‘We’ve Lived through What Happens When You Offer Too Much Choice’

(March 31, 2014) — The UK must learn the lessons of South Africa to avoid defined contribution (DC) members making the wrong decumulation choices, according to African investment consultants RisCura.

Petri Greeff, director at the firm, told aiCIO that the changes to DC pensions announced by UK Chancellor George Osborne earlier this month would lead to poor decisions being made by many beneficiaries.

“Giving members so much freedom led to them shooting themselves in the foot in the longer term,” he said.

“South Africa shifted to DC in the late 1980s to early 1990s, so we’ve lived through what happens when you offer too much choice.

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“Now in South Africa, we’ve gone full circle and are dialling back some of the choices available to members.”

Osborne’s Budget announcement included a number of changes for the UK pension industry, including removing the need for DC members to annuitise their pension pot at retirement.

In South Africa, where this situation has been in place for more than 25 years, the vast majority of members go into an income drawdown arrangement—as many as seven in 10, according to Greeff.

While income drawdown products aren’t necessarily a poor option, how the members make that decision has been openly questioned.

“Inadequate advice, inappropriate incentives by advisors, and short-term views by investors have led to a flourishing income drawdown industry and dwindling, unpopular annuity market. This in turn has led to many members retiring using an insufficient vehicle that robs them of the retirement they deserve, after diligently saving during their working lives,” Greeff said.

Equating moving into income drawdown as “the same as requiring them to suddenly become their own investment managers”, Greeff explained that many financial advisors had been persuaded to recommend the product because they received more commission than recommending an annuity or cashing the pot in.

This is thought to be less of a problem for the UK market however, as the retail distribution review has effectively banned commissions being paid to advisors for recommending products.

On a more positive note, the change to allow DC members to have more freedom around how to use their pension pot at retirement had led to innovation in South Africa, something which could also be seen in the UK.

Having initially adopted a pensions liberalisation attitude similar to the one Osborne announced earlier in March, the national treasury in South Africa has effectively performed an about-face: it is now pushing DC schemes to offer safe, default post-retirement products that have been vetted by the trustees of the DC scheme in terms of suitability and cost.

While most are planning to offer a vetted income drawdown product as their default, some of the larger DC funds have opted for a new breed of product, the in-fund annuity.

“Traditionally an in-fund annuity referred to a guaranteed annuity. In-fund annuities aren’t standard practise for most trust-based DC schemes in South Africa, and are mostly done on an ad-hoc basis,” explained Greeff.

“Even then, this is only by the larger DC schemes that have the capability of dealing with the added complexity this brings. It is an attempt by DC funds to still offer defined benefit (DB)-like benefits in a post-DB world.”

The DC schemes that do offer this take on DB-like risk: the asset side of the balance sheet is exposed to investment risk, and liability side of the balance sheet is exposed to mortality risk. The pensioners carry very little risk at all. In addition, the same selection of managers are used at the point of retirement at the same low fees, negotiated on an institutional basis.

(March 28, 2014) — Pension advisors have expressed their dismay at the latest update to the Europe-wide directive on retirement schemes.

Yesterday, the European Commission released the latest version of its Institutions for Occupational Retirement Provision (IORP) directive—much of its detail was immediately picked apart by experts.

“Whilst the National Association of Pension Funds (NAPF) strongly supports initiatives to ensure that pension funds are well run, this new directive simply adds further costs and administrative burdens without delivering practical benefits for members,” said Joanne Segars, chief executive of the NAPF.

These costs come in the form of a one-off implementation fee of €22 per member, which the NAPF estimated to hit the UK’s pension funds alone by £328 million. An additional annual cost of up to €0.80 per defined benefit (DB) member and €3 per defined contribution (DC) member angered others, who cited recent moves by the UK government to make DC pensions more cost effective and attractive to savers.

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Dave Roberts, senior consultant at Towers Watson, was disappointed that after much “leaking” of documents suggesting the contrary, cross-border pensions would still be expected to be fully-funded at all times.

Roberts said the move went against the European Commission’s own assessment that it would “hamper IORP’s willingness to engage in cross-border activities”.

A call for better member communication was widely applauded, but Jane Beverly at Punter Southall saw irony in the regulation document.

“There is much to admire… but the proposal as it stands is fundamentally flawed,” said Beverly. “It requires the statement to fit into two pages of A4 in characters of an ‘easily readable size’ and then proceeds to take six pages of A4 to describe what should go into it! It also includes a requirement for graphical representations of the risk and return profile of each investment option.”

While all sides agreed that the basis of the directive—putting effective systems of governance and risk management at the heart of a pension—it attracted more criticism than praise.

The most damning reproach came for the impact assessment that was published a few hours after the original document. This document formed the basis for the establishment of the new rulings.

Towers Watson’s Roberts said that the assessment had collected responses from just three UK pension funds—out of a possible several thousand—was deplorable and made the conclusions “meaningless”.

“The impact assessment paints a picture of regimes not fit for purpose. The reality is that the impact assessment is not fit for purpose,” he said.

The full text of the European Commission’s report can be found here.