31 MARCH 2015ALEXANDER FORBES GROUP HOLDINGS LIMITEDINTEGRATED ANNUAL REPORT
OUR OPERATING CONTEXT
In Q1 2015 the South African economy grew by 1.3% on an annualised, adjusted basis and the formal non-agricultural labour market shed 115 000 jobs, while business confidence indices also declined. In 2014 protracted industrial action, combined with a mixed global economic outlook, depressed commodity prices and power supply interruptions all weighed on growth as well as investor sentiment.
Negative real wage growth has a necessarily adverse effect on the employee benefits and investment savings sector and, between December 2013 and December 2014, the number of South Africans in formal employment reduced from just over 9 million to 8.989 million. More positively, however, at 7.6%, average salary and wage increases in 2014 comfortably exceeded consumer price inflation (4% to March 2015).
While inequality and unemployment remain deeply troubling and seemingly structural features of the South African economy, the situation and prospects of those South Africans in formal employment have continued to improve; in the decade since 2004, individuals in the upper 5 to 10 LSM segment grew from under 50% to three-quarters of the population. This trend had a positive impact on the proportion of the population that is employable and that is likely to participate in savings and insurance. Also encouraging was the fact that in 2014 the number of credit-impaired individuals – at almost 10 million – began to show a slight reduction as lenders adopted more conservative credit policies in the wake of the African Bank crisis.
In 2005 it was authoritatively estimated that almost half of all employed South Africans had no retirement savings arrangements. Added to these numbers would be those individuals who were informally employed but also unable to access adequate income protections. The National Development Plan refers to this social security shortcoming as the ‘retirement savings and risk benefit gap’. The challenge remains as to how to close it – if mandatory contributions are not an option.
South Africans who do have access to structured retirement plans and investments have a high propensity not to preserve their accumulated benefits. This, combined with low participation in such savings mechanisms in the first instance, means that fewer than 10% of South Africans have sufficient funds to maintain their lifestyles after retirement. The policy reform that seeks to address needs to be driven with urgency and wider adoption.
Faced with sluggish economic growth and flat job creation, the South African retirement fund industry has approached what, at least in the short term, appears to be a state of near maturity. But this appearance masks the reality of a dramatically changing industry.
In the shift from the defined benefit to defined contribution model in funding the most significant change has been the shift in focus from the fund to the individual member. Legislation relating to TCF (Treating Customers Fairly) particularly pertains here. Trustees now need to be far more accountable as to whether outcomes for these individual members adequately and appropriately address their needs.
It has also meant that members now carry the most significant risk of all: their financial planning risk. In the absence of mandatory preservation and annuitisation, this means it will now fall to employers and trustees to help members come to grips with their financial viability.
Competing in this changed environment means several things for the industry. It means that administrators must now be able to provide sophisticated solutions that allow trustees to drill down to member level outcomes. It demands that programmes improving financial capability and decision-making by employees will become an imperative.
At the same time, rising operating costs and increased governance and compliance obligations has meant that many employers have elected to shift their administration from standalone retirement funds to umbrella schemes. As a result, between 2005 and 2013, the number of registered retirement funds decreased by more than half, from 5 855 to 2 271.
While public sector employment has grown to the point that it represents a quarter of formal employment, informed consensus opinion is that the fiscus is today incapable of supporting further growth. The net result of slowing employment and slower economic growth is that competition for retirement fund assets is at an all-time high, with the majority of new administration and management opportunities coming from funds seeking to switch their administrators and/or managers.
In those sub-Saharan countries in which Alexander Forbes today has an established presence, economic growth is a much more robust 4.5% and individual access to employee benefits, including provision for retirement, is gaining momentum. This is largely being achieved through legislative action which includes mandating formal employers to provide employee benefits.
Similar consolidation to that experienced by the retirement fund industry has recently characterised the medical schemes sector where the number of such schemes declined from 144 in 2000 to 87 in 2013.
Medical inflation remains a critical factor for the industry, particularly as few employers continue to contribute to post-retirement medical costs. Of all the financial planning burdens an individual needs to shoulder post-retirement, this remains one of the most challenging.
A Competition Commission investigation into private healthcare, which could have important implications for the pricing of healthcare in South Africa, commenced in 2014. Ultimately, however, the future of the medical scheme industry will remain in question until deliberations on the final form of our national health insurance are completed.
Today, three-quarters of South African pension funds are defined contribution (DC) schemes, effectively shifting responsibility for the individual’s post-retirement well-being from the employer to the member. This has resulted in a shift away from insurance-based annuities to the kind of market-linked living annuities and savings vehicles provided by collective investment schemes. In the past decade the South African savings pool has grown ahead of GDP with a marked shift of assets from insurance companies to unit trusts. Investment Solutions has been a direct beneficiary of these shifting preferences; between 2011/12 and 2014/15 Investment Solutions’ retail assets under management increased from R29.7 billion to R46.8 billion.
