14 South African Insurance Markets

14

South African Insurance Markets Robert W. Vivian University of the Witwatersrand

14.1

INTRODUCTION

This chapter provides an overview of South Africa's insurance markets and it is important to not only evaluate it within the context of the world, but also the African continent. South Africa's life insurance market accounts for 95% of premiums on the African continent, while its property and casualty market accounts for 57% of premiums (Engels 1999). In the world market. South African insurance markets are important for at least two related reasons. First, South Africans spend more per GDP purchasing life insurance than any other country in the world (Birkmaier and Codoni 2004). It is important to note however, that this figure is misleading since much of South Africa's life insurance market involves savings, not risk products. Second, South Africa does not have a substantial state social security pension system. In turn, the South African government is not facing a pension crisis similar to those faced by most other developed countries. In fact. South Africa is in the position many other countries aspire to reach—a fully-funded privatized pension system. Thus, the South African insurance industry should be of considerable interest to other nations. However, South African's retirement ftinding system has its flaws and its approach may be more appropriately considered as a warning, rather than as an inspiration. The current position of South African insurance markets arose for historical reasons. It is thus important to examine the historical path which led to the current state, including the changes which have taken place since the advent of Nelson Mandela's African National Congress (ANC) government. Consequently, the first section provides a historical overview of the development of South African insurance markets including the changes introduced after 1994 when the ANC won South Africa's first universal franchise election, thus ending apartheid.^^' The remaining sections examine the various insurance markets including the public sector markets. Retirement funds, life insurance (called long-term insurance in South Africa), property and casualty (called short-term insurance in South Africa), ftinding for

^^' A large number of books exist on the general history of South Africa including Johnson (2004), Giliomee (2003), Davenport, et al. (2000), Muller (1990), and Lacour-Gayet (1977). Books on the economic history of South Africa include De Kiewiet (1941), Horwitz (1967), and Jones (2002).

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International Insurance Markets

medical and health services, and state insurance schemes are discussed. However, equities, bonds, futures markets, banks, and collective investment schemes (mutual funds) are not discussed. Before the insurance markets are discussed, market regulation is examined.

14.2

HISTORY OF SOUTH AFRICA'S INSURANCE MARKETS

14.2.1

White Afrikaners and Englisli-Speaking South Africans

South Africa has a controversial history which has produced complex insurance markets. Originally fashioned by historical forces. South Africa continues to be reshaped, especially after the 1994 election which the ANC won. In South Africa, race is divided into the two broad categories: white and black. Whites can be further divided into two subcategories: Afrikaans and English-speaking. This division is based not only on language, but also on culture. Blacks can be subdivided into three subcategories: Africans, Coloreds, and Indians. The Dutch were the first whites to settle in South Afi*ica. In 1652, they established a victualing station at the Cape, under the authority of the Dutch East India Company (VOC). To incentivize employees to settle permanently in the Cape, the VOC granted themfi"eedom.Today, the descendants of these settlers are considered Afrikaners. In September 1795, Britain sent its Navy to occupy the Cape as a precaution in its war against the French. In 1803, the Cape was restored to Holland under the Treaty of Amiens, but in 1806, the British once again invaded the Cape, this time to remain. Thus, Englishspeaking whites first arrived in 1795 and continued to do with Britain's second invasion, the largest immigration occurring in 1820 and then again with the discovery of diamonds and gold.^^^ There has always been tension between Afrikaans and English-speaking whites. This reached a breaking point in 1836, when a substantial portion of the Afrikaner population, frustrated with British rule, migrated inland away fi"om the Cape in what is now known as Die Groot Trek (The Great Migration). In so doing, they established the independent countries of Natal, Orange Free State, and Transvaal. The British were however not easily deterred, and in 1844, the British annexed Natal to the Cape. Traditionally, Afrikaners have always had strong farming roots; hence they were called Boers (meaning farmers). Transvaal and Orange Free State were Boer Republics. War broke out between the Boers and the British ending with the Boer victory at the Battle of Majuba in 1880. The British army also suffered defeat at the hands of the Zulu army in 1879.^^^ The Boers were however defeated in the Second Boer War (1899-1902), a particularly bitter guerrilla war. The British Army resorted to scorched earth policies where they burned the Boers' homes and crops and killed their livestock (Spies 1977). The British also herded women and children ^^^ These immigrants are called the 1820 Settlers. ^^^ The Zulus, at the time, constituted the independent kingdom of Zululand. Today, after the unification which established the current boundaries of South Africa, they are more correctly regarded as South Afi-ica's dominant (by numbers) black tribe. The best account of the history of Zululand during that period is Morris (1965).

