Costs of Saving for Retirement in SA

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  • 8/6/2019 Costs of Saving for Retirement in SA


    PapersCosts of saving for retirement inSouth AfricaReceived (in revised form): 20th July, 2005

    Rob Rusconiis Client Portfolio Manager at SEI Investments South Africa, He has worked in a variety of functions for life offices andconsulting firms both in South Africa and the United Kingdom and spent a year setting up the fund ratings business atFT,com, London, He has a BSc from the University of Cape Town, is a fellow of the Institute of Actuaries and his primaryresearch interest is old age reform in South Africa and other parts of Africa,

    Abstract How much are South Africans paying for their retirement funding? Whether inoccupational plans or private supplementary arrangements, workers pay for theopportunity to save for retirement through a variety of charges that erode the prosperityof the retirement years. This paper analyses the administrative charges paid by SouthAfricans saving for retirement in three tax-effective vehicles: occupational retirementfunds, individual life products and unit trust arrangements, using a model designed toevaluate the lifetime impact of these charges. The analysis presented here suggests thatretirement funds are cheapest, followed by unit trusts and then individual life products.These results are consistent with the flexibility of the more costly products. Overall,however, charges appear to be high. Comparison with international benchmarksconfirms these concerns. Policymakers should be addressing this through strongerdisclosure requirements and consideration of a standardised national product andpotential charge ceilings.Keywords: retirement; comparative costs; South Africa; savings veiiicles

    Rob Rusconi30 Balder Road,Douglasdale, 2021South AfricaTel: +27 11 [email protected],co,za

    South Africa's retirementsaving landscapeSouth Africa has an advanced, formal,tax-efFective, pension-saving sector and asuccessful means-tested social securitysystem for the aged. But many SouthAfricans do not receive significant benefitfrom either of these systems.

    Formal sectorThe absence of comprehensive old agesocial security benefits for themiddle-class and affluent sectors hassurely contributed to the development ofSouth Africa's successful insurance and

    pensions saving environment. Indeed,according to the South AfricanGovernment , Taylor Report , 2002,'South Africa's private pension andinsurance sectors are estimated to be thelargest in the world relative to grossnational product.''

    South Africans receive tax incentivesto save for retirement throughoccupational pension funds and throughindividual tax-efficient savingsarrangements, either unit trusts or lifepolicies, known as retirement annuities.The Taylor Report records pension fundcontributions of R54.3bn per annum, 14per cent of total personal remuneration

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    Costs of saving for retirement in South Africa

    and a further R8bn paid into retirementannuity funds. The report suggests that alarge proportion of the R27bn paid intoregular premium life assurance is alsointended to provide benefits payable atretirement. HelpAge International (2003)^quotes the Katz Commission estimatethat tax incentives to the formal sectorcost the South African Treasury 1.7 percent of GDP annually.

    The efficiency of the formal sectorretirement system and the resultingimpacts on the benefits that it providesto its beneficiaries are at the core of thisresearch paper.

    Social security grantsAt the other end of the scale is anextensive system of social grants to theelderly. This is a non-contributorymeans-tested flat-rate system that in thelate 1990s paid R520 per month,^ justover 2.5 times the per capita income ofblack South Africans at the time.Increases to grants are ad hoc, based onaffordability, but have been rapid inrecent years, most recently payable atR740 monthly. It is financed bygovernment from general revenues andcosts approximately 1.4 per cent ofGDP." The February 2004 briefing toParliament puts the number ofbeneficiaries for 2003 at over 2 million.

    A number of commentators havelauded the system, suggesting that inmany of South Africa's poorestcommunities, the old-age grant supportsnot just the aged but many of theirdependents as well.

    'The generosity and universality of SouthAfrica's pension system are unique bydeveloping country standards ... The systemis probably the most effective programme intargeting and reaching economicallyvulnerable groups. Its benefits reach deepinto poverty-stricken communities.''

    The analysis described in this paper doesnot cover social security grants.

    The uncovered middleSouth Africa does not have a retirementsavings environment consistent with theWorld Bank's definition of a three-pillarsystem. The social security system is pitched ata level that fends off poverty ratherthan providing substantially for old age. The occupational system is notmandatory and preservation of savings

    until old age is not required. Recentstatutory developments have beenaimed at ensuring fair treatment ofindividuals leaving a jo b early ratherthan ensuring adequate coverage atretirement.South Africa has a successful formalsavings environment and highly laudedsocial security safety net, but this doesnot mean that the system as a whole canbe described as successful. The TaylorCommission points out that 60 per centof South Africa's poor receive no socialsecurity transfers.**

    Purpose of the analysisSouth Africa's pension fund legislation isdated and currently under review bypolicymakers. This research is intendedto contribute to the analysis and debatearound this review.Why then a study of costs? Mostcountries provide a significant pubhcsector element to retirement saving. Incontrast, working citizens in South Africadepend strongly on the private sector inthe form of occupational retirementfunds and a variety of additionalvoluntary savings options. Understandingthe costs to which savers are subject isan important first step towards

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    establishing a sensible framework forregulating savings vehicles.