The South African Reserve Bank estimated the market for savings and investments at R5 trillion in June 2013. The challenge is how to develop investment solutions that can address hugely variable financial planning needs for these savings. In this respect, the multi-manager investment framework is ideally positioned to address rising demands.
The approximate breakdown of the savings and investment market is illustrated in the chart below:
Despite the significant growth of direct insurers, the short-term insurance sector is largely characterised by extensive inter-relationships and dependencies, with most distribution still being done by agents and brokers, whether tied or independent.
The non-life insurance market continues to grow, driven largely by the entry of previously uninsured individuals, most particularly those in the emerging black middle class. Given the fact that some 65% of vehicles on South African roads are still uninsured, the scope for growth is obvious and considerable. The market remains extremely competitive on price and the introduction of niche and differentiated products is seen as a key driver of premium growth.
The employee benefits opportunity
In 2013 Alexander Forbes launched the Benefits Barometer, an annual review of how effectively savings and financial well-being of South Africans was fairing. It pointed out the critical role that employee benefits played in South Africa in providing social protections for South Africans – at least for those South Africans who were employed.
In South Africa, the provision of social protection is multi-faceted and complex, consisting of social grants and free or subsidised state-funded services as well as support and relationships between families and communities. For South Africans in formal employment, however, employee benefits are the primary source of social protection, a critically important part of the social safety net. This social protection for the formally employed underpins the performance of companies and of government, performance which grows the economy while reducing the burden on the tax base, which currently devotes an unsustainable share of resources to social grants.
FIXING A FRAGMENTED SYSTEM
But equally, it is pointed out that, as a whole, the provision of these benefits and protections was fragmented, with key stakeholders – employers, government, the financial services industry and, most importantly, members and their representatives – not working as effectively as possible to deliver the best possible outcomes.
Even at the best contribution levels, provisions hardly get the individual to an acceptable replacement ratio at retirement, implying that most employed individuals today, will be significantly worse off once retired. At the point of resignation, retrenchment or retirement, there is no mandatory default to preserve or annuitise past contributions, further eroding the long-term retirement fund prospect of individuals who often ‘cash in’ their pension provision to fund much needed current expenditure. In the final analysis our research suggests that the average employee is ill-equipped to make decisions that adequately balance her/his needs and risks over the period of her/his employment. The challenge for many individuals is also balancing current financial needs with providing for future income as well as balancing provision for income and adequate risk protection.
Here is where we need to embark on an expansive collaborative effort between all the stakeholders to ensure that members are indeed delivered the protections they require. More importantly, if we want employees to engage and value these protections, we need to help them address their entire financial journey, not just the end part.
GROWING ROLE OF THE FINANCIAL SERVICES PROVIDER
Financial services companies such as Alexander Forbes are today shouldering a greater responsibility than ever before for the employee benefit outcomes that individuals and society need. With this greater responsibility comes greater opportunity – the opportunity to create real and lasting value.
Our commitment to SERVE our higher purpose requires us to step up our advocacy role and to catalyse a broader, more systematic dialogue.
Alexander Forbes has an 80-year track record, more than 4 000 skilled employees and 1.5 million individual customers who largely entrust their financial well-being to us. We believe that we have the know-how and the systems to help the key intermediaries (employers, trustees and unions, government, regulators and our own industry) to make a broken system work. That is why we invest so much in research and development (our intellectual capital) and in the skills and knowledge of our people (our human capital): so that we can contribute meaningfully towards achieving the real and rapid development of social value that the National Development Plan envisages.
(As much as we seek to create social value for South Africa, the value of our knowledge, insights and experience is increasingly being brought to bear on societies elsewhere in sub-Saharan Africa.)
We will make a difference by continuing to develop and refine our store of intellectual capital and then sharing that store freely with our fellow stakeholders – to work, together, to learn and to improve the core elements of the employee benefits framework: design, implementation and monitoring.
In designing benefits that work we will cooperate closely with employers and trustees to focus on the needs of real individuals, to design defaults that are the best they can be and that bridge the existing gaps between employer policies, legislation and insurance policies.
On implementation we will learn to communicate more effectively, investing the time and effort that it takes to understand individuals’ unique circumstances and expectations and at the same time demystifying complex concepts and products so that individuals are empowered to invest wisely and pragmatically in their own financial journeys. But time and effort cost money and we must understand which costs create value – and which costs destroy value.
Strategic intent addressing the big opportunity
Our Financial Well-being intervention (see here) aims to engage with other stakeholders to bridge the existing gaps in the employee benefits landscape and to begin to work towards a system that works for individuals, that gives them peace of mind.
Our 2016 – 2020 strategic intent (see here) maps out how we as a business will strive to achieve our ambitions to secure clients’ well-being, by constantly engaging with and empowering our people and by having a lasting and positive impact on society. By growing our social impact, by empowering individuals, trustees, management committees and employers, we are confident of growing our business, of creating sustainable value for our investors.
This is the great opportunity we as a business intend to action. This is the context in which we as Alexander Forbes creates value.