How have the new regulations governing retirement funds affected funds’ annuity strategies? We asked two OMCC consultants what they’ve learnt in the four months since the regulations came into effect.
Retirement funds and society
At the 2019 Batseta (the Council of Retirement Funds for South Africa)
Winter Conference, the retirement sector’s role in transforming South
Africa’s economy and society was explored in view of the long-term
nature of retirement provision.
The default regulations within the Pension Funds Act, which came into effect on 1 March 2019, are designed to meaningfully impact retirement outcomes for members.
Principal Consultant Thiru Govender and Asset Consultant Martin Poole of Old Mutual Corporate Consultants led a presentation that unpacked what they have learnt about the regulations and their impact on annuity strategies.
Here, they talk us through their insights and outline what the implications are (and might be) for retirement funds, their trustees and – most importantly – their members.
The role of the new regulations
The regulations require that preservation and annuity strategies have to
be made available by most occupational retirement funds (there are a
few exceptions) to provide cost-effective and simple-to-understand ways
for workers who are about to retire to either save their money for
later, or to draw an income for the rest of their life.
The regulations also introduced a new concept: a ‘retirement benefit counsellor’. Their role is to provide relevant and comparable information to members approaching retirement. This entails, among others, that funds must have an annuity strategy, which sets out the way in which a member’s retirement savings may be applied (with their consent). In so doing, a fund has to take a number of factors into consideration. These include the level of income that will be payable to a member, risks such as inflation that will affect the income, and the protection it offers a member’s beneficiaries. It could be a living annuity or a life annuity, but it has to be appropriate for members.
Solutions are ‘same-same, but different’
‘It was fascinating to see that, when it comes to with-profit annuities,
the four major South African insurers’ solutions are what we call
“same-same, but different”,’ says Poole. This, he explains, means that
the products are substantively the same, but the composition and the
underlying strategies differ to such an extent that they are ‘almost
impossible to compare’.
Many trustees have to be upskilled
Developing and managing an annuity strategy is an incredibly complex process. It is important that trustees understand it well, given the product differentiation and innovation in this area, particularly when it comes to less commoditised products, such as with-profit annuities. ‘Unless trustees understand and appreciate the risks that are being mitigated by the various annuity types, they will not be able to ensure that their chosen annuity strategy reflects the needs of their members, nor will they be able to monitor the administration and communication functions entailed in the delivery of their chosen strategy,’ says Govender.
There’s a preference for out-of-fund annuities
The regulations have, inevitably, had some unintended consequences – and
Old Mutual Corporate Consultants are already seeing them play out in
practice. ‘The spirit of the law was that fund members would enjoy
institutional fees, which are typically lower, within their living
annuities and I think the regulator’s preference was that they would opt
for in-fund annuities,’ says Poole.
‘The unintended consequence of the current legislation is that trustees could be held responsible for members’ decisions. With an in-fund annuity, where members’ money stays in the fund, their potential recourse to the fund would extend way beyond their retirement. This caused many funds – both umbrellas and standalones – to outsource their annuities.’ This – when the obligation to meet future pension payments is transferred from the retirement fund to an external provider – is what is called out-of-fund annuities.
Poole admits to having some sympathy for this approach. ‘If you’re going to be a pensioner for 35 years and you’re no longer connected to your employer, why should a board of trustees have to determine, 35 years from now, how to allocate your death benefit, for example? It’s like asking a board to make those kinds of decisions today for someone who retired in 1985.’
Do members really know what they need, and do they get that?
According to past surveys, the majority of pre-retired members don’t
feel that they understand annuities well. This underscores the
importance of engagement, and the need to provide members with education
and support, both in the years before retirement and when making an
annuity choice at retirement.
When a member understands the types of risks they are likely to face in retirement (and how such risks can be managed via their initial and subsequent annuity choices), they will be better equipped to make decisions that take into account their actual needs in retirement. It will also allow them to consider the features of different annuity options relative to the product and adviser fees involved.
To ensure that a default annuity achieves its intended purpose, it is necessary to monitor the annuity strategy continually with regard to the following aspects:
· take-up by retiring members
· the communication issued by the default annuity provider to pensioners, particularly in relation to those with living annuities, and its administration processes, as part of the regular review of the annuity strategy
· the annuity providers’ financial advice model. In essence, this is whether members, when they request further financial advice, are directed to investment portfolios in a balanced needs-based way, or whether they are only pointed to products that are aligned to the product sponsor
It’s important to note that, while the last point may not be a legal requirement (because the retirees have opted out of the default annuity strategy), it may be seen as remiss of the trustees not to consider such information in a future review, since having members who opt out is, on the whole, indicative of a weak advice process.
Information is not advice
The regulations require funds to provide members with information about
their retirement savings. To the extent that providers employ
non-FAIS-accredited counsellors, they are unable to provide simple
advice on how to apply that information, which could harm members’
financial position, Poole warns.
He illustrates the situation this way: ‘Let me ask you a question. Do you know how much of your retirement savings you want to take as cash when you retire, given the potential implications your decision has on tax and access to your cash? Very few people do. Yet funds are nudging people to take these crucial decisions – some of which are completely irrevocable – while stopping short of actually providing advice. Can you say you’ve really helped them, then?’
Will institutional pricing prevail?
‘As institutional and retail markets become blurred, we see competition intensifying,’ says Govender. ‘At the moment there is a wide range of out-of-fund living annuities that are priced at near-institutional levels, which means that over time only the very best products are going to gain market share.’
The annuity space will continue to develop – many funds only recently finalised their annuity strategies – and all competitors are still positioning themselves in terms of their products.
Mark van Dijk