The 2023 Mercer CFA Institute Global Pension Index rated South Africa’s pension system 38th out of 47 pension systems worldwide, awarding it a ‘C’ grading and a score of 54 out of 100. By way of comparison, the Netherlands, Iceland, Denmark and Israel all achieved ‘A’ gradings with scores in excess of 80. An ‘A’ grading is recognition of a first-class and robust retirement income system that delivers good benefits, is sustainable and has a high level of integrity.

Although each country’s system has evolved from its own economic, social, cultural, political and historical circumstances, the report bases its results on certain universal features and characteristics that are likely to lead to improved financial benefits for the older members of society, an increased likelihood of future sustainability of the system, and a greater level of community trust and confidence.

The index uses three sub-indices – adequacy, sustainability and integrity – to measure each system against a matrix of over 50 indicators. The adequacy rating is weighted to 40% of the score, sustainability 35% and integrity 25%.

South Africa’s pension system scored high in integrity (76.6) but low in adequacy (44.2). This indicates a relatively robust system, but one that is not sufficiently supportive of the needs of fund members or of a significant proportion of society.

What this means for south africa

Mercer CFA Institute Global Pension Index’s deeper dive into South Africa’s grading demonstrates that the overall index value for the SA system could be improved by:

• increasing the minimum level of support for the poorest, aged individuals;
• increasing the coverage of employees in occupational pension schemes, thereby raising the level of contributions and assets;
• introducing a minimum level of mandatory contributions into a retirement savings fund;
• introducing preservation requirements restricting members withdrawing funds from occupational pension funds prior to retirement.

Dr David Knox, Senior Partner at Mercer and lead author of the Index, explains that the top-scoring countries have strong pension fund-related regulation – though South Africa doesn’t do particularly poorly on that scale.

‘On integrity, the country’s system rates in the top half,’ he explains. ‘One of the poorest-performing areas is impacted by South Africa’s standing in relation to the World Bank governance indicators, which are included as a measurement because pension funds operate within a larger societal picture.’ Governance takes into account political stability, the prevalence of corruption and government effectiveness.

‘South Africa’s poor performance on the adequacy scale is linked to the basic pension being low, leading to low financial well-being for many retirees,’ explains Knox. ‘The Organisation for Economic Co-operation and Development (OECD) looks at net replacement rates for compulsory systems, which South Africa doesn’t have – resulting in a low score – but the introduction of the Two-Pot Retirement System will hopefully improve that. Pension coverage is poor compared to leading countries like Denmark and the Netherlands, where everyone is compelled to be part of the retirement system.’

The report shows that changing demographic structures in countries with falling birth rates have major consequences for pay-as-you-go pension arrangements, which rely on the next generation of taxpayers to fund the pensions paid to previous generations. This means that many governments will need to tackle the tricky issues of reducing the benefits or increasing the eligibility age for these pensions.

Inflation has also re-emerged and has damaged the community’s confidence in the ability of pension programmes to deliver adequate retirement benefits over the longer term. Although inflation may be falling in some economies, its re-emergence has highlighted this risk to current and future retirees. Indeed, difficult period for investors. Global assets outperformed but South African assets struggled to deliver Inflation +5% returns.

The global shift from defined benefit (DB) to defined contribution (DC) arrangements saw individuals carry all the risks relating to investment returns. In this world, longevity risk also plays a role in pension design.

‘Nobody has solved this for DC yet. 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, although the base pension is much higher, at 40% of the average wage,’ says Knox. ‘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 Australia, there’s no defined retirement age and that gives people the choice to decide on their needs depending on their health, their wants, their partners’ health and more.’

Knox says that successful systems, like those in the Nordic countries, Israel and the Netherlands, rely on a strong social compact. ‘That compact is an understanding that society collectively cares for the less fortunate, they don’t abuse the system and that everyone participates,’ he says. ‘They get good coverage because of a history of contributions – in the Netherlands, pension assets sit at 200% of GDP, whereas South Africa is at 92%. In the US, one of the reasons they don’t perform well is because of their splintered approach, with no federal regulator that looks at the system as a whole.’

The 92% South African value is relatively healthy on the global scale, but that percentage is driven by a small percentage of the contributing population – around 25%. ‘We have to think around how we broaden coverage and get more people into the system,’ says Knox. ‘That’s where the impending Two-Pot Retirement System – and, to a greater extent, auto-enrolment – will come into play. If there is strong support from government, which there is in terms of the system being established in the first place, and everyone starts understanding the power of the system, it will do well.’

The fact that the South African population is ageing gradually – at a far slower rate than many other countries – offers opportunities for earlier development and onboarding of pension products.

‘Start developing the system while the population is relatively young so they can start contributing and carefully consider where the money is invested. You want to diversify the investments geographically, and more and more funds are starting to do so,’ says Knox.

What does a ‘perfect’ retirement system look like?

Knox believes that the perfect retirement system is one with an income focus that allows access to capital – as South Africa’s Two-Pot Retirement System will, albeit to a limited extent.

‘At age 75 or 80, people may find that they need to modify their homes to make accessibility better as their health declines,’ he says, ‘and at that point they should be able to access some capital to improve their environment.’ He says that longevity protection is also important – and that, at least in part, should come from government, after a working lifetime of making compulsory pension payments. ‘In New Zealand, for example, the base pension is 40% of average income, which offers tremendous longevity cover – and then private pensions offer additional cover. The combination of income, capital access and longevity protection – and, within that, some flexibility – would make for an ideal system,’ he says.

Linked to that is a combination of education, guidance and availability of information – not only at the point of retirement but during retirement too. ‘Our individual circumstances change – what we set out with at 65 may not be relevant a decade later – we may have lost a partner, or our health may deteriorate or not,’ he says. ‘All these things need a flexibility that isn’t inherent in current systems.’