    Costs make a difference; they affectthe old age prosperity of citizens and,ultimately, the degree to which thepopulation depends on the State forfinancial support in old ^

    MethodologyShould the analysis consider charges oractual costs? As the objective of thispaper is to determine the impact of theseexpenses on the retirement savings of theindividual, the view has been taken thatmeasuring charges is more importantthan determining the costs incurred inprovision of the services. Furthermore, inthe long term, in a competitiveenvironment, the gap between chargesand costs should be fairly stable.

    Charge measuresThe most common types of chargesexperienced in the analysis are: life office products: a f ixed monthly

    deduction, a percentage of eachcontribution and an annual percentageof the assets, commonly deductedmonthly, although a fixed inception feealso applies;

    unit trust products: a percen tage of eachcontribution and an annual percentageof the assets;

    retirement funds: an annual percentage ofthe assets for asset management andregular annual costs for administrationthat are expressed as a percentage ofassets, a percentage of contribution ora percentage of the salary payroll onwhich the contribution calculation isbased.

    To allow for different types of charges,two summary statistics have beencalculated in all instances. The reduction

    in yield is the percentage point reductionin annual return over the period ofsaving that is equivalent in overall impactto the erosion of value due to allcharges. The charge ratio is thecorresponding percentage reduction inmaturity value equivalent in overallimpact to the erosion of value due to allcharges.**

    The reduction in yield and chargeratio each have advantages anddisadvantages. And each makes moresense in an environment in whichcharges are commonly quoted in thatway. Quoting both figures is consistentwith the approaches of internationalresearchers, for example, Whitehouse(2000),' Murthi et al. (1999),'" James etal. (2001)," Devesa-Carpio et al. (2003)'^and Diamond (1999).'^

    'When comparing funds or systems whichrely on different types of charge, reliance ona single measure can be misleading, and thebest approach is to use both the charge ratioand the charge as a proportion of assets.''**

    Areas excluded from the analysisIn an effort to reduce the complexityand volume of analysis the followingtypes of charges are not covered by theresearch: Trading costs, which include broker

    fees, stamp duty and the bid-offerspreads common to securities exchangeshares.

    Alteration costs, the charges resultingfrom interrupted or altered patterns ofsaving. This paper avoids modellingeither the cost of alterations orinterrupted periods of saving.

    Costs arising fi-om what is here termedprotection against anti-selection, forexample annuity purchases. Typically,the mortality calculations of the insurerfor pricing the annuity allow for some

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    Costs of saving for retirement in Soutti Africa

    degree of anti-selection by thepurchasers. Insurers are conservative intheir estimates and annuitants lose outas a result.These exclusions do not invalidatecomparison, but they limit the breadth ofapplication of the analysis.

    Methodology and choice of parametersA cash flow model has been developedto summarise the impact of charges. It ismore appropriate in this context than theformula method used in Whitehouse(2000)'^ and Devesa-Carpio et al.(2003),'* as it is more flexible and allowsbetter calculation of the impact of thevariety of charges encountered,particularly under individual lifepolicies."

    Neither of the charge measures isparticularly sensitive to the choice offinancial parameters,'^ but nevertheless itmakes sense to select parameters that aresensible and likely to remain appropriatefor some time to come. These are setout in Table 1. The choice of parametershas been guided by the followingcriteria: Parameters need to be appropriate tothe long term, because saving forretirement is a long-term process, butwithout being inappropriate to thecurrent environment . The differences between parameters are

    more important than the nominalvalues. Parameters must be reasonable in thecontext of the South African savingenvironment but should be, as far aspossible, consistent with thecorresponding parameters used by otherresearchers, to make possible a faircomparison of results.These are in line with the assumptions

    Table 1: Model parametersAnnual rates (%)

    Inflation rateSalary growthInvestment return



    used by other researchers. Murthi et al.(1999)''"' use the basis for the MinimumFunding Requirements, which specifiesan inflation rate of 4 per cent, equityreturns of 9 per cent nominal and wagegrowth 6 per cent n ominal. James et al.(2001)^" use annual real wage growthand interest rates of 2 per cent and 5 percent respectively.

