In June 2013, Treasury published its discussion paper into the charges in the retirement fund industry. That document is now over 5 years-old but it is worth revisiting this as ASISA sets outs guidelines for its members to disclose Retirement Savings Costs starting from March next year.
What was significant about this particular Treasury paper?
Treasury had published a series of papers discussing retirement reform prior to publishing this paper. For the first time, Treasury touched on the way in which the market behaved. Prior to this, proposals had focused on reforms to achieve better outcomes such as aligning pension and provident funds and aiming to ensure greater preservation on leaving an employer. Here, Treasury poked the bear – high costs and poor governance are as much to blame for poor outcomes as inadequate contributions, lack of annuitization and failure to preserve benefits.
What did Treasury have to say?
Among other issues raised in the paper, Treasury pointed out concerns unique to commercial umbrella relating to:
- Charge shifting – This issue relates to the ability of product providers who are both administrators and investment managers to shift costs between these product lines. An example is charging low administration fees while charging higher investment fees. Because employers are prone to only consider up-front charges (i.e. the deductions from contributions such as the administration fees), this methodology makes an umbrella fund look cheaper than it really is.
- Price discrimination – Price discrimination occurs in different forms. According to Treasury this “may be achieved either through changes in product design (level of investment choice, presence of guarantees, surrender penalties) which encourage self-selection by customers into differentially-priced products or uncompetitive headline prices, against which ‘discounts’ are offered through preferred distribution channels.” To experience this in practice one only needs to look at the practice of many umbrella funds of charging a lower administration fee when members invest in the sponsor’s investments as opposed to external investment vehicles.
- Cross-selling – Treasury realized that umbrella funds were being used for much more than retirement savings. Their comment reads: “sponsors of commercial umbrella funds may profit from cross-selling various services, such as living or conventional annuities, home loans, insurance products or investment services to fund members.”
The Retirement Savings Cost disclosure
“This measure may test some of the claims made by some of the new kids on the block about their charging models.”
Treasury also criticized the fact that there was no uniform way in which costs were disclosed: “Unlike in the retail market, there is no standardised disclosure requirement to allow customers to compare the costs of different products on the same basis. This lack of comparability is exacerbated by the large degree of flexibility in umbrella fund design and in the services provided to members and employers.”
ASISA has now responded to this criticism with the Retirement Savings Cost (RSC) disclosure. The RSC will include a disclosure over periods of 1, 3, 5 and 10 years of the following elements of the costs associated with retirement savings:
- Investment management
- Advice/consultant charges
- Administration charges and
Interestingly, the “other” category includes a variety of items which may interest consumers in their own right, such as the cost of the guarantee premium.
All said, the RSC is a move in the right direction in addressing Treasury’s concern about charge shifting. The RSC at least gives an indication to what degree administration and investment costs subsidise each other over time. This measure may test some of the claims made by some of the new kids on the block about their charging models.
Is the RSC enough?
Obviously, the RSC can’t and won’t address the issue of price discrimination. One administrator in the market charges almost 3 times the cost of its lowest administration fee for its top-tier administration offering. I wonder which administration fee basis it will be using in calculating the RSC? The RSC becomes an irrelevant measure if it is a moving target because of price discrimination applied at a member level. Unfortunately, for many of the leading umbrella funds this is the case. The RSC disclosure does not require ASISA members to stick to any one fee structure or to allow a client to select a fee structure for the disclosure.
When we consider cross-selling we don’t have to look far. In my 2013 presentation to the Principal Officers’ Association (as it was then known), I emphasised that risk costs need to be considered when a total cost comparison is made for retirement funds. There are a number of reasons for this:
· The 5 largest umbrella funds in South Africa are all operated by financial service companies with insurers attached to them. The approach in each of these funds to approved risk benefits is different:
- One allows only its own products to be used;
- One allows other insurers’ products to used but levies an additional administration fee;
- One allows other insurers’ products to used for employers with more than 100 members;
- One only allows employers to select from the products of the sponsor and one other insurer;
The last fund allows employers to select from a range of insurers. However, in this fund all of the consultants also work for the administrator and commission is paid to the administrator irrespective of the choice of insurer.
It is quite apparent that in the 5 largest umbrella funds, the sponsor will in almost all cases gather income from cross-selling on the risk products, whether this is through risk premiums themselves or through additional commission. My reading is that, except in the second instance above, the RSC will ignore the impact cross-selling has on the income of the sponsor. Even then, the impact will only be to increase the administration component of the RSC.
It is, however, acknowledged that the RSC goes beyond these 5 players in the market and most of the smaller umbrella funds do not find themselves in this position. For these funds, the RSC is likely to be a meaningful measure of the fund costs.
During the 1990s and 2000s, South Africa moved to a defined contribution environment in which retirement fund contributions were defined as a percentage of salary and in most instances this percentage included the cost of risk benefits. It stands to reason that because a provider charges very high risk benefit premiums, its allocation to retirement funding in an inclusively funded scheme (i.e. where the employer does not pay for the risk benefits in addition to the retirement fund) will be lower than competitors. Even if the RSC for this scheme is the lowest does it mean that this is the cheapest solution. One cannot say.
The fact that the RSC ignores the cost of risk benefits means that there is no single measure that a consumer can look at to determine the overall cost of the entire benefit package.
The only circumstances that will allow for this are if:
- The umbrella fund allows for freedom of selection of risk provider. (And most don’t – see above)
- The risk benefits are provided through policies not attached to the umbrella fund.
(I won’t go into the merits of attached versus unattached benefits here save to say that I’m certain that it was not the intention of the authors of the RSC for this measure only to be useful in this instance.)
Where to from here?
The RSC is not perfect, but it is a step in the right direction.
The RSC definitely does not replace the need for good advice, just as the EAC in the retail space does not do so. Cost is not the only factor that should be considered in selecting an appropriate retirement fund solution. You wouldn’t buy a car just because it was the cheapest, so why would you buy a retirement fund because it is the cheapest. Other factors including track record, ability to ease the administrative burden and good governance are bit a few to consider. A good consultant will be able to advise clients on the best way to manage their employee benefit programmes and to find the best solutions that meets their needs at an appropriate level of cost.