CDC plans could play a vital role in securing financial stability for SA’s future retirees

According to 2023 Old Mutual Corporate research, only 56% of recent retirees can support themselves and make ends meet, compared to 72% of pre-retirees who expect to do so.

Furthermore, 88% of South Africans face some level of indebtedness, with 44% of pre-retirees expecting to be debt-free by retirement, but only 34% of recent retirees have achieved this.

This gap between retirement expectations and reality highlights the substantial challenge many South Africans face in achieving a comfortable retirement.

In an aim to deliver better outcomes for retirees, a case was made at the recent Old Mutual Thought Leaders Forum for the country to consider a more progressive model outside the typical defined contribution (DC) pension arrangement, and embrace innovative solutions such as Collective Defined Contribution (CDC) plans. 

According to Old Mutual’s 2023 OnTrack Research, only 20% of retirement fund members are contributing at the recommended rate of 15% or higher.

This is down from 22% in 2022, and what's more concerning, is that only 6% of retirement fund members are on course to a secure retirement, a state of affairs that calls for the industry to do more to educate members on the benefits of savings and ensuring the industry is geared to deliver returns for members.

Colin Haines, Aon’s chief commercial officer for EMEA Wealth Solutions, told the Forum — which brought industry leaders together to brainstorm solutions to challenges facing the industry — that CDC schemes might be the panacea for SA’s retirement industry to achieve improved member outcomes.

CDC schemes were formally introduced in the UK via the Pension Schemes Act 2021. The schemes offer an additional option to the UK pension landscape, which many believe will help people achieve a better retirement. 

Under the CDC scheme, which is seen as a bridge between defined benefits (DB) and DC, fund members and employers make fixed contributions into a collective fund, these schemes then pool together funds with other members.

This collective investment management means that trustees of the fund have more freedom to invest in high-risk assets which may provide higher investment returns. It is therefore believed that CDC schemes can in turn provide a higher average pension throughout an individual’s retirement.

In essence, CDC allows outcomes and risks to be shared across employees of different ages and across business cycles. It also means that DC contributions are simply put to work harder, enabling better returns for longer and delivering better average outcomes than your existing individual DC savings plan.

The UK will later this year introduce the CDC for the first time, via the Royal Mail.

Haines, who is based in the UK, said CDC plans can be used to improve pensions at retirement by as much as 30% on average compared to individual DC plans, and can support a drive to consolidation, enabling investment in high-return assets for longer to fuel growth in the national economy.

“First CDC has the potential to deliver, on average, over 30% higher outcomes than individual DC, where annuities are used to secure a lifetime income,” said Haines.

“Second, CDC can align with what many employers want to provide; it could be a strong employee value proposition and become a differentiator in the labour market as employees would expect to receive an income for life without needing to make complex individual decisions.

“Finally, pooling risk over long-time horizons without insurance guarantees enables CDC schemes to hold more return-seeking assets like infrastructure, for longer. This aligns strongly with an ESG and responsible investment framework, allowing greater investment in private assets.

“You can have a great DC pension. However, if the stock markets collapse and interest rates go down, someone retiring five years later may get a very low pension from their DC because of the mismatch. So the whole point [of CDC] is it's trying to get 30% better outcomes on average — the higher average is achieved by the ability to invest in longer-duration assets for longer periods.”

The global shift from DB to DC regimes saw individuals carry all the risks relating to investment returns and longevity.

Fred van der Vyver, head of Corporate Savings and Income at Old Mutual, said there is no risk sharing happening in most DC funds at the moment, and the industry has seen the consequences of that.

“The most problematic consequence of individual DC is the volatility of the outcomes,” Van der Vyver said.

“What makes CDC compelling is the principle of sharing investment and longevity risk among a large group of individuals to provide more consistent outcomes. The current DC system is failing many South Africans. The root causes include the objectives, design and performance measurement of local DC funds, many of which are set up like typical investment platforms, focused on delivering an unknown pot of money at some point in the future.”

With the retirement industry’s focus shifting towards enhancing retirement savings and delivering income security, solutions like CDC are poised to play a vital role in securing financial stability for future retirees.

This article was sponsored by Old Mutual Corporate.

_{Old Mutual Life Assurance Company (SA) Ltd is a licensed financial services provider and life insurer.}