South African Insurance Markets

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into concentration camps in which tens of thousands died. The result was a lasting sense of bitterness by many Afrikaners towards the British.^^"^ A distinction is not maintained between the British Army, the British people, and English-speaking South Africans. However, the bitterness was not universal, with a significant section of the Afrikaner population willing to work with the British. In 1910, the Cape, Natal, Orange Free State, and Transvaal were united to form the Union. The Union enjoyed a large measure of self-government and in 1961, it gained its independence, thus becoming the Republic of South Africa. At the time of the first census in 1911, the white population constituted 21% of the total population. By 2002, it had declined to 10% (South African Institute of Race Relations 2004, p. 2). In 1911, 13% of Africans were urbanized compared to 52% of the whites (English-speaking whites have largely always been urbanized). By 2002, 45% of Africans and 92% of Whites were urbanized (Lipton 1986, p. 401; South African Institute of Race Relations 2004, p. 10). In 1960, Afrikaners represented 60% of the white population. Generally, the Afrikaans population has been greater, with the margin increasing, than the English-speaking population. This has meant that political power has always resided with the Afrikaners. In 1948, the Afrikaner Nationalist Party (NATS) won the general election and subsequently controlled the government until 1994, when the ANC took charge. During this period, consecutive Nat governments organized the political, and to an extent, economic systems based on the forced segregation between whites and blacks. This forced segregation constituted the apartheid system. A distinction also needs to be made between rural and urban areas. The segregation policy was aimed in part, at encouraging blacks to develop thriving political and economic systems within their traditional, mainly rural homelands, some of which were larger than European countries. In urban areas, separate residential areas were maintained for the various race groups. The apartheid policy was however not successfiil. There was an ever increasing migration of blacks from the rural areas to the urban areas, a process which has continued and accelerated since 1994. This has resulted in the development of massive squatter camps around major cities and homeless persons occupying buildings in cities and factories in industrial areas. Until 1994, most of the South African economies, including the financial service institutions were controlled by whites: English-speaking and Afrikaans. With high unemployment levels, the provision of meaningfiil universal social security benefits has never been an economically viable option. The usual state services and social security benefits, such as free education, old age pension, and first-world medical treatment simply could not be provided to all by the state. Pensions and medical-aid were thus linked to employers, rather than the state. The medical-aid system provided first-world medical treatment for the employed and retirees. However, the state provided adequate medical treatment via public hospitals for those who are not members of a medical-aid. For a long time, primary and secondary education was ^^"^ The Boer Republics of Transvaal and Orange Free State lost their independence and became colonies of Britain and were united with Natal and the Cape to form the Union. The franchise was limited to whites, Afrikaans, and English-speaking, but excluded blacks, thus culminating in apartheid. Initially, coloreds had the right to vote in the Cape Province, but this right also was removed.

