The amount of money managed by commercial umbrella retirement funds has increased almost four-fold over the past five years, but the average annual costs of one of the larger umbrella funds have decreased by less than 0.3 percentage points over the same period, the Actuarial Society of South Africa’s annual conference heard this week.
An actuary who is a consultant to this fund says although it may be too early to conclude that costs are declining for all umbrella funds, his research indicates that some costs are falling. It also shows that, within the next five years, umbrella funds could make a significant contribution to providing their members with a better pension.
David Gluckman, the head of special projects at Sanlam Employee Benefits, told the conference that costs are only one of the factors that affect your pension. According to research by Alexander Forbes, it is only the fifth most important factor (see “Seven factors that affect your pension”, below).
National Treasury, which is driving the reform of the country’s retirement-funding system, has said it expects costs to fall as the membership of, and the amounts invested in, umbrella funds increase.
Gluckman compared the average costs that a significant sample of members of the Sanlam Umbrella Fund paid five years ago with what they paid this year and concluded that costs have declined slightly.
The costs, measured as a reduction in yield (see “Definitions”, below), declined from an average of 1.9 percent of members’ annual savings to an average of 1.66 percent a year, he says. These costs are still well above what members of stand-alone pension funds are paying, independent actuary Rob Rusconi told Personal Finance. Rusconi’s research in 2005 estimated these costs to be between 1.04 percent and 1.65 percent of the savings in stand-alone pension funds.
Gluckman says it is not surprising that umbrella fund costs are higher: employers who participate in these funds have on average only 68 members and there is a fixed cost to administer the members who work for each employer.
Over the past five years, the savings invested in some 26 commercial umbrella funds have grown from R69 billion to more than R251 billion, while the number of members has grown from just over a million in 2011 to 1.5 million in 2016. Gluckman says this represents an annual growth in assets of close to 30 percent and an annual membership growth of more than seven percent.
Five years ago, Gluckman and another actuary, Megan Esterhuysen, looked at a sample of more than 36 000 Sanlam Umbrella Fund members. This year, the sample size was more than 94 000 members.
Five years ago, the average annual reduction in yields ranged from 2.5 percent a year for low-income earners (less than R3 000 a month) to 1.47 percent a year for higher earners (above R20 000 a year). Now the range is from 2.09 to 1.42 percent a year, Gluckman says.
He says the research was based only on data from the Sanlam Umbrella Fund, so he cannot say for certain that costs have similarly decreased for all funds, or if his findings reflect a decision by the fund’s board of trustees to pass on higher cost reductions to members on low incomes.
However, the average costs per income band mask the broad range of the actual reduction in yields across the sample, from 0.5 percent a year to five percent a year.
As some of the costs of saving in an umbrella retirement fund are fixed, the highest costs are typically paid by members who work for small employers.
But Gluckman’s research shows that, for members from employer groups of less than 10 members, the reduction in yield had decreased from above 3.5 percent to 2.4 percent, and the costs had fallen across most employer group sizes.
Another interesting finding was that the average contribution to retirement savings (after group life and disability costs) increased from 12.6 to 12.9 percent of salaries. Gluckman says this small increase in savings, combined with the lower average costs, could result in members receiving an eight-percent increase in their pensions when they retire after saving for 40 years .
Although Gluckman’s research does not reveal what members across the industry are paying to save in an umbrella fund, he says his sample compares favourably with statistics from four other large umbrella funds in terms of the size of the employer groups and the assets under management.
Average costs can be compared only if the same methodology and assumptions are used.
Gluckman says National Treasury, in its 2013 paper on retirement fund costs, compared the Sanlam Umbrella Fund’s reduction in yield of 1.9 percent a year with the cost of investing in an employer-sponsored defined-contribution pension fund (a fund that does not guarantee a pension) or a retirement annuity (RA) fund.
Although it is questionable whether the cost comparisons were valid, because of factors such as advice fees and employer subsidies, the paper stated that at the time, the cheapest RA was about 0.9 percent, and large pension fund costs were slightly higher, at about 1.1 percent.
Treasury said new-generation RAs (with underlying unit trust investments) have an average annual reduction in yield of 2.5 percent, while old-generation life assurance RAs cost about three percent.
The future looks brighter
It is likely that the cost of investing in an umbrella fund will decrease further in future because of increased transparency and increased competition, Gluckman says.
He says three large financial services companies, Allan Gray, Sygnia and Discovery, have launched, or plan to launch, umbrella funds.
And transparency around costs will also help. The Association for Savings & Investment South Africa recently introduced a single standardised measure of costs on retail savings products, known as the effective annual cost.
It is working on a similar cost measure for umbrella funds, which will be positive for competition, Gluckman says.
Gluckman was asked whether he thought the investment or asset management costs that umbrella fund members are paying should come down, because these make up the largest portion of the total costs. He confirmed that it was common industry practice to use the profits from investment management fees to subsidise other costs.
He says the average investment management fee on the Sanlam Umbrella Fund is 0.73 percentage points, and this could theoretically be reduced to 0.35 percentage points if every member used index-tracking investments.
One possible threat to umbrella funds is the call for social reform and the possibility that the government will introduce a regulated umbrella fund, he says.
However, it is also possible that the Financial Services Board will introduce legislation that supports better products and increased competition, and that a government umbrella fund could be just another competitor in the market, he says.
SEVEN FACTORS THAT AFFECT YOUR RETIREMENT
Alexander Forbes, in its 2014 Benefits Barometer, identified the following seven factors that most affect your pension and ranked them in order of importance:
1. Whether you preserve your savings when you leave a job;
2. Whether your contributions are a meaningful proportion of your salary, not simply a proportion of your pensionable pay, which is much lower than your total package;
3. How many years before retirement you start contributing to your retirement fund;
4. How your contributions are allocated between group risk benefits for death and disability and retirement savings;
5. The costs you pay on your retirement savings;
6. The fund’s long-term asset allocation strategy, or how much you invest in equities, bonds or cash; and
7. The additional value, or alpha, that your fund manager earns above the long-term asset allocation strategy.
An umbrella fund is a retirement fund for a number of employers that are either too small to afford a stand-alone fund, or do not want the administrative burden of sponsoring a stand-alone pension or provident fund. The umbrella fund is sponsored by a financial services company that provides services to the fund. The fund is run by a board of professional trustees.
The reduction in yield (RIY) is the reduction, in percentage points, in the annual return you earn over the period of saving and represents the erosion of value due to all the fees and charges you pay.