Kobus Kunz – Head of Consulting, Efficient Benefit Consulting
In the last five to ten years there has been a great push to make retirement fund costs more transparent. Changes to legislation mean there is a watchful eye on costs charged by providers of services and products to retirement funds. However, at the same time, other regulatory changes have made it more onerous for funds to meet compliance requirements, placing upward pressure on fund costs.
Given that the primary objective of any retirement fund is the provision of viable retirement benefits, boards of trustees or management committees of retirement funds have a fiduciary duty to curb costs to the best of their ability. A first step towards this is knowing how a fund’s costs are determined and calculated.
IMPROVED TRANSPARENCY THROUGH LEGISLATION
In the modern retirement fund environment in South Africa, there are numerous factors that will influence the success of a company’s retirement fund. The most obvious are factors such as the level of contributions, participation period, benefit preservation and adequate investment returns. All are key factors to ensure that members of retirement funds will be able to accumulate enough capital for actual retirement, and to draw a viable and sustainable pension income during retirement. The general view is that members will need to replace their salary income with a pension income of approximately 75% of their final salary at retirement. However, if not managed properly, increasing expenses related to the operation and management of retirement funds can cause the desired outcomes never to be achieved.
Some years ago, legislation did not compel service providers to disclose all fees related to their different product offerings and various hidden costs seriously impacted on the actual costs borne by members of retirement funds – especially costs related to administration and investment products. The latter was a major concern for the Financial Sector Conduct Authority (FSCA), which regulates the retirement fund industry. In recent years, the industry saw comprehensive changes to legislation that require all financial service providers to disclose all costs charged to members of retirement funds. This resulted in what is now known as the ASISA Retirement Savings Cost Disclosure Standard, developed by ASISA and its members, and implemented with effect from 1 March 2019. The aim is to build trust in the industry through meaningful disclosure. The disclosure requirements now make it much easier for retirement fund boards of management and management committees (in the case of umbrella retirement funds) to determine the full impact of cost on their retirement funds.
The so-called Retirement Reform in South Africa, places strong emphasis on the rising costs charged by providers of services and products to retirement funds. It sent out a clear message that the cost structures of products and services will be closely scrutinised in future. However, these providers are not the only culprits who contributed to the increase in the operational costs of retirement funds.
COST PRESSURES FROM COMPLIANCE
During the past decade much stricter compliance requirements were imposed by the regulatory authorities with regard to investment reporting, training requirements, default options to be made available to members, increased statutory fees, appointment of compulsory retirement fund counsellors, and the list continues. The implementation of these additional requirements inevitably resulted in additional expenses for retirement funds and will certainly not disappear any time soon. The latest change, referred to as the Two-Component System, intended to be implemented on 1 March 2024, may have a significant impact on the future administration costs of retirement funds. These financial threats will put even more pressure on boards of management to ensure that retirement fund expenses are managed effectively to achieve the desired objectives in respect of their retirement funds. The role of knowledgeable, professional consultants who have a good understanding of the pricing structures of the various umbrella funds, will become increasingly important to provide guidance on how to limit unnecessary fund expenses, as well as to ensure that all costs are disclosed to retirement funds’ boards of management and members.
KNOW HOW COSTS ARE DETERMINED AND CALCULATED
An important aspect that needs to be understood by boards of management of retirement funds is that the primary objective of any retirement fund remains the provision of viable retirement benefits. It can be argued that very few members remain in their retirement funds until they reach normal retirement and are more likely to resign before then. However, this does not remove the fiduciary duty placed on boards of management to act with responsibility and to curb costs to the best of their ability. In fact, it increases the responsibility to encourage members to preserve their resignation benefits when changing jobs because somewhere down the line they will have to retire. The Two-Component System will contribute to addressing compulsory preservation, but it will only reach its final objective within the next 30 to 40 years when most of the members with a vested component as on 1 March 2024 have transitioned from funding their retirement to generating income from their accumulated capital.
A direct result of the retirement fund industry’s increased expenses was the massive migration from private funds to umbrella funds, where operational costs are shared between all participating employers. Modern-day umbrella retirement funds offer much of flexibility and access to all the reputable asset managers, but boards of management must take care not to automatically assume that an umbrella fund will be more cost-effective than a private fund. A thorough analysis of all costs levied by the different umbrella retirement funds is indispensable.
At Efficient Benefit Consulting, we have done in-depth research on the cost structures of the most prominent umbrella fund service providers in the industry. Asset-based fees, as opposed to administration fees based on a percentage of payroll, may sound attractive in the event of a new fund with a small asset base, but as the asset base grows, asset-based fees can become excessive and are not always as visible as a fee based on a percentage of a company’s payroll. It is advisable to employ the services of a truly independent employee benefit consulting company who must, as part of their service agreement, perform regular investigations and negotiate the best financial outcomes in the interest of the members of the fund. Consulting on employee benefits is not a once-off exercise, but rather a journey on which a board of trustees or management committee and the consulting company embark together. They need to constantly monitor all costs related to administration, advice, risk-benefit insurance and investment management.
STRIKE A BALANCE BETWEEN OFFERING EMPLOYEE BENEFITS AND MAINTAINING THEIR INVESTABLE RETIREMENT CONTRIBUTIONS
Most caring companies always seek the best financial solutions for their employees. When it comes to their retirement funds, companies normally want to protect their employees against almost any bad life event that may occur; such as the death of the retirement fund member, his/her spouse and/or children. They also offer cover against medical disability (to continue their income), funeral insurance, critical illness insurance, and more.
None of these insured risk benefits come free of charge, and many of them can be quite expensive in some instances. In most cases, the costs related to these insured benefits are covered by the employees’ total contribution rate towards their retirement fund, which means that the addition of any of these benefits reduces the portion of the total contributions being invested on behalf of the members. This inevitably impacts negatively on the member’s accumulation of retirement fund capital.
The golden rule any board of trustees or management committee should follow is to ensure that a healthy balance is maintained between expenses (in respect of the operation of their fund and the insured benefits), and the contribution remaining available for investment in the members’ fund savings account. Advice should be sought to determine what the desired portion of the total contribution should be to ensure that members will be able to retire with adequate capital at their disposal. This should be done by means of determining a member’s required Net Replacement Ratio (the percentage of final salary required as income after retirement) and implementing the necessary measures to rectify any significant shortfalls.
If a healthy and sustainable balance between spending and investing is constantly monitored and managed, accompanied by a suitable investment policy, there is very little reason why your retirement fund should not be successful in its endeavours to ensure its members can retire with dignity. At the same time, you must be pragmatic about the benefits offered; it is just not possible to fulfil the insurance needs of all the members in a specific retirement fund. An acceptable balance must be found in this regard as well.
It is therefore important for employers or boards of trustees to utilise the services of an independent employee benefits consultant to do an in-depth review of their retirement fund and group risk benefit structures and costs.
This article only covers the basic concepts of managing retirement fund expenses. Your appointed employee benefits consultants should assist your fund management committee or board of management with this process.
ENDS