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provided, free of charge, by the state. About 15 years ago, the system was changed as state schools began to charge fees. These schools are called "Model C" schools. Free schooling has thus become an artifact of the past. The link between pensions, medical treatment, and employment evolved for historical reasons. In the early 1900s, the country faced a large poor-white population. This population consisted largely of Afrikaners since for various reasons, they migrated from rural areas to the cities.^^^ They could not find jobs since they were unskilled and better skilled jobs were filled by English immigrants (who were called uitlanders—literally people from outside lands). Consequently, white squatter camps developed around the cifies. The government solved this problem by providing public sector jobs mainly for Afrikaners and eventually this problem was overcome as the economy expanded. Soon, Afrikaners became more skilled and educated with many migrating from the public to the private sector. Many whites were employed in lowly-paid government jobs with salaries barely above what was regarded as a "civilized wage" (at the time a major debating point). They would nevertheless be assured of a pension for life and medical treatment after retirement; hence, the link between employment, medical treatment, and pensions. These public sector pensions were and still are funded on a defined benefit basis. The size of the economy created more opportunities for employment than the number of whites. Consequently, whites, most having more developed skills than blacks, were fiilly employed. The growth of the economy resulted in an increase in the employment of blacks. By 1995, they constituted the largest percentage of persons employed in the formal sector. Seventy-five percent of all formal jobs were held by blacks (Terreblanche 2002, p. 373; Botha 2003a, 2003b; DoUery 2003; Kenney 2004). On the other hand, the country also had a high level of unemployment, 40%. Furthermore, there has also not been any meaningful growth in the number of formal jobs since the mid-1970s. Indeed, during most of the thirtyyear period there has been a loss of jobs and a growing population. The bulk of the unemployed were blacks, with low unemployment rates among whites. Urbanized, employed blacks were increasingly moving into the professional and management positions in corporations, but in 1994, very few held senior positions. Many perceptive economists had correctly predicted the natural demise of apartheid because of this economic growth (Hutt 1964; O'Dowd 1964; Lipton 1986; Williams 1989). Part of the solution to the poor-white problem was the establishment of Afrikaner private sector financial institutions, such as Sanlam, the long-term (life) insurer, and Santam, the short-term (property and casualty or general) insurer. These were formed by Afrikaners driven by the determination to improve the economic standing of their population and account for the existence today, of what are regarded as Afrikaner insfitufions. The purpose of these institutions was to encourage Afrikaners to save and to channel those savings into productive assets, thereby giving Afrikaners a stake in the private sector economy (O'Meara 1983). Part of the Afrikaner strategy was thus to create powerful financial companies which would invest in industrial and commercial entities and provide jobs for Afrikaners. Strong, private sector financial institutions were part of the Nationalist government's ideals, ^^^ The poor-white problem is discussed in most history books but for a specialist discussion see Abedian, et al. (1985).


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as was a culture of savings and the conversion of savings into real investments. Persons employed by smaller companies which did not have pension schemes could save for a pension via endowment and retirement annuity policies with these savings also channeled into real investments. Many British financial institutions, on the other hand, were branches of their overseas parent companies, particularly short-term insurance companies. As such, they maintained stronger ties with overseas institutions and initially operated more in line with international best practices. This was less important to life insurance companies which dealt with a more diversified risk. In the 1970s, the Nationalist government adopted a policy to encourage foreign financial institutions to register local companies (i.e., branch operations were discouraged) and to allow the local population and institutions to acquire shares in these wholly-owned foreign companies (Franzsen Commission 1970). At the time, this was known as the process of domesfication and caused most foreign-owned short-term insurance companies to seek local partners (Vivian 1995). Towards the end of the apartheid period in 1994, overseas companies were increasingly forced to disinvest due to pressure from their own countries. As this happened, foreign companies were increasingly acquired by existing South African companies, in many cases, Afrikaans companies. Strict capital controls on residents were imposed in 1961, to prevent capital flight. The laws are contained in the Exchange Control Regulations. Under these laws, no resident could take any capital out of South Africa and all transactions involving foreign exchange had to be approved by the South African Reserve Bank (SARB). Foreigners, on the other hand, could freely invest and disinvest in South Africa, except during the 1980s, when the government declared a unilateral debt standsfill. Consequenfly, foreign capital could move into the country, but local capital was trapped within the country. This policy, which continues in a modified form to this day, greatly restricted investment decisions of South Afi-ican financial institutions and individuals, but ensured that funds were available should any foreign company decide to disinvest. Although local funds were available, foreign currency was not always available, resulting in a continual depreciation of South Africa's currency, the Rand, against foreign currencies. Thus for example, Barclays Bank, an eminent British bank, first operated in South Africa in the early 1800s. Upon disinvestment, it became the First National Bank of Southern Africa (for the early history of this bank see Webb 1992; Jones 1996). It was later acquired by Rand Merchant Bank, which initially was regarded as an Afrikaans bank. Other Afrikaans banks included Volkskas, Bankorp, and Trustbank. They merged with the United and Allied Banks, both English banks, to form ABSA, South Africa's largest retail bank. It was discovered shortly after the merger that some of the Afrikaans banks were in financial difficulties and ABSA was "assisted" or even rescued them by a secret multibillion 'loan' (referred to as a lifeboat) from the SARB (a predominately Afrikaans government institution). Today, ABSA is regarded as a largely Afrikaans managed bank which has a large Englishspeaking customer base. Recently, Barclays Bank returned to South Afi"ica by acquiring ABSA. The pre-1994 position can be summarized as follows. Funded, occupational pensions developed in the place of state provided pensions, mainly on a defined benefit basis. A strong culture of contractual savings existed. Financial institutions

