose more than 90% of their membership.

The private sector is lobbying for an opt-out clause for members of retirement funds in good standing, but the government is not sympathetic. It believes that because of the huge scale of the new fund, unit administration costs would be much lower than anything the private sector could offer.
It is concerned that even though contribution rates are reasonable, savings have been eroded by increased administration charges and much higher death and disability payments, particularly from those funds with a high incidence of Aids victims among their membership, such as those serving the mining industry.

A recent study, the Alexander Forbes Member Watch, found more than half of those who retired from
a pension fund received a pension of less than 28% of their pre-retirement income. The government hopes to change this by making membership of the national fund compulsory and by making it compulsory to preserve pensions when changing jobs. It would be good news for the pensions industry if this increases the available pot.

The sector also hopes to receive lucrative investment and administration contracts for the national fund, so opposition has been muted so far. The debate will start in earnest when the details of the national plan emerge.

Stephen Cranston is associate editor of the ‘Financial Mail' in Johannesburg

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