Beyond two-pot: a collective solution to SA’s pension problem

While SA adjusts to the introduction of the two-pot retirement system, industry insiders are already looking to future reforms — including, potentially, a move to Collective Defined Contribution (CDC) schemes. 

At the recent Old Mutual Thought Leadership Forum, Colin Haines, EMEA chief commercial officer: Wealth Solution at Aon, spoke about the impending introduction of a CDC system at the Royal Mail in the UK. Similar systems exist in Canada and the Netherlands. 

SA used to have a defined benefits (DB) system, where risk was shared and retirement fund members knew what their outcomes would be. SA, like many other countries, then moved to defined contributions (DC), where each fund member had to take care of themselves. 

In a defined contribution (DC) world, longevity risk is heightened as retirees outlive their pension savings.

“Nobody has solved this for DC yet,” David Knox, senior partner at Mercer, told delegates at the Old Mutual Thought Leaders Forum. “In Australia, people see their pensions as their money, and they want to do what they want with it. In Israel, there’s a minimum pension rate and the government doesn’t look at what private policies do beyond that. The same is true in New Zealand, though the base pension is much higher, at 40% of the average wage. We need to aim for a system where there’s dignity in retirement, where people at either end of the spectrum are not penalised.”

In SA, where National Treasury estimates that 94% of working South Africans will not be able to retire comfortably, the DC system is not working.

“We have a big problem in SA with volatile outcomes from DC funds, leading to a lack of trust in the system, poor member engagement and generally poor outcomes,’ said Fred van der Vyver, head of Corporate Savings and Income at Old Mutual. “The improvement in outcomes delivered by CDC plans around the world is compelling.”

CDC systems offer a hybrid of DC and DB. Like a DC plan, employees and employers contribute a fixed amount; but like a DB plan, those contributions are paid into a collective (or pooled) fund, aiming to provide a target retirement income for life rather than a lump sum amount at retirement.

“Not every individual has the ability to choose the right investment strategy or to determine how to balance the pace at which they take their retirement savings against their unknown life expectancy,” Haines said. “With CDC, the investment strategy is decided by a board of trustees, which means that employees aren’t required to become experts and make complex decisions. In addition, CDC is expected to offer on average over 30% higher outcomes in retirement compared with DC, where annuities are used to secure lifetime income.”

CDC has been successfully deployed in the Netherlands for some time, and lessons from the Dutch experience have influenced the development of CDC in the UK. Haines said that SA isn’t quite there yet (it would require a change in legislation, for starters). “However,” he said, “it’s a very attractive option for employers, especially those with lots of lower-paid workers, because funds are pooled, the investment risk is spread and it provides employees with the dignity of a wage in retirement with the familiarity of DC’s cost and risk stability for companies”.

This would mean covering different generations of workers to keep the returns sustainable over the longer term — and it would also help to smooth any ups and downs in the markets. That smoothing principle aligns with the underlying philosophy of Old Mutual’s smoothed bonus products. 

“When we looked at the benefits of CDC systems around the world, we immediately identified many similarities between the core principles behind the success of CDC funds and our smooth bonus and with-profit annuity products in SA,” said Van der Vyver. “By combining the investment risk-sharing technology of our smooth bonus portfolios and longevity risk-sharing of with-profit annuities as part of an integrated default solution to DC funds, the key benefits of CDC funds can already be delivered in our current DC system.’

Van der Vyver concluded that though SA does not yet have a regulatory framework that would allow CDC plans in their current form, we could still implement similar principles within our current DC system. “At its core, what makes CDC compelling is the principle of sharing investment and longevity risk among a large group of individuals to provide more consistent outcomes,” he said. 

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This article is sponsored by Old Mutual Corporate.