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PENSION PENSION REFORMREFORM…Fundamentals of
Presentation to the Pencom Conference
Elias Masilela
Theme of conference Investment…? Basic fundamentals remain important
i. Retirement system can never be over-mature
ii. It cannot be implemented in isolation of other reforms
iii. Investment is an intermediate step, yet an important one
- It assumes that money has been saved and available for investing
- Savings are inadequate in SA…
- Savings performance has been a global concern in the past
Aim of presentation
Highlight the importance of a sound
retirement design
Identify the importance of sound
regulation
Interrelationship between retirement
saving, investment and growth
Road map Why retirement funding Social objective function (SOF) Hurdles to SOF – value chain Why reforms Other social considerations Role of sound investing Role of regulation in investment
environment Balancing financial and social returns Conclusions
Why retirement funding?
Consumption smoothing
Deal with household vulnerability
Poverty alleviation amongst the elderly
Income redistribution
Manage long term fiscal risk
Adequacy of savings
At macroeconomic level, improve saving/investment
balance
Deal with a rising passivity ratio
Role of retirement savings (1)
Role of retirement savings (2) Source of long term savings Financial market deepening Enhanced intermediation Catalyst for efficient trading and
settlement system Influence corporate governance
i. Particularly under mandatory regimeii. PIC in SA
Conditions for success Investment policies are critical
i. Buy and hold has minimal impact on liquidity
ii. Dynamic trading related to short-term speculative positions
Geographical limitationsi. Exchange control restrictions
Implications of poor saving
Higher cost of capital
Low investment thresholds
Increased fiscal costs and reduction in social
and economic delivery
Poor growth
More difficult to deal with poverty
Household vulnerability
Saving decisions
Source: Eighty20, 2007, The Savings Market for the Poor
Short term savings leading
0
10
20
30
40
50
60
1 2 3 4 5 6
Stokvel
Pension/Provident fund
Retirement Annuities
Savings/Transaction
LSM
%
Source: Finscope South Africa 2006
Social objective function
Multi-pronged objectives Saving for retirement cannot be the
only objective Policy should deal with all other
societal objectives Income distribution is major challenge
i. Inadequate incomes to saveii. Lack of information and educationiii.Rampant poverty
Social security becomes an imperative
Time value of consumption?
Current stateEnd state
(Retirement)
•What retirement amount is adequate? Replacement ratio
•What form of retirement is appropriate?
•How many people will reach retirement?
•Preserving income growth
•What level of welfare should society enjoy?
•Ability to manage immediate risks (death, disability, unemployment)?
•How meaningful is retirement funding, therefore?
•What is the aim of the retirement design?
•Retirement and/or social security?
•How many people can afford to save for retirement
Transition to retirement
•For low income earners, risk and current welfare is more important•For high income earners, retirement is more important
Social Security defn.“… an institutional arrangement, driven by the state to secure the welfare of members of society through securing a certain amount of minimum income, during their productive years and in retirement. It is a system that prevents destitution in the case of members of society faced with incapacity and unemployment. It is a highly distributive institution that relies on the principle of solidarity amongst the income capable and the less income capable…”
The design of such system varies from society to society depending on the underlying philosophies and circumstances.
Hurdles to social objective function
Value chain
Retirement savings = (Replacement ratio)
+ Contributions: ƒ(Ŷ, Cons. behaviour…)
+ Returns: ƒ(ř, Ρ˙, choice of manager…)
+ Period to retirement: ƒ(Ŷ stability, Ē/Ū…)
- Leakages: ƒ(Т, Ρ˙, erratic Ē, Intermediate
costs, ancillary benefits…)
Conditions
Sound macroeconomic policies
Effective regulation
Robust accounting and legal standards
Information symmetries/transparency
Consequence
If objective function is sub-optimal or
society fails to realise optimality
…Need for reform
…Any resistance often is imposed on
the state
Why reforms
Concerns of most economies Cost of provision Poor efficiency Lack of competition Poor coverage Future fiscal risk Lack of trust of government and politicians Design flaws Inability of state to administer
i. Poor fund management Inequitable benefits Regressivity in income distribution
Triggers for reformGlobally:
Reactionary considerations…
Short term budgetary
constraints
Demographic pressures,
ageing and dependency
ratios
Inefficient public systems
Untrustworthy
governments
South Africa:
Proactive considerations…
Long term fiscal abilities
Acute social imbalances
and dependency ratios
Inadequate private
system
Fragmented public sector
system
Backdrop to Chilean reform Considered it as a macro rather than a sectoral reform
Unsustainable PAYG systemi. Demographic pressureii. Abuseiii. Premature retirements
Reform had to be based on honest promises to deliveri. Guarantee promise way into the futureii. RDP and GEAR nostalgia…?