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had developed along cultural lines, English and Afrikaans. However, the earlier division between Afrikaans and English companies began to disappear. Increasingly, the lingua franca of the South African commercial world was becoming English, especially in the major commercial centers. Significantly Santam, South Africa's largest short-term insurer, recently appointed an English-speaking CEO. 14.2.2

The Post-1994 Economy

The current events in the financial sector need to be understood within the context of South Africa's historical background. It is a mere decade since a black majority government was elected, too short a time to arrive at any definitive conclusions about the economy. There have been a number of works published to celebrate the first decade of black majority rule—all generally positive (Parsons ed 2004; Bruggermans 2003). The latter half of the past decade has been marked by transformation. Black Economic Empowerment (BEE), charters, and scorecards. These concepts are imposed by legislation, e.g., the Employment Equity Act 55 of 1998, the Broad-Based Black Economic Empowerment Act 53 of 2003, the Preferential Procurement Policy Framework Act 5 of 2000, and the Promotion of Equality and Prevention of Unfair Discrimination Act 52 of 2002. The current state of insurance markets cannot be understood if these concepts are excluded from the discussion. Transformation Transformation is a term not clearly defined. Its simplest meaning is to give more importance to the black population in the South African Economy by transforming the economy into a black-controlled economy. In the labor field, transformation factually, is to replace wherever possible whites with blacks, i.e., ostensibly to transform the labor force from white to black. In fact, since whites constituted only 25.0% of the formal labor force, labor transformation is more correctly defined as the transformation of the labor force into a more black one. As pointed out above, in numerical terms, there has not been any meaningful growth of employment in the formal sector since the 1970s. In 1975, 4,669,735 persons were employed in this sector. In 1998, this had increased to 4,926,843 or an increase of 5.6% over the 23year period. During this period, the private sector employment had decreased by 5.7%, with this decrease being more than compensated by a public sector employment increase of 34.7% (South African Institute for Race Relations 1999, p. 264). It was widely accepted that the public service was bloated. With a stagnant labor force, increasing black employment can only be achieved by causing white unemployment, or white emigration. The net result of labor transformation is thus to restrict the participation of whites in the economy. This has been happening. The percentage of whites in the public service, previously the bastion of the white Afrikaner has declined to 8.9% (Naidoo 2005, p. 119). It is not clear how many whites have emigrated since 1994. The government has embarked on a policy of job creation, but even before it started, the Minister of Finance has admitted that the economy will not create sufficient formal jobs to deal with the employment problem (Hartley 2004).