    No allowance has been made formortality in these calculations, assumingthat its impact is roughly neutral and thatbenefits paid on death are approximatelyequal to the fund accumulated at thattime in whatever vehicle is used by thesaver.As costs in occupational funds arepooled across the membership, the cash

    flow model does not lend itself toanalysis of costs in this structure. Fundsare analysed on the basis of current costs,contributions and assets, the assumptionbeing that these relationships remainconstant.

    Analysis of costsTax complicates the comparison acrosschannels. In all cases, qualifyingcontributions are exempt from tax at thefuU marginal rate, but there aredifferences in the ceilings to theexempted amounts. Assets undermanagement during the accumulationphase are taxed and this may impact thethree channels in different ways. Rulesconcerning the way in which these assetsmay be invested also differ.^'

    No attempt has been made toincorporate these differences in the

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    analysis. This paper is not intended toprovide a detailed comparison of thesavings channels, but rather a reasonablycomprehensive analysis of the costfeatures of each.Occupational retirement fundsThe South African retirement fundenvironment is complex.^^ The analysisin this paper covers a subsection of thecountry's occupational funds referred toas 'self-administered funds'. These arefunds 'that invest their assets with bodiesand institutions in the public and privatesectors of the economy on their ownbehalf.^'' They form the largest pool ofoccupational retirement funds and this iswhere the Registrar also puts the greatestweight of his analytical effort. Thesefunds are a natural area for analysisimpacting the choices faced by SouthAfricans saving for retirement.

    The Registrar was unable to providethe data required at fund level. Analysisof occupational funds has beencomplicated by this and other factorssuch as undisclosed costs, subsidy ofexpenses by the fund sponsor, a varietyof measurement methods and the needto utilise a number of informationsources. The analysis in this section istherefore somewhat piecemeal. It ishoped that it encourages better disclosureof charges and a more uniform basis,allowing funds to understand costsincurred and authorities to monitorindustry trends far more closely.Registrar of pension fundsThe Registrar publishes informationconcerning fund expenses in his annualreport. The 2003 report quotes a totalcost for self-administered funds ofR2.9bn, equivalent to 13.1 per cent oftotal annual contributions or 0.799 percent of total assets. Breaking this down,investment advisers' fees are equivalent to

    4.9 per cent of contributions or 0.302per cent of total assets. Administrationfees and consultancy fees are equivalentto 5.4 per cent of contributions or 0.327per cent of assets (Registrar of PensionFunds, 2003 and author's calculations).^'*As shown below, analysis suggests thatthese figures significantly understateactual costs.Asset management costsInformation on asset management costscan be difficult to obtain from theaccounts of retirement funds becausethey are sometimes not disclosed, havingbeen deducted from gross investmentperformance in the income figures. Assemanagement fees have been analysedinstead using an Alexander Forbes surveyof fees quoted by the asset managersthemselves.^^

    The results presented below are basedon an equal weighting of asset managersData have been excluded where unclear:performance-related fees are difficult toinclude but are rare; negotiable fees forlarge funds have been included on aconsistent basis; only one passivelymanaged portfolio is included in thesurvey and that has been excluded;with-profit portfolios from insurers, hereknown as guaranteed funds, have beenexcluded due to a lack of transparency ofee structure. Of 49 portfolios availablefrom 23 different managers (not countinguaranteed funds), 42 have been includein this analysis.Table 2 illustrates the results; furtherdetails are available from the author. Fora self-administered fund of average sizeof approximately R150m, assetmanagement charges average around 0.6per cent and most funds of this size canexpect to pay between 0.50 per cent an0.70 per cent per annum. Smaller fundsmight expect to pay up to 0.15percentage points more and larger fundsaround 0.10 less.

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    Costs of saving for retirement in South Africa

    Table 2: Institutional asset management costs in South Africa, equal-weighted managersAmountinvested (Rm) Mean annual chargeas % of assets Standard deviation (%)


    Source: Alexander Forbes and author calculations.

