On 17 November 2021 the Financial Sector Conduct Authority (FSCA) and National Treasury (NT) published an updated economies of scale report on the retirement fund industry of South Africa. The report is an update of an initial study done in 2011 and analysed data sets up to 2018 to understand the relationship between size of funds and fund administration charges.
The report aimed to investigate the relationship between scale and administration charges in the retirement fund industry. In summary, the findings suggest that the efficiency of administration charges in the industry has improved to some extent between 2006 and 2018. However, significant unused capacity of around 26% remains within the industry. Based on the methodology used, it concluded that the optimal fund size to reach efficiencies of scale is 300 000 members.
Alexander Forbes wishes to clarify the efforts made to reduce charges across the industry over the past decade.
Retirement reforms are aimed at improving value for money
Following several commissions in the late 1990s and early 2000s, culminating in the 2002 Taylor Commission report, National Treasury has taken various steps to strengthen the ability of the retirement savings industry to improve retirement outcomes for members.
It recommended that members need to get the best possible value for the retirement savings they have accumulated and charges must reduce to achieve this.
Over this period, the retirement fund industry has been on a journey to improve retirement outcomes for members. It has implemented the following reforms over the past 10 years:
Reducing charges whilst delivering value for money
Administrators incur costs to provide their services and charge clients accordingly. Margins available to administrators have compressed over this period as charges have reduced due to competition even though regulatory requirements have increased. The industry needs to balance administration charges against the need to put safeguards in place to:
- protect retirement savings
- invest in quality IT systems
- deliver security of personal data
- support members to ensure good retirement incomes
Disclosing charges transparently for informed comparisons
The industry has introduced disclosure standards for retail savings and umbrella savings arrangements. It’s easier to compare charges for more informed decisions on whether sufficient value is being achieved for the level of fee, which puts more competitive pressure on providers.
Encouraging savings and improved preservation before retirement
According to the Alexander Forbes Member Insights™ analysis for 2021, only 9% of members keep their retirement savings invested when leaving their employer. Lack of preservation is the main driver of poor retirement outcomes. Reductions in administration fees will not deliver as meaningful an impact on outcomes as would improving preservation by investing in retirement benefit counselling, member education services and the financial well-being of members. The industry has made progress in encouraging preservation through these efforts combined with default preservation options (including in-fund options) at institutional charges, which are typically cheaper than similar retail products.
Meeting increased governance, compliance and regulatory requirements
Over the last number of years the regulators have introduced significant additional governance, compliance and regulatory requirements in the retirement fund industry to safeguard retirement fund savings. Whilst these have resulted in additional costs to administrators to implement, in some instances providers have absorbed these costs, providing increased protection to individuals without increasing charges. For instance, most major administrators provide retirement benefit counselling as a complimentary service despite their investment in systems, counsellors and engagement.
Simplification, harmonisation and consolidation
To ensure an efficient system, the industry has taken measures to simplify the structure of the industry which, over the long term, would result in improved cost efficiencies. Some changes introduced include the harmonisation of retirement funds, aligning the tax treatment of contributions and how benefits are accessed at retirement between different funds. Smaller funds have consolidated into commercial umbrella funds to benefit from their scale, simplicity and governance.
Alexander Forbes wishes to challenge some key findings in the report:
Estimated cost of administering National Social Security Fund is understated
The paper provides a broad range of estimates of the fund administration costs in relation to the National Social Security Fund based on a set of assumptions. However, these oversimplify its model relative to the complex reality of retirement fund administration in practice. We believe that the range of costs set out in the paper are significantly understated because beyond a certain point no scale benefits are likely given the:
- significant technical and experience requirements to run such a scheme
- substantial upfront costs required to set it up
- many complexities in managing the contribution, benefit and engagement requirements across the diverse set of members
It would be impossible to hold the service provider to account
The envisaged NSSF removes agency and the power of self-determination from employers, bargaining councils and unions. Currently, members benefit from the competitive pressures applied to service providers to improve service levels, innovate and control costs. Should the value proposition of an incumbent provider falter, then funds can select alternative providers best able to meet the needs of their members. The proposal would result in an effective monopoly and monopsony within the retirement funding space with little to no freedom of choice to the employer or individual member. The ability to hold the service provider, government in this case, to account is nullified and the competitive incentive to reduce charges over the long term is absent.
Where to from here?
Alexander Forbes agrees that there is room for further consolidation in the industry. We have actively pursued this agenda as a key aspect of our corporate strategy by seeking to grow our administration client base organically and inorganically. We believe that it is important to reach scale to extract efficiencies from the investment required to provide quality administration services, implement regulations and meaningfully connect with members.
Alexander Forbes will continue to engage through industry bodies and directly with policymakers to improve the industry. In doing so, we will amplify the impact we have on the lives of retirement fund members.