685

Black Economic Empowerment The past few years have been dominated by the Black Economic Empowerment (BEE) program, again not a well-defined term. The closest equivalent concept would be affirmative action, but on a much grander scale. Whereas affirmative action is applied to assist minority groups, BEE is applied by the majority. While the main thrust of affirmative action is employment situations (i.e., transformation above), BEE aims to do more than this. It aims to transfer the equity and the company itself to the preferred group. In addition to equity transfer, it includes increasing the numbers of black employees at all levels. Thus, there is an overlap between transformation and BEE. Each economic sector has drawn-up a charter indicating how the BEE objectives will be achieved, including specifying measurable objectives within that sector. The Financial Sector Charter (FSC) requires that 25% of the equity of financial services companies be transferred to blacks (§5, paragraphs 10 and 11 of the FSC). Since most major financial companies are quoted on the Johannesburg Securities Exchange (JSE), an equity transfer program is not necessary. The equity is available for anyone to purchase. However, transfer does not imply the sale for value, but rather the giving of equities, even if the word 'sale' is used and the word 'giving' is not. The financing of these transactions have become very complex. The FSC specifically requires financial institutions to deploy funds for BEE deals. In many cases, the transfer of equity is achieved by issuing additional shares which accordingly dilutes the capital stock of existing shareholders. BEE also poses risks to investors. An investor may inter alia find its capital diluted, and its ability to select directors, management, staff, suppliers, and products are all restricted in terms of the BEE program. The BEE program has progressed quite far, with virtually every major financial institution having announced its BEE partner. There has been widespread public concern that BEE is benefiting a very small percentage of politically wellconnected blacks (BEE Helps Only Elite 2004). The more recent deals have aimed at a broader based spread of the equity. In order to measure and monitor progress of transformation and BEE, scorecards have been created. In the case of the financial sector, scorecards are made in line with the objectives of the FSC. Included in the charter and scorecard are the number of blacks at each level in the firm (§1 of the FSC), the types of products to be sold (§3 of the FSC), the black status of service providers (§2 of the FSC), the investments financial institutions must make (§4 of the FSC), the transfer of ownership to blacks (§5 of the FSC), the appointment of black directors (§5 of the FSC), and the appointment of black executives to run the company (§5 of the FSC). The inclusion of service providers (§2 of the FSC) poses a particular problem to small and medium enterprises. These are usually closely held family enterprises and if they are owned by whites it is unlikely that they will get any contracts fi"om the government or major corporations. Recently, two white brothers were arrested on the allegation that they lied about their BEE status. Increasingly, the government is also using the licensing process to transform companies into black companies.

686 14.3

International Insurance Markets REGULATORS

Three different regulators for the financial markets exist. Banks are regulated by the central bank, the SARB, medical schemes by the Registrar of Medical Schemes, under the auspices of the Department of Health, and most of the remaining markets are regulated by the Financial Services Board (FSB). Each financial market is regulated via its own piece of supervisory legislation. Separate legislation exists covering banks (deposit taking institutions), long-term insurance business, short-term insurance business, medical schemes, pension funds, and collective investment schemes (mutual fiands). In addition to specific legislation for each market, a host of other legislation exists to which financial companies must comply (e.g., the Companies Act 61 of 1973, the Income Tax Act 58 of 1962, and the Estate Duty Act 45 of 1955). The legislation has been subjected to a considerable overhaul over the past decade. Although the legislation generally operates at a national level, provincial and municipal legislation, which are of less importance, also exist.^^^ The structures of the various pieces of supervisory legislation all follow a similar pattern. First, the class of financial business is defined, e.g., long-term insurance, short-term insurance, or medical aid. Then, the legislation proclaims it to be a criminal offense to carryout the defined class of business without being registered to do so. In some cases, the legislation goes on to require licensing for each line of business within the class. Thus, to conduct short-term insurance business in South Africa, the insurer must be registered to carry out short-term business and apply for a license for each specific line of short-term insurance business. A registrar is then appointed for each class of financial business. Thus, there is a registrar for medical schemes, long-term insurance, short-term insurance, retirement fiinding, and so forth. Generally the registrar is the same person, the Chief Executive Officer of the FSB. This peculiar state of affairs exists for historical reasons. 14.3.1

Financial Services Board

The main supervisory body for financial institutions is the Financial Services Board (FSB), a body established especially to supervise financial services.^^^ The FSB is fiinded by way of a dedicated levy on financial institutions (§15A of Financial Services Board Act 97 of 1990) and is empowered in terms of other statutes to impose other levies. The FSB interacts regularly with the various markets in a number of ways, formal and informal. It holds regular meetings with industry bodies and the registrar or one of his senior staff is usually invited to industry conferences and fianctions. In addition, each Act makes provision for an Advisory Committee, which the FSB can consult on matters pertaining to the industry. The legislation calls for the submission of statutory returns which must be submitted periodically for supervisory purposes. These are usually completed by management and checked by the company auditors. In some cases, the legislafion requires directors to sign-off on the statutory returns. The statutory returns are voluminous and it is unlikely that the

"^^ Copies of the legislation are available at www.acts.co.za. ^^'' The Financial Services Board was established after the Melamet Commission's report into the collapse of the A A Mutual Insurance Company was considered.