    Table 3: Retirement fund cost ratios for participating actuarial valuation providers



    Mean ratio (%)(unweighted)8.911.516.09.09.8

    Mean ratio (%)(weighted)5.15.912.35.84.4


    Percen tiles (

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    Table 4: Regression statistics for retirement fund cost ratios versus lvaluation providers (membership) for participating actuari

    Provider DB or DC R-square Slopestatistic co-efficient p-value Regression ratios (%)500 members 100 members 40 member








    12.517.418.212.216.4DB : defined benefit plans; DC: defined contribution plans. *The number of observations in this group is low andthe results are unreliable. The lowest cost ratio in the set is 2.1 per c ent.Note\ The cost ratio used is the total reported adm inistration cost, including actuarial fees, for the most recentreporting period, divided by the total employer and member contributions, net of risk benefit contribution costs.'Regression ratios' show the points on the regression line for each membership specified. The p-value providesmeasure of the significance of the overall fit and of the slope f-statistic.Source: Participating actuarial consultants and author calculations.

    regressed ratio for a fund with 40members is more tban twice thecorresponding ratio for a fund with 700members.Information provided for a muchlarger set of defined contribution fundsnot subject to valuation confirms thesepatterns. Median ratios in size bandsrange from approximately 6.0 per centfor funds of more than 1,000 membersto over 22.0 per cent for funds of 20

    members or fewer.A charge ratio range of 6-12 per centof contributions captures an acceptableproportion of all funds, but ratios as lowas 4 per cent and as high as 22 per centprovide reasonable estimates of the moreextreme circumstances of some funds,without including all cases. Using theRegistrars figures for industrycontributions and assets, these ratios areequivalent to a 'core range' of 0.370.73per cent of assets and an 'outside range'of 0.24-1.34 per cent.Other retirement fundThe Registrar's report suggests that thesecosts together average around 2.8 percent of contributions. This may representan understatement of reality, consistentwith the experience for assetmanagement and administration costs, butit is difficult to confirm or refute this.

    Summary of analysis of occupationalretirement fundsRetirement fund costs are extremelyvaried. There is a clear relationshipbetween fund size and cost incurred. Buthere is also a considerable element ofvariation apart from the size relationship.Combining the analysis discussedearlier, and converting ratios to ensureconsistency of measurement, gives a 'corrange' of between 17.0-27.1 per cent ofcontributions, equivalent to a range of1.04-1.65 per cent of assets per annum.An 'outside range' of between 13.438.7per ce nt of contrib utio ns is sufficient toencompass mean costs within anysubdivision by size, but not outliers. As percentage of assets, these figures areequivalent 0.81-2.36 per cent of assetsper annum.

    Individual policiesConventional business wisdom suggeststhat life assurance policyholders are notsensitive to cost. This suggests thatanalysis of charges in this sector is moreimportant than in others.Methodology and dataThe model and assumptions set out inthe section 'Methodology andparameters' are used to analyse these

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    Costs of saving for retirement in South Africa

    Table 5: South African life policy co st ratios for 40-year saving period at average asset man agement feeReduction in yield (%) Charge ratio (%)

    R200 starting premiumFirm A retirement annuityFirm A provident fundFirm B retirement annuityFirm C retirement annuityFirm D retirement annuityFirm D provident fundR 1,000 starting premiumFirm A retirement annuityFirm A provident fundFirm B retirement annuityFirm C retirement annuityFirm D retirement annuityFirm D provident fund



    Source: Participating life offices and author's calculations. Assum ed 10 per cent annual rate of return on assetsand 7 per cent annual rate contribution growth.

    costs. Model policyholders earningrespect ively R24,000 and Rl20,000, andcontributing 10 per cent of their incometo their policy are assumed.^^ The chargeratio and reduction in yield have beencalculated for a 10-, 20-, 30- and40-year saving term.Providers offer a range of investmentoptions at different costs. The mid-point

    of the range of asset management chargeshas been used for illustration, but theextremes have been calculated as well.With-profit products have been excludeddue to non-transparency of costs to theclient, consistent with their treatmentunder occupational retirement funds.Data have been obtained from fourfirms covering approximately 80 per centof the market. All of these firms refer totheir standard tax-ex em pt p rodu ct as a

    retirement annuity. Two of these firmsalso offer a low-cost alternative withsignificantly reduced choice and lowercharges, designed principally for thosesmall groups of employees for whom anoccupational fund is impractical. Thesehave been referred to as provident funds.ResultsResults are sum^marised in Table 5;further detail is available from the author.

