Experts predict that the cost of your fund providing you with risk benefits could quadruple within 10 years. Unless your trustees take action promptly, this could seriously undermine your retirement savings.
You could be in for a shock when your pension package is paid out, because the escalating cost of risk benefits, driven by Aids, may be eroding your retirement nest egg.
Risk benefits provided by pension funds include life assurance, disability and funeral cover.
The rules of many defined contribution funds allow for risk benefits as well as the fund's administration expenses to be deducted from the company's contribution to the fund.
John Murphy, the Pension Funds Adjudicator, has expressed concern about the erosion of retirement funding due to the increasing proportion of the employer's contribution being siphoned off to pay for more expensive risk benefits.
Aids is one of the main causes of the increase in the cost of risk benefits, such as life assurance.
The effect of Aids on retirement funds is only now beginning to show, according to Wouter Thom and Kobus Hanekom, who were involved in last year's comprehensive survey of retirement fund trends - the Sanlam Biennial Survey of Retirement Funds in South Africa.
In a worst-case scenario, the cost of providing risk benefits could become four times more expensive in the next 10 years. In most pension funds, if the cost of risk benefits were to double, they would swallow up the employer's entire contribution to the fund, leaving only what the employee contributes to be invested for retirement.
Thom and Hanekom say retirement fund trustees have no option but to place a cap on the cost of risk benefits in order to protect members and ensure that adequate provision is made for retirement. The implication is that as the cost of risk benefits increases, the level of cover will have to be reduced.
The best way to deal with the increasing cost of risk benefits, the researchers say, is for the fund to provide a core benefit for death or disability of about twice a member's annual salary and then allow members to select additional cover based on their individual needs.
For example, a member who no longer has dependants, and is close to retirement, has less need for life cover and a greater need to maximise retirement savings, while for a younger member with dependants, adequate life cover is crucial.
Shift in responsibility
A disadvantage of lower risk benefits is that it shifts the responsibility to the members of the fund to ensure that they have adequate life cover. Members, now more than ever, need the help of a personal financial planner, Hanekom, who is the head of employee benefits at Sanlam, says.
The increase in the cost of life cover, as a result of Aids, will continue to put pressure on the level of cover provided by retirement funds.
The Sanlam survey shows that the cost of risk cover for half of the respondents increased by between 10 percent and 30 percent over the past two years. And the costs are expected the soar in the future.
Rob Rusconi, from Sanlam Consultants & Actuaries, says in the manufacturing sector, for example, costs are expected to double in the next five years and treble in less than 10 years, or perhaps even sooner.
Rusconi says that although on average the costs of risk benefits have not yet increased significantly, there appears to be a cut in the cover provided by funds to their members.
He says the question is: are members aware of the fall in the level of death or disability cover?
Hanekom says that during 2002 the cost of risk benefits increased by 10 percent and he expects the increase for 2003 to average at 15 percent. For individual funds, the increase could be anything from nothing to an increase of between 50 to 100 percent. Sanlam Life has had a few funds which have had particularly bad experiences, primarily as a result of Aids, he says.
"I am a little concerned that many trustees have not taken appropriate action. Although I have gone on record a number of times to say that it would be reckless for trustees not to attend to this matter by the end of 2002, I suspect many fund trustees have not yet taken action," he says.
Last year 10 employees of Premier Foods, who were Genfood Provident Fund members, were appalled when they received considerably less than they expected after being retrenched. The 10, including Samuel Nkosi, took their complaint to Murphy.
They said they were promised that when they left the company, they would receive their own contributions to the provident fund, as well as the company's, including interest.
Murphy found they had received both contributions, but had been unaware of the drastic affect of risk benefit costs on the employer contributions. Murphy urged the fund to find a solution to the problem in consultation with the members.
He said the fund had considered various ways of reducing the costs, such as offering a lower death benefit, or paying different death benefits according to age groups, together with a reduced disability benefit.
According to the Sanlam survey, it is a growing trend for defined contribution retirement funds to allow their members to choose the amount of their death cover.
What are risk benefits?
Risk benefits are the life and disability cover, which may be provided by your retirement fund, and which pay out when you die or become incapable of doing your job. Sometimes funeral cover is provided, which pays out a sum of money to cover the costs of a funeral for you.
What you should do
- Consult a financial planner to find out how much life and disability cover you need;
- Assess how much cover you already have in place via existing policies;
- Check with your retirement fund how much life and disability cover is provided;
- Check with your retirement fund what you are paying for the life and disability cover and by how much the cost is expected to increase (although you do not pay premiums directly, the costs are generally deducted from the contribution that your company makes to the fund on your behalf);
- If you require extra life and disability cover, discuss with your financial planner the best way to supplement your cover, possibly by taking out a policy with an insurer.
The case of Samuel Nkosi
Samuel Nkosi contributed R7 617.13 to his pension fund and his employer, Premier Foods, contributed R7 863.24. On retrenchment, Nkosi says, he received a total of R11 010.87, of which only R2 708.52 was from the company's contributions.
The costs that came out of the employer's contribution were administration costs, disability income cover and funeral cover.
The Genfood Provident Fund told John Murphy, the Pension Funds Adjudicator, that Nkosi was paid out his full share account, which included employee contributions, employer contributions plus interest on these amounts, less risk benefits and administration costs.
The company gave the following example of the costs deducted from a salary of R2 429. (In this case, the member's contribution of seven percent would amount to R170.08, and the employer's contribution of 7.5 percent would be R182.23.):
- Group life assurance (death cover) of 3.9% = R97.09;
- Permanent health insurance (disability) of 0.9% = R24.08;
- Administration fees of 0.89% = R21.62;
- VAT (on administration fees) of
14% x R21.62 = R3.03; and
- Funeral cover = R20 (flat rate)
Equals total costs of R165.82
In this example, the costs gobble up 91 percent of the employer's contribution, leaving only R16.41 of the employer's R182 for the member's pension savings.
"With such a high proportion of the employer's contribution being allocated to risk benefits and expenses, there is very little left of the employer's contribution for retirement funding, and the returns on it would be concomitantly low," Murphy says.