In South Africa, many of the processes put in place by funds leave members to their own devices. This essentially assumes that individuals are financially literate and are able and willing to make the right choices. Unfortunately this assumption is generally incorrect in the South African context with members generally being more financially illiterate and evidence showing that they are generally making inappropriate decisions (i.e. members in South Africa generally fall into the left side of the above spectrum). This then implies that more should be done to support members to ensure a good outcome
In achieving the above, a fund, Manco or employer’s governance budget and the roles and responsibilities depends on their experience, expertise and time available. The less expertise and time available the more issues should be outsourced to ensure appropriate management. In these cases, Trustees should ensure there is then appropriate review of the outsourced functions and its performance.
Appropriate structuring of Trustee meetings by applying outcomes-based governance
It is important to ensure that trustee meetings are structured to ensure that sufficient focus is given to the key issues impacting the achievement of the objectives of the fund.
Some key items can assist in facilitating this:
- Having a 3 year plan. Here, all the key strategic issues are focused on in addition to the ongoing operational matters. Such a plan ensures that the fund plots out its goals and plans appropriately ahead to ensure a long-term focus on the right things
- Ensuring that the trustee meeting is structured to facilitate discussions on the key factors impacting members’ net replacement ratios. This can be built into the 3 year strategic plan and every future trustee meeting can, for example, focus on one of the key issues impacting net replacement ratios as a theme (so for example, the November 2010 meeting can be dedicated to the non-preservation factor, the February 2011 meeting to the annuitisation factor etc).
- Ensuring that trustee meetings aren’t consumed unnecessarily by operational matters that could be dealt with in the ongoing operations of the fund. Importantly, the role of the board of Trustees is on the strategic operation of the fund. One should avoid a situation where the board micro-manages the operational issues to such an extent that it becomes the focus of a trustee meeting. Instead, a separate operational subcommittee could be established to deal with these matters and report to the Trustees at the regular trustee meetings instead.
- Ensuring that appropriate and information is included in agendas focusing on the key strategic issues. Here, the information should centre around the fund’s objectives, the key factors impacting those objectives and whether the fund is on track in terms of its goals set out in its long-term plan.
Ensuring that the roles and responsibilities are clarified for each of the issues impacting the net replacement ratios. Ensure that the structure is relevant to the time and expertise of board, and get appropriate advice and outsource functions where appropriate.
The Role of the Employer should be elevated in Outcomes-based Governance
Internationally as DC becomes more prominent, there is a realisation that the move has resulted in less employer involvement. There have been calls for more employer involvement and there may be regulatory changes to facilitate this.
“While employers are moving from trust-based to contract-based schemes [this is where the relationship is a direct one between the provider and member] to reduce their responsibilities, there are some indications that the regulators may wish to see employers take more direct responsibility for the oversight of contract-based schemes.” – (The Reluctant Investor, Pensions Institute)
In South Africa, there is a key role for the employer to play to ensure that the key strategic issues impacting retirement outcomes are focused on and addressed (this includes a prominent role in the provision of defined contribution pensions). These include:
- reviewing the contribution rates and benefits, their appropriateness and competitiveness
- Measuring the return on investment (since retirement funding plays a crucial part in the employee value proposition). Here, measuring employee satisfaction can provide a suitable proxy (this can, for example, assist in identifying where areas need to be addressed such as sections of employees wanting more flexibility for the benefits to remain competitive)
- Assisting with member communication and education. This is an area where the employer can make a significant difference (for example, making it compulsory for employees to attend a retirement induction, fund update or education initiative)
- Ensuring appropriate and targeted communication when an employee joins or leaves the fund
- Ensuring appropriate communication and assistance provided to dependants on death of an employee (often, families look to employers for assistance)
- Editorials – in staff communications / magazines on awareness / education of “planning for life”
- Contracting with firms for the advice and mechanisms to review such contracts with a set of criteria
The employer has an important part to play and should ensure it has a governance process that facilitates this and ties in with the scheme’s governance to ensure better outcomes for employees.
The Importance of Targeted Communication in Outcomes-based Governance
It is vital that the role of the employer be elevated and focused on more in South Africa. We believe that employers should, as part of their governance processes, establishing a benefit strategy committee (or some other review mechanism) that ensures that the retirement arrangements meet their objectives and remain appropriate for employees in the context of the total package of benefits provided by the employer. Such a review mechanism should also focus on the link between the employer and the retirement fund and ensure that relevant issues are addressed. By doing so the complete governance process (which includes the decision making of members, Trustees and employers) is enhanced and completed in a cohesive manner.
There is an increasing realisation that communication needs to be more targeted to ensure that members take notice of them and take appropriate action where necessary.
Occupational schemes put effort into providing information, including targeted communications, to scheme members.
Source : Defined contribution pension schemes : risks and advantages for occupational retirement provision, EFAMA
Targeting is about giving people information that they are likely to pay attention to because it relates to a relevant point in their lives
Employers and Trustees can use targeted communications to try to influence the behaviour of members who appear to be making mistakes.
