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Harsh business climate fosters prudent pension reform

Baron Furstenburg, head of pension reform strategy at Liberty Corporate Benefits, revisits pension reforms in light of the current financial crisis.

Plummeting equity markets, tight credit conditions and low business confidence may be tough on the economy, but the reality check could prove instructive for policy-makers working on pension reform and their private-sector counterparts.

A period of market exuberance is not the best incubator of prudent reform. After years of strong equity gains, it is understandable for unbridled faith in free markets to develop in some quarters. In fact, a sturdy partnership between government and private sector players is necessary in a field such as pensions. This is especially so when one considers the differing apportionment of risk between state, individual and employer under defined contribution as opposed to defined benefit arrangements.

Active government involvement in the pension fund sector to secure a more equitable dispensation should be an easy ‘sell’ after recent events offshore. No financial package can be made entirely crash-proof, but current market conditions are a reminder that realistic planning is a necessary precondition for a realistic and sustainable outcome. Government plans extensive reform of the pension industry, originally announcing implementation as early as 2010. Early proposals included two compulsory contribution pillars to the current framework, one involving mandatory social security contributions for employees earning up to a certain earnings level and additional mandatory supplementary retirement savings for those above that level. A number of different models have however, been discussed with a view to finding the most reasonable for the South African environment.

Key issue facing reformers

The sight of large financial groups in developed markets seeking a government bail-out has helped to crystallise the key issue facing reformers – ensuring that money is safe even in times of financial crisis. Recent international events increase the likelihood that any national pension and savings system will have some sort of guarantee built in. The intention would be to give members peace of mind that their money will attract a decent return and be safe at the same time. Government should design the guarantee carefully in view of recent reminders about the need for prudence. It’s easy to be generous with guarantees, but they must be sustainable. European experience indicates that overly generous implicit or explicit promises are not sustainable in the face of demographic change.

Before taking responsibility for pension reform strategy at Liberty Corporate Benefits, I was a senior official at National Treasury. I believe old colleagues among Treasury policymakers can build on numerous local positives that have been highlighted by international events. Big South African banks and insurers are relatively safe and government would stand ready to underwrite a more equitable national pension system they had helped design. Government is a credible partner in view of its sound fiscal management record. This along with leveraging off private sector capability can help South Africa find a partnership solution to the pension reform problem.

Furthermore, the scale of a truly national system would enable economies of scale to be applied, leading to lower fees. Accumulated monies shouldnot be eroded by excessive costs. What is important is to improve the value proposition for members. The recent flight of foreign investors from South African equities and bonds had also drawn attention to the need to supplement ‘hot money’ from offshore fund managers with long-term domestic capital commitments.

A national fund and domestic savings can be used to invest locally to help grow our capital markets and spur domestic growth. Our much-changed economic situation remains extremely challenging, but international lessons underline the need for proper partnership and balancing of risk between government and private-sector players.

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