    Charges are high: The mean unweightedreduction in yield across all sixcontracts for policies with contributionsstarting at R200 per month is 2.43 percent per annum and the equivalentcharge ratio 38.6 per cent.Charges are higher for small policies: N o tsurprisingly, owing to the fixedcomponent of the policy fee, ratios arehigher for low-contribution policies.All contracts show this effect to someextent, depending on the relationshipbetween fixed and variable costs.The provident fund arrangem ents arecheaper than their retirement annuitycounterparts: The firms that offer bothretirement annuities and providentfunds have succeeded in providing acheaper alternative to the retirementannuity, though the difference isgreater in the case of Firm A.Three of the retirement annuity productshave very similar charges: Firm B offersby far the best value for money in aretirement annuity. The other threeretirement annuities are remarkablyclose in their charging levels, despitehaving very different chargingstructures. Differences are greater atshorter policy terms.The range of costs is high: The di f ference

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    Table 6: South African mean un it trust cos t ratios for 40-year saving period (standard deviation in brackets)Reduction inyieid (%) Charge ratio (%)

    CashIncomeBondsBalancedEquityEquity passiveInternationalOtherAil funds

    0.74 (0.37)0.93 (0.27)0.97 (0.28)1.73(0.28)1.80(0.34)0.94 (0.27)1.87 (0.42)1.77(0.31)1.58(0.37)

    14.14(6.22)17.70(4.51)18.25(5.03)29.92 (3.98)30.83 (4.56)17.64(4.60)31.65 (5.64)30.42 (4.41)27.43(5.11)

    Assumed annual rate of return onassets 10 per cent and annual rate of growth of contribution 7 per cent.Source: I-NET Bridge inassociation with MoneyMate, and author's calculations.

    between the cheapest and the mostexpensive might be regarded asunacceptably high, particularly as theimpact of cost is unlikely to loom largein the mind of most prospectivepolicyholders.

    Analysis ^vas carried out across chargetypes, commission, asset-based chargesand administration charges. Patternsbetween providers were markedlydifferent, suggesting a lack ofcompetitiveness and transparency acrossthe industry.

    Unit trust productsSouth African unit trusts are likely toplay a leading role in retirement funding,says Di Turpin, executive vice-chairmanof the Association of CollectiveInvestments. 'Because of their simplicity,transparency, flexibility and costeffectiveness, unit trusts are being usedincreasingly as a fundamental buildingblock of virtually any investment andretirement vehicle today' (author'semphasis) . *Methodology and dataData have been provided by I -NE TBridge in association with MoneyMatecovering the period 2002-2003. Of the457 funds on the MoneyMate database.

    369 are included in the charges database.Thirty-four of these have been discardedfrom the analysis for reasons includingcharges expressed as a range or as a^veighted average of domestic andinternational holdings; performance-basedcharges; initial charges that depend onthe size of the investment; and a fewcases of zero charges throughout. Thisleaves 335 funds with complete andreliable initial and annual charges.

    The data cover the whole of the unittrust industry, not just the portion withtax benefits. This brings into questionthe relevance of the data set toretirement saving. The mix of assetclasses suggests a savings patternconsistent with long-term retirementsaving and fairly close to thecorresponding mix in occupational fundsand have elected to use it in total.

    The methodology is as described inthe section 'Methodology andparameters'. Charge ratios and reductionin yield have been calculated for everyfund for 10-, 20-, 30- and 40-yearsaving terms.ResultsTable 6 provides the reduction in yieldand charge ratio for each category over a40-year investment period.^*^ The averagereduction in yield without weighting forassets under management is 1.58 per cen

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    Costs of saving for retirement in Southi Africa

    Table 7: Summary comparison of South African savings channelsChannelRetirement funds (narrow range)Retirement funds (wide range)Individual policiesUnit trust products

    Charge ratio (%)Low17.013.426.722.3



    in yield (%)High1.652.362.801.95

    Note: These figures are not designed to be directly comp arable. Definitions of ranges, in particular, have beendetermined in different ways an d are intended to give a reasonable impression of the spread of results.Source: Various sources as disclosed in the main text.

    per annum, equivalent to a charge ratioof just u nde r 27.5 pe r cent. S tandarddeviations across all unit trusts are 0.37per cent and 5.1 per cent for thereduction in yield and charge ratiosrespectively.

    The analysis shows an intuitiverelationship between the charges for eachclass of assets. Cash funds are cheapest,followed by bond funds and those thatdescribe themselves as 'income funds'.Balanced, equity, international and allother funds are fairly closely bunched,with the exception of funds that couldbe identified as passively managed, whichhave overall charge levels closer to thecash and bond funds.'"

    The analysis suggests that the unit trustindustry offers fair value for money toretirement savers. A reduction in yieldrange of 1.201.95 per cent captures asubstantial proportion of South Africanunit trust funds and there is little reasonto suggest that funds earmarked forretirement are significantly cheaper ormore expensive. These figures areequivalent to charge ratios of 22.332.5per cent.