Source: Dealing with the reluctant investor: The Pensions Institute, 2007
Examples of targeted communication include:
- Annual projection statements showing whether members are on track in terms of their net replacement ratios (and how much additional contributions need to be made or the extent to which the member will need to retire later)
- Annual death needs analysis showing the level of death benefits provided to the fund compared to a specified benchmark to provide a sufficient income for dependents
- Communication to members who are expected to have a net replacement ratio shortfall
- Communication to members who are expected to have a shortfall of death or disability benefits relative to a reasonable benchmark
- Communication on exit demonstrating the impact to the member of non-preservation based on the individual’s actual information
- Communication before retirement showing the expected pension based on actual quotations from the market (showing pensions under different options)
- Retirement seminars prior to retirement
- Communication to members who opted a particular investment option that may be inappropriate (e.g. young members who have opted for cash, members who appear to be engaged in market timing etc)
The importance of education in an outcomes-based governance approach
An important aspect in retirement funding given the shift from DB to DC, as well as the rate at which individuals switch jobs (and hence are increasingly faced with decisions related to their pensions on what to do before, at or during retirement), is member education. It is well-known that financial literacy in South Africa is generally quite low. An important contribution Trustees, employers and Manco’s can make in this regard is to provide appropriate education programmes for members focusing on the key issues impacting their financial security
Initiatives to enhance the general financial capability of individuals through educational programmes are also being implemented and have been shown to deliver some positive effects, if only in the longer term.
Source : Defined contribution pension schemes : risks and advantages for occupational retirement provision, EFAMA
This is a key ingredient of a good outcomes based governance approach since, if successful, it can improve the long-term retirement income outcomes of members.
The importance of measuring net replacement ratio positions and the factors impacting them – staying the course in an outcomes-based governance approach
There is a clear trend internationally that employers and funds are taking member behaviour into account in their governance and decision-making processes. This ensures that outcomes are measured, success of interventions tested and amended where necessary to improve their effectiveness.
As individuals are given greater control and responsibility, their decision-making ability is likely to improve over time through learning and familiarity. In the meantime, addressing the concerns about individual choice in DC schemes is likely to remain a key policy objective. Examining how individuals make choices and what can be done to help them make better choices when it comes to their retirement provision is also likely to remain an important area of further research.
Source : Defined contribution pension schemes : risks and advantages for occupational retirement provision, EFAMA
The Importance of Member Advice under an Outcomes-based Governance Approach
It is becoming more and more clear that communication and education for members is not sufficient (at least in the short to medium term) to ensure that members make appropriate decisions. This is evident by the fact that members’ net replacement ratios achieved over the last few years have been significantly impacted by their decisions, despite the increasing communication and education. Therefore, the provision for financial advice has become a very important component of an effective outcomes-based governance approach.
If Trustees, employers and Manco’s want to create an effective, outcomes-based governance framework, this kind of diagnostic that focuses on the key objectives and the factors impacting the outcome needs to be regularly applied – e.g. once a year. Without it, any other “governance” exercise could be seriously misguided.
Financial advice and automated pension decision tools can further add to individuals’ ability to make the right decisions.
Source : Defined contribution pension schemes : risks and advantages for occupational retirement provision, EFAMA
For members, understanding basic investment fundamentals and the confidence to make decisions are quite separate characteristics. Even where a member has a reasonable understanding of investment issues, putting this into action is a separate task. It is important not to underestimate the member’s fear of making the wrong decision. This we contend is a major factor that explains the concentration of members in the default fund, which further implies that additional information and communications, although very important, will not by themselves convert the reluctant investor into an active one. Our research suggests that what most members want is not more information, but rather to have an expert make the investment decision for them.
Source: Dealing with the reluctant investor : The Pensions Institute, 2007
The approach that Trustees, Manco’s and employers can take here would vary on their beliefs on the governance abilities of the members of their retirement arrangement as set out in an earlier section (i.e. to what extent do members need advice and to what extent should we be more active in sourcing such support for our members?). Some variations range from:
- Encouraging members to obtain advice. This is a passive approach that is more linked to education. Unfortunately, in practice the reality is that this approach has limited success in improving outcomes
- Allowing financial advisors to consult members at the office premises prior to exiting the fund.
- The fund or employer contracting with a financial planning institution to provide their members with advice. This is a more pro-active approach where a financial planning institution is contracted on a group basis to provide advice to individuals. A service level agreement is put in place and the service is monitored and the appointment reviewed from time to time in line with the regular governance processes applied by funds and employers.
- With this approach, a governance process should be in place to put in place the most appropriate advisory house together with a review mechanism. Factors to include in this process include:
- Experience of financial advisors, size and depth of team
- Quality of advice, quality of advice framework and philosophy
- Tools used by advisors in providing advice and education to the member
- How well the advisors understand the fund, objectives and operations
- Attention to ongoing advice, annual reviews and reporting offered to members
- Cost of advice and how this will be borne
- Access to advisors services in all major geographic areas
- Scale of services – can they cope with the number of members requiring advice
Financial Planning Tools for Members under an Outcomes-based Governance Approach
It is important that DC scheme members understand that the outcome from their scheme is risky and that different courses of action, in terms of contributions and investment strategy, have different distributions of possible outcomes. Stochastic modelling is the appropriate tool for estimating what these different ranges of outcomes are. These models use simulation techniques to illustrate not just the most likely outcome from the member’s strategy, but also the possible range of outcomes. For example, the model might show that a strategy has a 50% chance of achieving a pension of at least £10,000, but a 1-in-20 chance that the outcome could be £6,000 or less.
Source: Dealing with the reluctant investor: The Pensions Institute, 2007
It is increasingly being recognised that members should be provided with adequate tools to assist them in their decision-making. This assists in improving the retirement outcomes.