Conversion from DB to DC Funds. Did we do the right thing?
The history of Retirement Funds in SA
South Africa is one of the first countries in the world to come up with a legislation that governs private sector retirement funds, the Pension Funds Act 24 of 1956 which is also still very much in use in South Africa and Namibia today. Initially, all retirement funds that were set up were based on a Defined Benefit Funding basis and although beyond the understanding of the average man in the street, the system was for most part a healthy one.
The basis of Defined Benefit funds lie in statistics and assumptions (made primarily very conservatively to reduce volatility and risk) and aims at a longer-term horizon to manage a retirement fund cost effectively and efficiently. It sets a definition of retirement (historically an average of 2% of a person’s final salary for each year of membership). With this target defined, contributions for members were usually a fixed percentage of say 7.5% of salary whilst employer contributions were adjusted from time to time to make up for the balance needed to hit the target.
As mentioned above, a degree of stability was continually sought to keep the employer balance pf payment contributions to a reasonable and stable level and should any degree of underfunding exists, this was mitigated by a set plan to bring funding levels up to par within a reasonable time. I cannot recall a single case where an employer was suddenly faced with an insurmountable crisis of underfunding.
Fund administration costs were also fairly cheap in comparison to today as member retirement benefits were a function of a formula and not dependant on detailed and costly tracking of individual choices and other particulars.
Success in retirement for a member was based on years of membership and the delivery of a rules-based promise and as a result was fairly risk-free. The employer on the other hand carried the risk having the obligation to ensure there was sufficient funding to deliver on each of these member promises.
Employers and their service providers therefore managed these funds between themselves without member input nor representation. In a politically charged environment as there existed at the time, workers displayed a lot of mistrust and scepticism and things were about to take a dramatic twist.
The winds of change - Conversion of the Pension Funds into Defined Contribution Provident Fund
With the accelerated change to the political landscape in the 1980’s, Labour was at the forefront of the conversion of defined benefit pension funds into defined contribution provident fund purely because the latter is easy to understand while the former is complicated for an ordinary member to understand. There was also this belief that with defined benefit fund the employer could easily embezzle the members’ money.
With defined contribution (money purchase) provident fund, what you and your employer contribute to your retirement savings is what you get out plus investment growth when you retire or withdraw. It works just like a savings account.
The downside of a defined contribution provident fund is that a member carries the investment risk hence members are given member investment choices or defaulted if they don’t make use of the member investment choices. With a defined contribution provident fund members receive lump sums on retirement. In most instances members lack the financial management skills to handle such bigger amounts and few years down the line they are bound to become penniless.
Comparing this to a defined benefit pension, as stated above, when you retire your benefit is determined by a formula that takes into account your years of services and salary as at the date of retirement. It gives a member a fixed guaranteed benefit.
With these funds also structured as pension funds, a maximum of one-third could be taken as a lump sum and the balance had to be used to provide a monthly pension. Albeit perhaps seen as a very paternalistic approach, the upside of this arrangement is that not allowing members to access their retirement benefits all in one lump sum, mitigates the risk of it all being squandered in a short space of time. The end result is that members also received a monthly pension that provided for them in retirement and for members with long service periods, these pensions were invaluable.
Except for the GEPF and the Transnet Pen