    SummaryTable 7 summarises the analysis of SouthAfrican costs. Comparison across channelsis difficult. There are differences incalculation methodology, data sources,employer sponsorship and the flexibilityavailable to savers. The comparison of

    unit trust products to individual policieshas been criticised as meaningless becauseit ignores the fact that tax-deductibleunit trust products are not activelymarketed while the life offices have aconsiderable network of advisers tosupport.

    It is nevertheless clear that individualpolicies are generally more expensivethan unit trust products, in turn moreexpensive than occupational funds.

    International comparisonWhat is more concerning is that all ofthese vehicles appear expensive againstinternational benchmarks. Again,comparison is difficult: very few nationalpension systems are directly comparablewith South Africa's and the internationalresearch focus has been on these systemsrather than on the unit trust or insurancealternatives.^^

    Overall, however. South Africa'soccupational system does not comparewell with international counterparts,despite its relative maturity andsignificance in the national economy.Nearly all countries studied experiencedlower average costs than South Africa,the exception being Croatia, with ayoung and inefficient system, and parts ofthe Australian system where choice andflexibility is high.

    The unit trust industry appears tocompare well with the alternativesconsidered, notably the US mutual funds

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    industry. Life insurance products, on theother hand, compare poorly withinternational alternatives. Commentatorsin South Africa have suggested that this isin part due to low average contributionsand short average policy terms.

    Policy implications andfurther research'Financial regulators and supervisors areconfronted with an increasingly complexglobal environment in which the traditionaldistinctions between financial institutions andbetween banking and other types of financialactivity are blurred. The complexity of thefinancial environment is increased by thespeed with which portfolios can change, andby the globalisation of the operations ofmajor financial institutions and marketsoutpacing the national accounting, legal andsupervisory systems on which safety andsoundness of individual institutions andfinancial systems rely'''''

    A number of policy alternatives suggestthemselves.Closure of channelsThis paper does not recommend theclosure of any of the channels based oncost alone, or the removal of the taxconcessions currently offered toindividuals saving in any of thesechannels. Each vehicle offers a particulartype of saving and they vary in theirflexibility with respect to savings leveland investment choice.Consistent disclosure of costsCosts are not transparent. This isparticularly so in the life insurance andretirement funds environments.Difficulties as a researcher gathering datasuggest that industry consumers w^ouldfind it very challenging to compareproviders on the basis of cost.

    Life insurance products require policy

    value projections but these are notsufficient to claim transparency of coststo the consumer. The unit trust industryis better, helped by having a lesscomplicated range of charges, but hereagain, information 'would be improvedby providing consistently calculatedsummary ratios, with clear definition ofterminology.

    The issue is more complex in theretirement funds environment, buttrustees retain fiduciary responsibility toensure that funds are well managed andthis includes control over costs. Theyshould gather aU the informationrequired to ensure that costs incurred bythe fund are reasonable. Initiatives thatwould accelerate this process include: clear reporting requirements from theregulator, the Financial Services Board; industry analysis to enable trustees tomeasure fund expenses againstappropriate benchmarks; a requirement that asset managementcharges be disclosed separately from

    gross investment performance; industry initiatives increasing theawareness of the impact of costs andrecommending minimum disclosure tomembers, including discussion of theimpact of costs on member benefits.The reporting requirements of theCanadian Joint Forum of Capital MarketRegulators^"* for defined contributionarrangements might serve as a usefulstarting point. In the longer term,consistent measurement and pubhcationof charges across all parts of the industryis surely attainable and should be pursuedby the regulatory authorities.Cost limitationsThere are a number of cases in whichregulatory authorities have imposed costceilings on providers, with mixedsuccess.

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    Costs of saving for retirement in Soutti Africa

    In the complex South Africanenvironment, cost ceilings would bedifficult to apply. A consistent measureof pricing would need to be developedand careful analysis undertakenregarding the level of any proposedceiling. The consequences of theceiling -would need to be considered ascarefully as possible beforeimplementation, and measured as wellas possible thereafter. Regular review ofthe system would be required.

    Cost ceilings may be more appropriatein the case of a newly created class ofproducts, such as Stakeholder in the UK.New class of productsThe high-profile launch of theStakeholder range of pensions savingproducts in the UK makes an equivalentin South Africa an attractive option. ButStakeholder is just one optio n: a privatelymanaged, funded, voluntary system.