Key macroeconomic pre-requisitesi. Structural fiscal surplus targetting (1%)ii. Inflation targetting (3%)iii. Floating exchange rate regimeiv. Labour market flexibility
Economic impact of reform Labour market impact
i. Flexibilityii. Productivity
Shifting and sharing of riski. Government vs individuals
Poverty impact Industry impact
i. Employmentii. Firm efficiency
Fiscal impact
South African reforms
Why reform? Increasing access Increasing welfare Reduce dependency on the state
i. Adequacy of retirement savings Deal with household vulnerability Increase overall savings Increase shareholder activism
i. Empowerment of individual saver
Efficiency, sustainability and equitability
Feature of SA economy
Poor domestic savings (15%)i. Long history of government dissaving
Low inflation environment (6%) High unemployment (35%) Loe literacy levels Skewed income distribution High dependency ratios High poverty levels Rising marginal propensities to consume
i. Greater social transfers Financial liberalisation
i. Higher credit-financed consumer spending Low income levels
Implications
Cannot plan for retirement only
Social security is equally…, if not
more, important
i. South Africa does not have a
comprehensive social security net
ii. Huge gap between haves and have nots
Key proposed reforms Compulsory state retirement fund
i. Compulsory social security- Risk benefits and annuities
ii. Individual savings accountsiii. Critical contribution thresholdsiv. Wage subsidy
Administration of national fund by state? SOAP means test made non-binding
i. Double dipping Consolidation and pooling of funds Preservation Changes in tax treatment Common legislation Post retirement medical aid
Social security model
A B C
50-60%
40-50%
Social Security (DB) Individual
accounts (DC)
Death, disability, Annuities, Unemployment
•SOAG•CSG
Unfunded DB, from fiscus
Funded DB, from productively
employed
“A” is similar to “C” save only for
funding
Cross-subsidisation - solidarity
Basic social security and welfare - Universe
Opt-out option
Accreditation(Factors) Inflation linked
bonds
Guaranteed rates of return?
Retirement (DB)(Income based)
Macroeconomic consequence
Increased retirement provision Provide without risking job creation Poverty reduction Increased aggregate savings More competition on service provision Short term loss of business to private sector
i. Consolidation has positive impact on umbrella business
Expansion of markets Shift from supply to demand led market…
i. Reduced need for large marketing budgets
What is the net impact…?
Industry challenges identified Likely shrinkage of private sector participation
due to mandatory nature of scheme
i. Admin business
ii. Risk business
iii. Annuities business
iv.Asset management business
v. Benefit and other consulting business?
Role of sound investing
Case for sound investment Preserve purchasing power of savings
Mitigate for
i. Low contributions
ii. Leakage
Build confidence towards the system
Deal with short and long term
expectations
Sequencing Internationally, retirement saving leads
financial markets development In South Africa we started with financial
deepening to the detriment of the poori. Poor coverageii. Complex systems that excludes the average
personiii.Large conglomerates and high concentration
Role of deep capital markets Essential economic assets in their own
rightsi. Need to be treasured
Encourage better portfolio returns and risk management
Efficient diversification of investment Essential growth vehicles
Assets
-
200,000
400,000
600,000
800,000
1,000,000
1,200,000
1997 1998 1999 2000 2001 2002 2003 2004
Years
Am
ou
nt
(R)
66.0%
68.0%
70.0%
72.0%
74.0%
76.0%
78.0%
80.0%
82.0%
84.0%Assets of pension funds by fund type (R'm) As a share of GDP
Coverage
-
2,000,000
4,000,000
6,000,000
8,000,000
10,000,000
12,000,000
1997 1998 1999 2000 2001 2002 2003 2004
Years
Nu
mb
er o
f m
emb
ers
Membership
Why sound investing is critical Conversions from DB to DC
i. Shifting risk to beneficiaries
ii.Managing past and future conversions
Effective member representation on boardsi. Better skilled cadre of trustees (Numbers??)
ii.Deciding on the amount of investment risk that is appropriate for the members
Growing market volatility Corrosion on savings
Investment (1) In the age of DC funds individual bears the
investment riski. Trasparency in managementii. Competitive returnsiii. Beat inflation at all times
- Preserve purchasing power
iv.Take account of life cycle Costs remain an essential element of realising
good returns Socially useful investment Sound regulation
Why regulate investment Pension and insurance reserves are
biggest component of household wealth Protect savers Establish more certainty in the industry Ensure healthy returns over time Avoid over-speculation and risk taking
i. Exposure limits in particular to currency risk Ensure asset/liability matching Compensate for absence of strong and
transparent markets
Arguments re country limits Advantages Retains domestic
savings Capital market
deepening Forces creative
intermediation Encourages investment
in real economy Growth
Disadvantages Capital outflows and
possible flight Failure to reap benefits
of domestic savings Disallows divesification
Global rule of thumb
Thresholds for phasing out limits
i. Assets/GDP ≤5% Bonds
ii. Assets/GDP >5%, ≤ 20% Bonds and equities
iii.Assets/GDP > 20% Bonds, equities and
alternative investments
Global rule of thumb
Depends on
i. Risk appetite
ii. Sophistication of market and society
iii.Economic openness
iv.Macro stability
v. Regulatory effectiveness
Risk of regulation Over-regulation
i. Breeds bottlenecks and inefficiencies Potential abuse of resources by
governmenti. Asset prescriptionii. Inappropriate financing of government
deficitsiii.Poor returns to beneficiaries
Regulation in SA context Shifting focus from financial stability… Emphasise increased access
i. Poor ii. Previously disadvantagediii. People in outlying areas
Diversificationi. Relaxing limitsii. Prudent-expert rulesiii. Sound investment policy statementiv.Performance and transparencyv. Member choice?vi.Phasing out exchange controls
Investment decision challenge
Short versus long term views
Socially responsible investment decisions
i. Political or economic imperative?
ii. Are returns comparable?
iii.Is it compulsory?
iv.How conscious are owners of assets?
Investment decision challenge
Economic returns
Financial returns Social returns(Short-term) (Long-term)
(Long-term)
Risk of not doing this?
Summing up - Key themes End state Optimal replacement ratio DB vs DC Funded vs unfunded Benefit structure and design
i. Savings vs riskii. Annuity, Housing, medical
Compulsion vs voluntary savingsi. Incentives and impact
Preservation Appropriate regulatory structure
Conclusion Investment focus on its own, will be
inadequate to deal with our challenges Macroeconomic environment is
important Income levels should allow for adequate
savings first Sound retirement regime is essential However, sound investment is essential
for the realisation of comfortable retirement for our societies
