‘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.

“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.