    Another option might be a nationalprovident fund, in line with many of thedefined contribution arrangements inSouth Africa, but centrally managed toensure economies of scale. If a new classof products were to be set up, whateverform it took, it should at least bestraightforward to understand andimplement, inexpensive to run, anddesigned for the benefit of the savers. Itshould also dovetail with existingarrangements, reducing the potential forunintended consequences like lowersaving in other areas.Lessons from overseasMany of the benefits to be gained fromobservation of experience outside ofSouth Africa can only be applied to amandatory system, or at least a voluntarysystem with considerable national reach.For completeness, however, these lessonsare listed as a reminder of the policysteps that might bring benefit to theSouth African environment:

    centralise elements of retirementsavings administration; look for ways to develop economies ofscale; restrict the set of allowable charges; fmd ways to impose limits onmarketing costs; establish limitations on portfoliofreedom that reduce costs withoutunduly restricting investment choice; shift costs to other areas, by postponingthem to later generations or by movingthem to other parts of the economy; find ways to cross-subsidise thelow-income earners.Further researchThis analysis represents the first attemptin South Africa to measure administrationcosts in a consistent manner acrosschannels. The publicity that it hasgenerated, both in the personal financepress and in policymaking circles surelydemonstrates this. Consideration shouldbe given to further research in a numberof areas: Obtain and analyse deeper, morewide-ranging data, particularly in theoccupational funds industry. Consider the impact of violations ofthe assumption of lifetime contributionsand seek to understand actual SouthAfrican saving patterns. Investigate the return-reducing impactsof implicit costs in investment products. Conduct a deeper comparison of thechannels, taking into accountdifferences in the design and objectivesof the alternatives. Consider in more detail the linksbetween charges and policy: how tospread total costs across a system iscomplex, economically andphilosophically.

    'Some analysts treat loweringadministrative charges as the only goal of

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    designing a pension system. I have tried tospell out the important trade-ofFs involved.Lower administrative charges can involvesubstantial constraints on individual choiceof pension provider and of pension-fundportfolio and limits on competition. Thisconflicts with other goals of pensionreforms and might adversely affect pensionfunds' net rate of return.'^^

    This repor t sheds some l ight on the costsof saving for retirement, but these costsare only one piece in a complex puzzleaffecting the prosperity of South Africa'scitizens in their golden years.

    AcknowledgmentsThis research has received financial assistance from theActuarial Society of South Africa, gratefullyacknowledged, but it has been carded outindependently of the Actuarial Society and the author'semployer, SI Investments. The author could not havecompleted this research without a great deal ofassistance, received with gratitude. The responsibility forany errors in analysis and interpretation is entirely theauthor's.

    References1 South African Government (2002) 'Transforming thePresent Protecting the Future' , Report of the

    Cominittee of Inquiry into a Comprehensive Systemof Social Security for South Africa (Taylor),Consolidated Report.

    2 HelpAge International (2003) 'Non-contributoryPensions and Poverty Prevention: A ComparativeStudy of Brazil and South Africa', supported by theUnited Kingdom Department for InternationalDevelopment .

    3 Ferreira, M. (1999) 'The generosity and universalityof South Africa's social pension system', TlieACP-EU Courier, No 176, July-August, pp. 55- 56 .

    4 HelpAge International (2003) op . cit.5 Ferreira (1999) op. cit, p. 55.6 South African Government (2002) op . cit.7 This study was first presented, in a significantly

    longer format, to the 2004 Convention of theActuarial Society of South Africa. The publicity thatit generated, from extensive coverage by thepersonal finance press, to an appearance by theauthor to the Finance Committee of Parliament,suggests that the objectives of the analysis are beingmet and that policymakers are paying attention.

    8 A 1 per cent of assets annual management fee isequivalent to 14.13 per cent of every premium overa 30-year policy and a 2 per cent fee equivalent to25.90 per cent, assuming contribution growth of 7

    per cent pa and investment return 10 per cent pa.The corresponding figures over a 40-year policy arerespectively 18.94 per cent and 33.70 per cent.

    9 Whitehouse, E. (2000) 'Administrative charges forfunded pensions: An international comparison andassessment'. World Bank Social Protection DiscussionPaper Series.10 Murthi, M., Orezag, J. M. and Orszag, R (1999)'Administration costs under a decentralised approachto individual accounts: Lessons from the UK', WorldBank, presented at New Ideas About Old AgeSecurity World Bank conference, Washington DC,14th15th September.

    11 James, E., Smalhout, J. and Vittas, D. (2001)'Administrative costs and the organization ofindividual account systems: A comparativeperspective', in 'New Ideas about Old Age Security',Holtzmann, R. and Stiglitz, J. (eds), World Bank,Washington DC.

