Follow-up on Retirement Funds hearings

Meeting report

Submission by National Treasury
Submission by Bruce Cameron (text)
Submission by Bruce Cameron (Powerpoint)
Submission by Association of Collective Investments
Submission by C.D. Howe Institute study

SUMMARY
The Committee received inputs from the National Treasury, Personal Finance and the Association of Collective Investments on the costs associated with retirement funds in South Africa. National Treasury was currently compiling a policy document on this issue. Some of the main points raised included that leakage remained a major problem; that the regulatory environment would have to change; that a National Savings Fund may be established; that tougher legislation may be required; that commission structures and levels would have to be reviewed and that the lower income market would have to be accommodated in the life insurance industry.

Members were mostly concerned with compulsory life insurance; defined benefit vs defined contribution type funds; fund migration; fund and lump sum taxation; commissions and the competency levels of sales agents in the life insurance industry.

MINUTES
The Chairperson explained that the meeting was a follow-up to the hearings held on 10 Nov 2004 Retirement Industry and Life Assurance costs: hearing. The original meeting had arisen as a result of an article by Mr Rob Rusconi concerning the costs of retirement funds. Mr Rusconi had pointed out that the cost of these funds were higher than those found internationally. The low-income market was particularly loaded. In response, National Treasury was in the process of preparing a policy document to address the concerns raised. The present meeting was therefore being held to look at the policy document. The National Treasury and the Financial Services Board would make presentations to which the Committee, journalist Mr Bruce Cameron and the Association of Collective Investments would respond.

National Treasury briefing
Mr E Masilela, Chief Director: Macroeconomic Policy, addressed the Committee. He said the concern was not just a legislative problem, but also a socio-economic one. It was not Treasury’s aim to meet its objectives only in one lifetime but rather in two to three lifetimes. It was important that those individuals made adequate retirement fund provision. It was therefore important that a comprehensive exercise be done and not piecemeal ones. He would not be addressing the taxation of retirement funds as this could be elevated and all the other issues forgotten. The structure of the retirement fund institutions was according to World Bank regulations. The question however was whether it was optimal. Treasury felt comfortable with it at the moment but wanted to give it more thought. The coverage could only be considered optimal when it was 100%. In comparison to other countries, the present coverage was not good as other countries were more robust.

Referring to leakage, he said that this was the area where there was the biggest concern. There were three causes of leakage, namely the costs of management, inflation and taxation. Treasury was of the view that all three areas had to receive equal attention. It was Treasury’s opinion that a lower inflation environment was better for returns. It was therefore advisable that South Africa tried to keep the inflation rate at stable levels. National Treasury had certain recommendations. These recommendations assumed that the regulatory environment would change and that the literacy level of beneficiaries would increase. There were huge challenges however that had to be considered and it was important that partnerships be formed. The recommendations included the establishment of a National Savings Fund, enforcing employers to have pension funds for employees, increasing disclosure and explicit regulation.

The issue around lump sums was also an ongoing debate. Life expectancy affected the type of lump sum. If life expectancy increased, a smaller lump sum was favourable. It was important to find a balance. Treasury did not feel that benefits should be borrowed for housing. Treasury felt that instead of borrowing against savings to buy a house, it should rather be used as a guarantee. On the issue of regulation he said that education was important. It was important that trustees of funds be educated but not just trustees but everyone involved. In order for trustees to be more effective, it might be necessary to consider professional trustees. Professional trustees should not be elected but only be brought in for their technical capacity. Many boards were not operating optimally because they did not have the necessary capacity. He stressed that the reform envisaged would not change the entire landscape that they operated in. It was however there to strengthen what was already in place. Only certain aspects of current legislation would change as it was felt that there was not much wrong with the legislation. Regulations however had to change. This would change significantly. This would probably not please everyone. The goal was not to maximise profits but to balance the benefits in the industry. The goal was a long term one. Following the present meeting, Treasury would be going back to NEDLAC and then a roadshow would be embarked upon in which consultations would be done. The discussion document would then be recirculated before the draft legislation would be done.

