Employers and retirement fund trustees are blithely making decisions about members’ retirement savings, switching from employer-sponsored funds to umbrella funds and between umbrella funds, without much idea of the cost implications for members.
This is one of the conclusions that can be drawn from a paper due to be delivered at the annual convention of the Actuarial Society of South Africa next week. The paper, entitled “A critique of the umbrella retirement fund charging model”, is based on research by David Gluckman, the head of Sanlam’s umbrella fund business, and Sanlam actuarial student Megan Esterhuysen.
One of the aims of the research is to develop “an industry-agreed method of comparing charges across all defined contribution retirement funds (employer-sponsored stand-alone funds and financial services industry umbrella retirement funds)”.
The model developed by the research offers employers and retirement fund trustees, for the first time, a tool with which to assess properly the cost-effectiveness of whether your retirement savings in an employer-sponsored fund should be moved to an umbrella retirement fund, or switched from one umbrella fund to another.
However, the researchers say the model needs further refinement to make it an easy “plug-in” tool.
They warn that costs should not be the only reason for switching funds. Other factors that should be taken into account include administrative ability, corporate governance and the cost of risk cover.
Gluckman and Esterhuysen’s paper is a follow-up to the controversial research by then independent actuary Rob Rusconi, who, in 2004, blew the lid on the high cost of local retirement-savings products.
At the time, Rusconi conceded that his research was not perfect, because he had found it extremely difficult to access comprehensive and accurate data.
Rusconi’s research contributed to the government’s commitment to overhauling the country’s retirement-funding system.
Little has been done since Rusconi’s research to establish the true costs across all retirement products, including umbrella retirement funds and retirement annuity funds provided by the retirement industry.
In this cost-data vacuum, the financial services industry has hard-sold umbrella funds, with employers and trustees making decisions with little idea of how costs will affect members’ retirement benefits over the long term.
In its National Budget Review earlier this year, the National Treasury gave notice that it intends to introduce a code of ethics for the retirement fund industry and to discuss its concerns about “high fees” with the industry.
Gluckman and Esterhuysen’s research has been referred to the treasury so that it can be fed into the retirement reform process.
Their paper draws on research by Sanlam Employee Benefits in its annual benchmark survey of umbrella funds. According to the 2011 survey of 100 employers participating in umbrella funds:
* Few were able to list all costs;
* Although 91 percent of employers knew how administration charges were expressed, only 70 percent could quantify the costs in rand terms; and
* While 54 percent of employers knew how consulting fees were expressed, only 34 percent could quantify the charges in rand terms.
The Gluckman/Esterhuysen research included 805 participating employers and 36 679 members with total savings of R3.6 billion, representing accumulated average savings of R99 198 a member, for which funds were charged an average of R1 218 a year (R102 a month).
DEFINTIONS
* Reduction in yield (RiY): The amount by which the annual returns on your savings will be reduced by costs.
* Average RiY: The total RiY of all members of a fund divided by the number of members.
* Charge ratio: The percentage or rand amount by which costs will reduce your retirement savings. It is also known as a reduction in maturity value.
* Umbrella retirement fund: An umbrella retirement fund is made up of a number of sub-funds. Each sub-fund in a financial services sector umbrella fund is for a separate participating employer.
* Net replacement ratio (NRR): The percentage by which you can expect your pension (based on your retirement savings) to replace your final salary. Most retirement funds seek to provide you with a pension of 75 to 80 percent (NRR) of your final salary.
INADEQUATE PENSIONS MAINLY DUE TO NOT PRESERVING SAVINGS
The behaviour of umbrella retirement fund members, and not costs, is the main reason that members retire without sufficient savings to fund an adequate pension.
Younger members of umbrella funds who stick to their retirement plans “appear to pay reasonable charges”, and at the start of their careers can anticipate that their fund will deliver reasonable payouts after 40 years of membership. And yet few members will retire financially secure, because they will not preserve their savings when changing jobs.
The low levels of preservation of retirement savings has a knock-on effect, increasing the cost of saving for retirement and therefore reducing the retirement benefits of all members, even those who preserve their savings.
Finance Minister Pravin Gordhan announced in his Budget earlier this year that the government intends to introduce legislation to ensure that you preserve your retirement savings for a pension in retirement.
The above conclusions about the impact of not preserving retirement savings are some of the key findings of research by David Gluckman, the head of Sanlam’s umbrella fund business, and Sanlam actuarial student Megan Esterhuysen.
According to their research, the average member of an umbrella fund will retire with a pension of less than 30 percent of his or her final pensionable income.
The research shows that the average member who starts to save at age 20 will have an anticipated net replacement ratio (NRR) of more than 100 percent. The potential average NRR drops to slightly less than 75 percent if the member starts to save at age 30 and to below 50 percent if the member starts saving at age 40.
An actual NRR of less than 20 percent at age 64 equates to a capital amount of 2.67 times annual pensionable salary.
The rule of thumb for the desired capital amount at retirement is 15 times annual pensionable salary, to provide an NRR of between 75 and 80 percent.
