Why fund members are hesitant to adopt trustee-endorsed annuities

Despite the significant support and effort behind incorporating Regulation 39 into the Pension Funds Act, why has the adoption of trustee-endorsed annuities been so limited?

Regulation 39 mandates that the boards of pension, pension preservation, and retirement annuity (RA) funds establish an annuity strategy. Where the rules of a provident or provident preservation fund enable a member to elect an annuity, the board must establish an annuity strategy.

Before 1 March 2019, members were required to exit their fund upon retirement. The introduction of new regulations provided members with the option to choose trustee-endorsed annuities. This shift enabled trustees to leverage their bargaining power to secure annuities at institutional or wholesale prices, often resulting in lower fees for members.

Karen Wentzel, the head of annuities at Sanlam Corporate Investments, told the recent Institute of Retirement Funds Africa conference that among the 100 standalone funds that chose Sanlam as their default annuity provider, only 37 had any flows over the past four years.

“This means that two out of three members are missing out on this opportunity to get institutional pricing,” she said.

Interestingly, when it comes to pre-retirement investment decisions, members seem far more willing to trust the default option.

According to the Insights Report on Sanlam’s Benchmark 2024 Survey, default investment portfolios with member choice remain the most common strategy, adopted by 54% of standalone funds and 53% of umbrella sub-funds. Of those that offer member choice, an average of 87% of employer fund members and 82% of umbrella sub-fund members are invested in the trustees’ choice/default portfolio.

Wentzel refers to this as the “default paradox”. She explains: “In pre-retirement, most members leave the hard work of picking an investment portfolio to the trustees, but when they reach retirement, they choose to navigate this seemingly complicated decision without the help of the trustees.”

Highlighting the benefits of trustee-endorsed annuities, Wentzel referenced the 2023 Actuarial Society of South Africa paper “Fairness of annuity pricing for low-income earners in South Africa”, which indicated that the difference in the price of an annuity in the retail and the institutional markets can be 6% and 27%, depending on the insurer, product, and category of member.

“Now if, for example, you work on an average of 10%, that additional 10% is not only an initial 10% saving, but that is saving for the rest of somebody’s life. A lot of people haven’t saved enough, and this extra 10% may just give them that kicker to help them retire comfortably,” Wentzel said.

Wentzel said that just as the default pre-retirement investments were geared towards accumulation, the trustee-endorsed options focused on longevity protection, cost effectiveness, and inflationary increases.

“The interesting fact is that a lot of members still end up in much more expensive retail options. And it can either be because the members are not aware of the default options, or second, that they don’t understand it well enough to consider that as one of the options when they reach retirement.”

Danie van Zyl, head of the Smooth Bonus Centre of Excellence at Sanlam Corporate, also believes the low uptake of trustee-endorsed options is largely because of a lack of awareness.

“The onus is there on the trustees to make sure that members know there is this option available.”

He added that they are not discouraging members from exploring the retail market, but they should keep the institutional pricing in mind.

“I believe in getting financial advice. You can go out there, but make sure your adviser has a copy of your trustee-endorsed wholesale pricing annuity on one side and compare this to other options. I suspect many members go out in the retail market and only see the other options,” he said.

Need to grow capital for longer retirements

Lara Warburton, managing director of Integral Wealth Management and FPI Financial Planner of the Year 2023, says many of her clients avoid trustee-endorsed options because they believe they need to hold equity to grow their capital to fund ever-longer retirement periods.

She explains that most occupational pension and provident funds start down-risking about five years before retirement, shifting more into cash to protect against market downturns. “This action protects some investors, but many see low returns from their pensions in a year or two of strong market returns.”

Warburton notes that corporate trustees often view retirement as the end point, aiming for full liquidity by that date. However, she says financial advisers understand that retirement marks the beginning of a 30- or 40-year period when clients rely entirely on their savings for income. “Most pensions cannot last for current lifespans, forcing retirees to buy back into the same markets they exited for five years,” she adds.

“In privately managed RAs, we do not down-risk for retirement, knowing the capital will move from an RA into a pension and then start to pay an income – there doesn’t have to be a portfolio change. This positive return over a period when pensions have been in cash often encourages people to want to leave their current pension funds.”

She adds that, in her experience, life annuity quotes have been disappointing, even with the high interest rates in recent years. She says, hoping to capitalise on the high interest rate, she looked to convert some of her living annuity clients into life annuities.

“The quotes I have received have been disappointing. If one adds in the spouse as a second life assured for income, and a 10-year guarantee for a single annuitant, the rates have been worse than what we can achieve in a self-managed living annuity pension with a globally diversified portfolio.”

A decision with lifelong implications

Warburton observes that many clients realise before retirement that choosing the right option is one of the most significant decisions they will ever make.

“And the implications of the wrong decision are enormous, as they can no longer generate any further income if things go wrong. Many want the reassurance of working with a financial adviser,” she explains.

Warburton highlights that advisers provide a holistic view of a client’s financial picture, unlike pension fund trustees, who focus solely on annuities.

“Many clients are able to take low-income draws in the early years of retirement to minimise tax and receive income from other assets they hold. As bracket creep happens and rebates increase, they can then draw higher taxable incomes from their pensions. Preserving their pensions also offers estate planning benefits should they die young,” she adds.

She believes most retirees feel that corporate pension trustees lack personal connection and flexibility, which they can get from a trusted adviser.

“I think many clients want their portfolios managed holistically by someone who can support them into old age, deal with their children when they become infirm, and protect them from scams and fraud, which are especially prevalent among vulnerable retirees.”

Warburton also points to South Africa’s institutional trust-deficit. The Sanlam Benchmark 2024 Survey found that 60% of pensioners do not believe the country’s challenges will be resolved in their lifetime, with corruption cited as a primary issue. This mistrust extends to financial institutions, with 66% of respondents feeling financially vulnerable or exploited.

“Everyone has a story about a policy or contract that didn’t deliver what it promised. They are tired of non-responsive call centres and are often willing to pay for a financial adviser to alleviate that pain, especially as they get older and struggle to hear well over the phone,” says Warburton.

Comparing costs – flexibility and service

Warburton says most clients she sees come to her with the retirement packs from the trustees.

“Legally, we all have to supply a lot of information, but most clients do not understand the terminology, and they feel overwhelmed. They need their adviser to explain what the documents say, and in many instances, there are fund fact sheets on the fund options they have, but the clients don’t understand them.”

Warburton says she does not always see a clear explanation of the costs that would enable a cost comparison. Although a cost comparison is not always possible with the documents that clients provide, she always discloses all the layers of fees when recommending products to clients.

“There is full disclosure of all costs including unseen investment manager costs. I encourage clients to not just focus on the cost, but to focus on the whole offering, and the value they are receiving.”

She says there is value in flexibility to make changes to income, flexibility around being able to invest more or all of their pensions in hard currency if clients emigrate to be closer to children and grandchildren overseas, and flexibility in preserving pension capital to save estate duty on death.

“These options are not possible in a corporate pension fund. So, if people want value for money, they are often prepared to pay more, to have more choice and less hassle personally.”