Discussion
Ms B Hogan (ANC) asked for more detail about the National Savings Fund. Since the move in the industry had been towards defined contribution, she asked if this was a preferred environment. She asked if a single national regulator would be running parallel to the process under discussion.

Mr K Durr (ACDP) asked what the timeframes were for the new act to be in place. He asked how many of the changes could be achieved through moral persuasion, through regulation or through legislation.

Mr M Stephens (UDM) suggested that it be made compulsory for employees to enter retirement funds. The fund should take out insurance so that members would not lose their benefits. Funds should also be compelled to do index tracking. The performance of a fund could therefore be measured against an index. It would therefore be important to consider these points when regulations were drafted.

The Chairperson suggested that the shift from defined benefit to defined contribution was an inappropriate model for the lower income group. There were many costs involved in the new model. He asked if there was a standard product that was more appropriate.

Mr B Mnguni (ANC) asked if there would be any supervision of the fund managers.

Ms R Joemat (ANC) expressed concern about the migration between funds. She felt that there was the danger that the bigger funds could swallow up the smaller ones.

Mr Y Bhamjee (ANC) pointed out that funds were racially divided in the past and asked if this would delay the legislation to be drafted since there was a change of mindset that was needed.

Ms J Fubbs (ANC) felt that compulsory preservation of funds could be negative for members since they would not be able to access a lump sum. A worker might need the lump sum for something valuable such as education or a house. She asked if there would be a moratorium on the fund, should a worker be unable to contribute because of a loss of employment. The possibility of lowering the age of maturity should also be examined. Although it was mentioned that trustees had to be educated, it was in reality the whole of the country that needed to be educated since everyone was a stakeholder. She asked whether legislation would be retroactive so that funds that were inequitable were brought back into the loop.

Mr Davidson (DA) said that with defined contribution, the risk was now on the employer. Treasury had stated that profit maximisation was not the goal. If the risk were with the employer however, increasing profit would be of benefit for the employer. He asked what the broad economic benefit was for the employer.

Mr T Vezi (IFP) asked if it was not possible that some arrangement could be made with SARS that less tax be paid on a lump sum if it was going to be used in the establishment of an enterprise.

Mr Masilela replied that it was difficult to say whether defined benefits or defined contribution was preferable. There were various permutations between cost and benefit that made it difficult to decide. As the risks shifted from employer to employee it was important that the employee be more informed. With a defined benefit fund, the benefits were backloaded whereas the defined contribution was frontloaded. This meant that the defined contribution fund was consistent with a young emerging intellectual group that was mobile. The movement from one employer to the next would therefore not attract a big cost. With the defined benefit fund there would be a penalty to leave a fund.

Referring to a single regulator, Mr Masilela said that the Minister had gone public on this matter. In discussing pension reform, Treasury had used the framework of a single regulator. Whether there was a single regulator or not, there was a need to prioritise this section of the industry. He continued to say they hoped to have all inputs on the new legislation by the end of March 2005. The inputs would then have to be incorporated into the new paper. This would probably take about two months. A revised document would then be made available before drafting began. It was important to get agreement on the principles, as this would make the drafting easier. Change in the industry could be brought about by legislation and moral persuasion. It was important to find a balance between the two. When supervision of fund managers was considered, it was important to ask why managers had to be supervised, what needed to be supervised and who needed to be supervised. These needed to be answered simultaneously so that an optimal decision could be reached. Treasury’s view was that supervision was to be done for the benefit of the consumer. The added benefit of supervision was that it provided stability in the market. He did not feel that the issue of race would delay the reform process, as this was not the sole issue. There were other issues that also needed to be considered. Treasury felt that the fundamental solution to higher savings, in any economy, was growth, employment and increasing incomes. Referring to training, he said that this was a shared responsibility between the state, the Financial Services Board (FSB) and organised labour. Training was a very complex issue and a process was needed in which the training process could be defined. Profit maximisation was what everybody wanted. This would be favourable if there was not a high risk. There was however a high correlation between high return and high risks.