    12 Devesa-Carpio, J., Rodriguez-Barrera, R. andVidal-MeliB, C. (2003) 'Administration costs for theafFiliate in individual account systems: Assessmentand international comparison'. University ofValencia, Spain, Mimeo.

    13 Diamond, P. (1999) 'Administrative costs andequilibrium charges with individual accounts'.National Bureau of Economic Research, WorkingPaper 7050.

    14 Whitehouse (2000) op . cit.15 Ibid.16 Devesa-Carpio et al. (2003) op . cit.17 For example, most policies impose a monthly rand

    deduction called a policy fee. This is a relativelysmall amount, but is rarely fixed for the duration ofthe policy. Inflationary increases to the policy fee aremore easily modelled through the model thanthrough a formula.

    18 This was tested when setting up the model andseparately when analysing each of the product typesdescribed in the analysis of costs section.

    19 Murthi et al. (1999) op . cit.20 James et al (2001) op . cit.21 Trustees of occupational retirement funds are limited

    to investing 75 per cent of the assets of the fund inequities, for example.

    22 Readers are referred to the annual reports of theRegistrar of Pension Funds, available at the websiteof the Financial Services Board, for moreinformation on the South African retirement fundenvironment (

    23 Registrar of Pension Funds (2002) 'Forty-thirdAnnual Report 2002', Financial Services Board,South Africa.

    24 Registrar of Pension Funds (2003) 'Forty-fourthAnnual Report 2002', Financial Services Board,South Africa.

    25 The effective date of the Alexander Forbes survey is31st December, 2001.

    26 The sample has smaller funds than the set ofself-administered funds as a whole, which may helpto explain the difference.

    27 Occupational retirement funds are subject to a

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    Costs of saving for retirement in Soutti Africa

    bewildering array of costs as listed in the Registrarsreport. Examples of these costs include salaries, rentand office expenses, auditors' fees, secretarial feesand an item referred to by the Registrar as 'all otherfees' include items from Financial Service Boardlevies to trustee training costs.

    28 The average contributions to policies lie comfortablywithin the range of R200 to Rl.OOO suggested bythese model points.

    29 Turpin, D. (2003) 'Likely leading role in retirementfunding'. Business Day, 26th November, p. 20(http://w\

    30 This period is surely unrealistically long for a savingsvehicle as flexible as the unit trust, but it providesthe basis for comparison with other products andwith the results of international studies.Corresponding figures for other investment periodsare in the appendix.

    31 Closer analysis of the passively managed funds showsthat they are more expensive than bond funds atshort terms and cheaper at long terms. This reflectstheir higher average initial charge than the bondfunds and lower average annual charge.

    32 A nuniber of authors need to be acknowledged forthe cost analysis of various international systems:Anusic, Z., O 'Keefe, P. and M adzarevoc-Sujster, S.(2003) 'Pension reform in Croatia', World BankSocial Protection Discussion Paper Series 0304;Andrews, E. (2001) 'Kazakhstan: An ambitious

    pension reform'. World Bank Financial SectorDevelopment Department; Chlon, A. , Gra, M. andRutkowski, M. (1999) 'Shaping pension reform inPoland: Security through diversity'. World BankSocial Protection Discussion Paper Series 9923;Devesa-Carpio et al. (2003) op. cit; Diamond (1999)op . cil; Fornero, E., Fugazza, C. and Ponzetto, G.(2004) 'A comparative analysis of the cost of Italianindividual pension plans'. Center for Research onPensions and Welfare Policies, Working Paper 33/04;James et al. (2001) op. cit; Lasagabaster, E., Rocha,R. and Wiese, P (2002) 'Czech pension system:Challenges and reform options'. World Bank SocialProtection Discussion Paper Series 0217; Mitchell,O. and Bateman, H. (2003) 'New evidence onpension plan design and administration expenses:The Australian Experience', University of NewSouth Wales; Murthi et al (1999) op. cit; Rocha, R.and Vittas, D. (2001) 'The Hungarian Pensionreform: A preliminary assessinent of the first years ofimplementation'. World Bank Policy ResearchWorking Paper 2631 ; and Whitehouse (2000) op. cit.

    33 Marcus, G. (2002) 'Financial Services Board AnnualReport 2002', Financial Services Board of SouthAfrica.

    34 Canadian Joint Forum of Financial MarketRegulators (2004) 'Guidelines for CapitalAccum ulation Plans', 28th May, Joint Fo rum ofFinancial Market Regulators, Canada.

    35 Whitehouse (2000) op. cit.

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