At the early stages of the Covid-19 lockdowns, the Organisation for Economic Co-operation and Development (OECD) in June 2020, published a paper called “Retirement savings in the time of COVID-19”. It identified amongst some of the main challenges arising from the coronavirus being:
- A decrease in the value of assets in retirement savings accounts from falling financial markets;
- An increase in liabilities from falling interest rates in retirement savings arrangements with retirement income promises (for example, defined benefits retirement plans and life annuity arrangements);
- A lower capability to contribute to retirement savings plans by individuals, as they see their wages reduced or lose their jobs, and by employers suffering financial distress; and
- A reduction in savings and compound interest earned as a result of measures intended to provide relief in the short term that can have a large negative impact in the long term, especially on retirement income adequacy (for example, contribution holidays, early access to retirement savings).
The OECD also called for regulatory flexibility by providing proportionate, flexible and risk-based supervisory oversight. This could be achieved through close co-operation between relevant stakeholders.
The South African approach
South Africa has had a history with inadequate retirement savings that is older than the Covid-19 pandemic. The pandemic itself was a catalyst for South Africa to introduce stronger preservation measures that policy makers wanted to introduce but faced resistance from different corners, including from labour.
In 2019, the so-called ‘default regulations’ introduced new concepts relating to default preservation, default investment portfolios and requirements for an annuity strategy. The approach was softer, encouraging better behaviour instead of enforcing it. Speaking at the FSCA’s Retirement Funds Conference in September 2019, then Divisional Executive of Retirement Funds Supervision, Olano Makhubela said “The new area of economics, called behavioural economics, has tried to give insight into dealing with some of these problems through analysing human behaviour. And its key message is that as humans, we can be inherently and justifiably irrational, because we procrastinate; we have doubts and cannot decide if offered too many choices; sale persons can take advantage of our ignorance; we excessively focus on the short term and we can be greedy! So important is behavioural economics that Richard Thaler was awarded the Economics Nobel prize in 2017… The default regulations were largely fashioned around behavioural economics.”
It was said that the default regulations needed time to mature in the system before its effects could be measured. As world events would have it, it would not be afforded that time.
Responding directly to the pandemic, on 26 March 2020 the FSCA issued Communication 11 of 2020 (RF) calling on funds that did not have rules allowing for relief to financially distressed employers, to apply urgently for rule amendments introducing same. The amendments would allow employers to only pay risk premiums during the identified period of relief so that members remained covered on the occurrence of an adverse event.
Continuing on the path previously set, on 1 March 2021, the Taxation Laws Amendment Bill brought in the compulsory annuitisation of provident funds. In the explanatory memorandum, it recognised the link between inadequate retirement savings post-retirement and receiving lump sum payments by retirees from provident funds. It was hoped that this would eventually lead to a decrease in the number of persons relying on old age grants.
“Never let a good crisis go to waste” was the motto that catalysed some of the changes brought about by the two-pot retirement system. But South Africa was fortunate enough to draw learnings from the experiences around the world. It was crucial that a balance be struck between allowing early access and mitigating its long term effects.
Early access was originally punted as a form of relief to financially distressed members during the Covid-19 lockdowns but given that the intervention of the two-pot system comes about four years later, it also addresses a long held concern by many in industry, that is the lack of preservation pre-retirement. It faced less resistance than other interventions perhaps because it dangled the proverbial carrot in the form of early access. But there are still concerns about whether this comes at the right cost.
Firstly, compulsory preservation is a concept that many South Africans are not accustomed to. Whilst the early effects may be warded off by the grandfathering of certain provisions and seeding capital, it will become felt once members realise that they no longer have the financial cushion that was previously available when their employment terminated, irrespective of the cause. It is a real concern that the effects of compulsory preservation have not been sufficiently communicated to the public and what effects this lack of understanding will have on social cohesion.
Unscrambling the compulsory preservation egg will have disastrous consequences for retirement savings where early access has been exercised. Therefore, once we have gone down that path there is a very steep hill to climb back up. Awareness around the issue of compulsory preservation is therefore an important matter to be addressed.
Secondly, exercising early access will have long term consequences for retirement savings. We have heard all too often by experts about the impact that one percent of costs can have on the overall benefit at retirement, in some cases reaching up to a forty percent difference. Communication and education on this aspect of the two-pot retirement system is not lacking. As to whether members will pay heed to the free advice is yet to be seen.
There are no requirements in the two-pots legislation for a member to satisfy the fund as to the need for early access. Informative, thought provoking ways of educating members about early access should be implemented by the industry. Modelling the effects of early access is one way of doing this, including how an early access benefit would be calculated considering the monetary limitations and tax implications. A cost-benefit analysis would go a long way to informing a member about the potential impact of their decision to exercise early access.
Lastly and admittedly very speculatively, there could be unintended consequences of compulsory preservation through a lack of competition between service providers. Whether competition sufficiently exists in the current market is a matter for debate with most members participating because of employment conditions. Members need to see the value of remaining invested in a retirement fund and this should be the main incentive for wanting to preserve their benefits. Perhaps in the future we will see interventions by the policy makers that zooms in on the value for money that retirement funds provide. In the current market, it is not unheard of that a member who contributes regularly for over thirty years receives less than the amount contributed on retirement because of costs associated with administration and risk benefits. It is hoped that the two-pot retirement system will not amplify these type of issues but if it does, then appropriate policy interventions to combat it should be considered.