Mr J Dixon, Chief Director: Financial Sector Policy, National Treasury said that the main objective of regulations was to protect the consumer and to provide financial stability and efficiency. In the past regulations had focussed on financial stability and not enough emphasis was placed on consumer protection. The balance between defined contribution and defined benefits should be seen in this light. Regulations would be able to eliminate risk, but perhaps it would be possible to shift the risk so that it could be managed better. Referring to the National Savings Fund, he said that it was still a conceptual idea. No firm details were available as yet. It was not easy to say if retirement funds should be compulsory for young people. This could have a negative effect even though it was more advisable for people to enter a retirement fund as early as possible. He agreed that the bigger ones could swallow up smaller funds. He felt that consolidation might be good.

A Member of Treasury’s delegation referred to the taxation of lump sums. She explained that there were a number of reasons why people would withdraw a lump sum from their pensions. Even though some of the reasons might be good, such as housing and education, one had to look at the cost of withdrawing a lump sum early. The Pensions Fund Act aimed at incentivising savings to provide sufficient income after retirement. If early withdrawals were allowed and the tax rate reduced, the cost would be a reduced retirement annuity or reduced income after retirement.

A Member from the FSB said that the present Pension Fund Act was unsuited to modern day needs. More detail was needed in the Act. She explained that the FSB had a staff of 250 people, but that there were plans to increase the number. Of this number approximately 60 dealt with pension funds.

Mr B Cameron’s submission
Mr B Cameron, editor of Personal Finance, said that since the last hearing, it had become more difficult for players in the industry to change. It was therefore clear that tougher legislation was needed. He felt that the document by the Treasury was sound and very comprehensive. The National Savings Fund was a key to the whole issue. Compulsory membership was also key to the industry. Domestic workers and agricultural workers were of concern in this regard. He did not believe that there should be any cash withdrawal from a fund. In most cases the money was not used for crucial expenses, but rather for things such as holidays. Greater use should be made of deferred pensions of employer sponsored funds. Unless there was a new fund, the money should remain in the existing fund. Preservation and umbrella funds had been abused in the industry. Millions had been paid out in commissions in the case of umbrella funds. He felt that a moratorium should be placed on migration between funds. It was imperative that some way be found that would minimise costs in defined contribution funds. At present in defined benefit funds, the big life insurance companies were outsourcing pensions. This was causing problems as pensioners were getting less than what they had thought they would get. Living annuities were also incorrectly sold, as the people who sold them were not properly qualified. It was also important that the structure of commissions had to be looked at. He felt very strongly that incentives for trustees should be banned. Many of these incentives could really be considered as bribes.

Association of Collective Investments (ACI) submission
Ms D Turpin, Executive Vice-Chairperson, stated that the ACI supported the discussion paper. It was important to address the need for transformation in the industry. The lower income group was the area that had to be addressed, as some gaps existed here.

Discussion
Ms Hogan (ANC) asked about the problem with umbrella funds

Mr M Johnson (ANC) said that there was abuse by the industry as asset managers dictated the terms of the fund. It was important that education be done.

The Chairperson asked whether there had been any response from the industry about perverse incentives since it had been raised a number of times in the media. He also asked if the speakers felt that there should be a capping of commissions and administration fees and if there was the capacity to do this.

Mr Cameron explained that small companies that did not have their own funds had used retirement annuities in the past. These annuities would be sold to individual employees. The problem with these funds was that they were forfeited if the member left the employer. The move had therefore been to go into umbrella funds. The ones that had been brought in by the life companies were particularly problematic. They provided all the services and would set the fees. The agreement would be between the employer and the fund and not with the employee. Referring to education, he said that it should really start at school. The Education Department needed to educate children about the whole financial services industry. Surveys had been done to investigate perverse incentives. Many companies had responded dishonestly. These companies were trying to find every way to avoid complying with legislation. It was important to expose these companies and enforce the legislation. He did not think that capping of commissions would work. The answer would rather be in proper disclosure by companies. People should be able to understand what they were getting. His newspaper would be publishing a form that people could take to the insurance companies so that they could see what they would be getting. He concluded by saying that companies should train their sales staff properly as many of them were not competent.

The meeting was adjourned.

FINANCE PORTFOLIO COMMITTEE
15 February 2005
RETIREMENT FUNDS: PUBLIC HEARINGS

Chairperson:

Dr R Davies (ANC)

Documents handed out: