In today’s newsletter we focus on using lifestage principles to structure benefits and we look at ways to improve the retirement funding experience and result.
Structuring insured benefits according to lifestage principle
By Awie de Swardt, executive consultant at Simeka Actuaries and Consultants
When we hear the term “life stage”, most of us think of investments. The term is commonly used to describe investing according to your age based investment needs. However when one applies the same principles to insurance benefits, one also gets very interesting results. In Sanlam’s 2010 Benchmark Survey, a couple of important statistics were highlighted:
• 60% of current 20 year old males won’t live to retirement
• 10% of high net worth individuals won’t live to retirement
• Average cover for a retirement fund member is 3.5 x annual salary.
If we compare members’ typical needs for insurance benefits during their life stages, statistics will paint an even gloomier picture.
Between the ages of 18 and 40 is when most members start working, buy their first home and start a family. The average South African has two to three children. If a 40-year-old male breadwinner passes away, he should leave his family with approximately 75% of his final salary for them to maintain their standard of living. This amounts to risk cover of almost 6 x annual salary. At the market average of 3.5 x annual salary, such a member could be underinsured by almost 42%.
Between the ages of 40 and 50, members’ retirement fund benefits will typically grow to anything from 1 x annual salary to 4 x annual salary. A male breadwinner in this category should have approximately 5 x annual salary provision in case of his death. There could therefore be a need for 1 to 4 x annual salary life assurance in this category.
This is the age group where heart attacks, cancer and other life-threatening illnesses become more prevalent. Dread disease cover for these types of diseases is vital. They are typically also offered as a multiple of salary. Should the member become physically disabled, a blend of lump sum disability and income replacement disability is advised. The lump sum will cater for immediate capital expenses linked to the illness/event, whilst the member’s income will be paid from the disability income scheme. An important factor to consider when structuring disability cover is waiver of the retirement contributions. This means a member’s retirement contributions will be paid whilst on disability and his retirement benefit will therefore be protected.
Between the ages of 50 and 65, members typically require lower insurance benefits because they should have built up significant retirement fund benefits. The average life cover of 3.5 x annual salary should be sufficient during this phase if the member built up adequate retirement money. Most lump sum disability schemes reduce the cover from 5 years before retirement.
A New Approach
If we consider all these examples, it is evident that funds should seriously consider insurance benefits that cater for members’ typical age based needs. The solution is to introduce a life stage insurance scheme with cover that is age based; allowing members to choose multiples that are higher or lower than the default (example alongside). According to a survey, SA citizens are under-insured to the value of R10 trillion rand!
Trustees of retirement funds therefore have a responsibility to not only focus on retirement benefits and the fund’s investment strategy, but take a close look at their members’ insurance needs. If based on the latest life expectancy tables most members won’t live to retirement, adequate insurance benefits have to be a top priority.
Example of LifeStage Life Cover
The member can choose from 0 – 7 times based on their own needs.
Cheaper to change an organisation’s behaviour than its fund manager
Changing a retirement fund manager, and in many cases an investment approach, almost always incurs a cost to the fund – without any guarantee that this cost will be made up by the new strategy’s improved performance.
Instead, John Anderson of Alexander Forbes Financial Services (Pty) Limited argues that “changing governance, the behaviour of Human Resources departments or the conduct of fund members themselves costs very little and is something trustees, management committees of umbrella funds or employers can and should change.”
The point of contributing to a retirement fund is to help an individual accumulate enough money to be able to sustain themselves in retirement. The Net Replacement Ratio (NRR) is a measure that has been developed to help individuals gauge their ability to save an adequate sum of money for retirement.
Helping individuals achieve a reasonable NRR is best achieved by adopting what Anderson calls an outcomes-based approach to governance in South African organisations.
By using the NRR measure in conjunction with an outcomes-based approach to the management of funds Alexander Forbes is shifting retirement fund management thinking about defined contribution arrangements from one of routine administration, compliance and returns – “to the real purpose of retirement, namely, ensuring that members maintain their lifestyles after retirement,” says Anderson.
The outcomes-based approach, however, requires the following kind of human resource and governance changes if the ability of retirement funds to maintain members’ lifestyles in to retirement is to be improved:
• Ensuring appropriate allocation of resources to structures that help members achieve a reasonable retirement outcome.
• Employers, trustees and management committees of umbrella funds ensuring that members, who in South Africa are generally not financially literate, able or willing to make appropriate decisions, are provided with the right support.
• Issues that have the greatest impact on retired lifestyle outcomes should attract the greatest trustee, employer and management committee attention.
• Making sure that trustee, employer and management committee meetings and decision-making processes dedicate time to discuss all the factors (not just investment returns) contributing towards the NRR outcomes.
• Ensuring that outcomes and the factors impacting on them are measured appropriately. Such measurements assist in determining whether members are on track and whether any interventions put in place by employers, trustees and management committees are in fact improving outcomes.
• Ensuring that governance becomes about equipping scheme members to make the right decisions.
An outcomes-based approach also requires that individual South African retirement fund members make the following kind of behavioural changes to improve their ability to achieve a comfortable retirement:
• Contributing sufficient amounts and investing appropriately to ensure a good outcome.
• Preserving withdrawal benefits upon resignation.
• Taking a smaller portion of their retirement benefit in cash, ensuring that drawdown rates on living annuities are at a level that will sustain pensions for life.
• Ensuring that better allowances are made for inflation when purchasing an annuity at retirement.
• Ensuring that sufficient allowance is made for a spouses pension at retirement.
In short, a different approach is required for defined contribution funds in South Africa if the retirement industry is to improve the outcomes achieved by members.
This approach “requires both organisational, structural and behavioural changes that focus on investing to maintain the lifestyle that members will live after retirement – as opposed to narrowly focusing on returns along with operational and compliance matters,” concludes Anderson.
The opinion and comment in this newsletter is opinion and comment only and does not in any way constitute financial advice. Please consult a professional financial adviser for all investment and financial decisions.
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