Gluckman and Esterhuysen say that by imposing a minimum contribution of five percent of pensionable income (and assuming no one leaves the fund as a result), the average reduction in yield (RiY) for all members decreases from 1.9 percent to 1.74 percent.
Up the contribution level to 10 percent of pensionable income and the average RiY drops from 1.9 percent to 1.53 percent.
Gluckman and Esterhuysen say their figures are not 100-percent accurate, because the Sanlam database used in the research did not reflect other savings of members nor savings in the process of being transferred between funds.
THE LESS YOU CONTRIBUTE TO RETIREMENT SAVINGS, THE GREATER IMPACT OF COSTS
The average member of an umbrella retirement fund can expect his or her pension to fall by almost 25 percent over 40 years due to costs, based on current contribution levels.
And the less you earn and the less you contribute as a percentage of your income to retirement savings, the greater the impact of costs on your retirement savings and the less you will receive at retirement.
These are the conclusions drawn by the Gluckman/Esterhuysen research into umbrella fund costs.
The researchers’ findings on the costs of occupational retirement funds are similar to the findings of Rob Rusconi in 2004. An independent actuary at the time, Rusconi expressed how costs affect retirement fund members in two ways:
* As an annual reduction in yield (RiY); and
* As the percentage or rand amount by which costs will reduce your retirement savings – known as the charge ratio or the reduction in maturity value.
All retirement funds have costs, which include administration fees, consulting fees, investment management fees and charges related to regulation, as well as VAT.
The Gluckman/Esterhuysen research drills down further than Rusconi’s research in that it looks at the relationship between costs and member income levels, contribution levels as a percentage of income and years to retirement.
The findings include:
* Cross-subsidies. Remove high-income earners from a retirement fund and the costs shoot up for the remaining members. Charge retirement fund members an equal rand-based fee, as opposed to a percentage of their accumulated savings, and the costs for lower-income earners again spiral upwards.
The research shows that the effect of excluding the top 10 percent of earners from a retirement fund “is very significant, even punitive, for the remaining members, with fund operating expenses increasing from 1.01 percent to 1.7 percent of pensionable salaries”.
* Safety in numbers. The more members a retirement fund has, the lower its costs. The average RiY for an umbrella fund participating employer with less than 10 members is 3.63 percent, whereas that for a participating employer with more than 500 members is 1.19 percent. The overall average RiY is 1.9 percent, which is the same for participating employers with 51 to 100 members.
* Cost inputs. The single biggest contributor to umbrella fund costs is administration fees. For the funds surveyed in the research, the average RiY attributed to administration fees is 0.78 percent, followed by 0.56 percent for consulting fees, 0.54 percent for investment management fees and 0.02 percent for other costs. These splits of the average RiY are for a participating employer with an average of 46 members. The research also shows that the splits differ significantly between employers of different sizes.
* Best cost option. Occupational retirement funds, whether they are umbrella or stand-alone funds, offer the most cost-effective retirement-savings option. This was one of the findings of the Rusconi research in 2004 and has been backed, with qualifications, by the Gluckman/Esterhuysen research.
Rusconi found that retirement annuities (RAs) offered by life assurance companies were the most expensive option, with costs in some cases reducing your final benefit by more than 40 percent after 40 years of fund membership.
Gluckman and Esterhuysen note that new-generation RAs that use unit trust portfolios offered by a linked-investment services provider have brought down costs, but they are not comparable with life assurance RAs, because unit trust RAs require much higher minimum monthly contributions, from R250 to R500, making them inaccessible for low-income earners.
SMALL STAND-ALONE FUNDS UNLIKELY TO BE COST-EFFECTIVE
A stand-alone retirement fund, even one with more than 500 members, is unlikely to be more cost-effective than an umbrella fund.
David Gluckman and Megan Esterhuysen, of Sanlam Employee Benefits, say that, when conducting their research, they could obtain full co-operation and data from only four stand-alone funds, with a total membership of 5 288 members. This, they concede, is not a sufficiently large sample on which to base sweeping conclusions.
However, Gluckman and Esterhuysen have no doubt that small stand-alone funds of less than 20 members are not cost-effective. However, they do not provide a cut-off point where stand-alone funds are not cost-effective, saying this can vary from fund to fund.
In comparing the four stand-alone funds with each other, as well as with six Sanlam Umbrella Fund sub-funds with more than 500 members each, they found that, on average, the annual reduction in yield (RiY) for the stand-alone funds was 0.91 percent, against 1.19 percent for the umbrella sub-funds. However, the RiYs are affected by two factors:
* The average assets per member of the stand-alone funds (R342 280) were higher than those of umbrella sub-fund members (R142 587); and
* The average number of members of each stand-alone fund (1 322) was higher than that of each umbrella sub-fund (766).
Gluckman and Esterhuysen argue that these two factors, as well as other factors, such as the non-inclusion of employer costs in the stand-alone funds, should result in even higher RiYs for the stand-alone retirement funds.
In other words, the smaller the membership of a retirement fund and the less the members earn and contribute to the fund, the more likely that an umbrella fund may be the more cost-effective savings vehicle.