A new course for Defined Contribution funds

By Danie van Zyl, Head: Guaranteed Investments of Sanlam Employee Benefits

Research conducted by Sanlam into the South African retirement industry shows that employers have a vital role to play in the continuing evolution and improvement of Defined Contribution (DC) Retirement Funds.

Employers are uniquely positioned to assist members because they:

• have the necessary infrastructure and access to members to facilitate communication to members;
• can utilise their new employee induction process to help members with their retirement choices when they join the employer; and
• can advise and assist members with preserving their retirement savings when they change jobs.

Becoming a proactive employer will help address some of the poor outcomes observed in our Sanlam Benchmark Survey over the last few years. This does not mean that other stakeholders do not have an important part to play as well, but a member’s journey to retirement starts on day one of employment. It is then that an employer can help put the member on the right track to a better retirement outcome. While working, as many as 51% of members turn to their human resources department for retirement queries.

Poor outcomes for South African retirees

• 51% of pensioners surveyed not making ends meet
• Trustees believe that only 13% of their members will retire comfortably

Evolution of the employer’s role in retirement provisions
With the shift from Defined Benefit (DB) to Defined Contribution (DC) retirement funds, the responsibility and financial risk of providing a pension in retirement has moved from the employer to the employee. Individual members now have to shoulder the burden of saving enough, investing appropriately and securing and managing their own retirement income. While some members thrive on all the flexibility and options available to them, many ordinary members find the range of choice bewildering.

Whereas in the DB environment, the employer could rely on actuarial and investment professionals to advise on how to manage the risk, the same level of expert advice is not usually available to DC fund members. Moreover, our 2013 Benchmark Survey shows that an astounding 63% of members are not willing to pay for financial advice.  Instead of looking for help, these members often choose to ignore their retirement savings. This apathy manifests itself in a number of ways.

Member apathy

• 90% of members never revisit their retirement decisions made when they first joined their employer
• 41% of members invested in the default investment option “Do not really care where the money is invested”.
• 62% of members withdraw their retirement savings in cash when changing jobs, mostly to service debt

In a very real sense, many members belonging to a DC fund still have a DB mind-set. In other words, they’re not taking full responsibility for their financial wellbeing at retirement and have an expectation of some sort of paternalism and interventionism from their employer and trustees.

Member retirement choice
DC Fund members need to find their own annuity solution from an array of service providers on retirement. The Benchmark Survey showed that the biggest concerns members have on retirement is whether their retirement savings will last the rest of their lives (67% of members) and whether their retirement income would be sufficient (56% of members).

Given the extent of member apathy regarding their retirement savings and their dependence on the trustees during their working lifetime, it is unlikely these same members will suddenly become adept at securing an appropriate retirement income or, in the case of a living annuity, prudently  managing their savings over several decades. In stark contrast to the popularity of living annuities, 82% of pensioners surveyed wanted certainty of a guaranteed income for life. Only 18% would accept a 50% chance of a 5% higher of 5% lower income.

The risks confronted by members choosing a living annuity when they retire include:

• Retiring with inadequate savings, which will lead some to investing too aggressively after retirement and possibly suffering investment losses which they cannot sustain. Others may choose a draw-down rate which is too high, depleting their savings.
• Members not familiar with investments may invest too conservatively due to their fear of loss; this “reckless conservatism” may lead to their income being eroded by inflation.
• Members do not appreciate increasing longevity, causing some to outlive their retirement savings.

A new course for DC funds
Given the above findings, should one not design a retirement fund with the end result in mind, that being an adequate income in retirement?

A targeted retirement income should be the goal of the members and the trustees, and all benefit options should help members increase the likelihood of achieving this goal. This extends to nudging members in the right direction at every point where they need to make a choice, either through targeted communication or how the choices are designed and presented.

By the employers and trustees assuming a more active role, they can make a significant difference in members achieving a good outcome in retirement. These actions include:

Ensuring that members receive adequate longevity protection upon retirement through an appropriate annuity product.

• Giving members access to institutionally priced annuity solutions.
• Thoroughly vetting members’ default annuity options with the help of the Fund’s investment consultants.
• Helping members understand that accessing their retirement savings when changing jobs to finance debt or other discretionary purchases will have a detrimental effect on their ability to retire comfortably.

“Employers which take greater responsibility for the overall financial well-being of their workers, including through the design of their retirement funds, reap the rewards of a more stable and happier work force.”    National Treasury, 2013 Retirement Reform Proposals.

By taking the lead, employers can make a critical contribution to resolving our county’s retirement savings crisis – this is the ultimate goal of all stakeholders involved in this discussion.

Sanlam Life Assurance Company (Ltd) is a licensed financial services provider.