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directors will be in a position to actually verify these returns. In order to maintain a degree of standardization across the markets a Policy Board exists which considers recommendations and proposed legislation from the different registrars and advisory committees (Policy Board for Financial Services and Regulation Act 141 of 1993). 14.3.2

Legislative Review

Over the past decade or so, the FSB embarked on an extensive legislative program, probably the most extensive in the history of South Africa. This includes the passage of the Long-Term Insurance Act 52 of 1998, the Short-Term Insurance Act 53 of 1998, including subsequent amendments to these Acts, the Financial Services Board Amendment Acts 1992, 2000, 2002, various Financial Institutions Amendment Acts, the Financial Advisory and Intermediary Services (FAIS) Act 37 of 2002, the Financial Intelligence Centre Act (FICA) 38 of 2001, the Collective Investment Schemes Control Act 45 of 2002 (i.e., mutual funds), and so on. Secondary legislation has also been promulgated and revised. This includes the Policyholder Protection Rules for long- and short-term insurance. There is no single reason for the extensive review. Partly the review was to modernize the legislation, some of which have been on the books for decades. For example, the previous insurance Act was passed in 1943. Financial intermediaries have never been regulated, but are now regulated in terms of FAIS. FICA was passed to bring South Africa's money laundering legislation in line with international practices. The legislative review has not been brought about by any serious event in the market place, such as the collapse of an insurance company. This is unlike previously when the FSB was established as a consequence of the collapse of the AA Mutual Insurance Company in 1986. Nevertheless, the review is not complete. "Clawback of Commissions" regulations are under consideration. In some cases, life insurers involving certain classes of insurance, pay brokers an up-front commission on the acceptance of periodical business. For example, an insured may purchase a retirement annuity in which he intends to make monthly payments for several years. The insurer then pays the broker the full commission over a two-year period and if the insured stops paying, the insurer charges the cost of the commissions to the savings of the insured, resulting in a substantial loss to the insured. This has been a major source of contention as discussed below as the upfront commission saga. "Decapping of Commissions" has been under discussion for several years. The current regulations specify the maximum commission that an insurer may pay a broker. The purpose of the proposed decapping regulations is to repeal these existing regulations. It has been agreed in principle to de-regulate commissions. The plan was to phase these in by first enforcing disclosure. This was achieved in terms of the policyholder protection rules and now FAIS, but decapping still has not taken place. The regulator seems to have had second thoughts on the issue. The current view is to put the repeal on hold in view of the United States (U.S.) investigation into the American International Group (AIG), which may throw some useful light on the relationship between brokers and insurers (da Silva 2004). The Pension Funds Act 24 of 1956 is also under review and a new Act is expected in 2007.

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The implementing of PAIS is currently engaging the industry in considerable effort. In terms of this legislation, all financial advisors and intermediaries must be registered with the FSB. However, because of the broad wording of the legislation, insurers have also decided to register. Consequently, insurers are now registered in terms of multiple pieces of legislation. The general consensus within the industry is that it has had an excess of legislation and time is now needed to consolidate the positions before any further legislation can be digested (Haken 2004). Table 14.1 shows the number of employees at FSB and in the insurance industry. In line with government policy, the FSB set-about increasing the number of black employees. The number of FSB employees increased by 119% while the number of employees in the industry has decreased. The FSB's CEO announced at a recent conference that further staff increases are being planned. This will result in an increase in the annual levy paid by financial institutions to the FSB. Table 14.1. Employment Figures for Financial Services Board and the Insurance Industry, 1993-2004 Year

1993

1996

1997

1998

1999

2000

2001

2002

2003

2004

53 32 21 93 49 44

52 28 24 80 42 38

67 36 31 81 40 41

78 42 36 83 39 44

114 59 55 91 38 53

133 64 69 93 37 56

143 73 70 94 54 40

146

132

148

161

205

226

237

69,003 81,051 80,387 78,833 64,373 61,780 58,476 60,134

N/A

N/A

Blacks Male Female White Male Female Unclassified

10

33

39

98

92

89

Total: FSB

108

Number of Employees in the Insurance Industry

1 126

128

Source: Financial Services Board (1996-2004). Note: FSB is the Financial Services Board. In financial markets, disputes are inevitable. Various mechanisms exist to resolve disputes. The matter can be taken to a court of law. South Africa, has, as in the case of Britain, a split bar consisting of attorneys and advocates. Generally lawyers are paid on a fee basis, but a statutorily defined contingency fee system exists, which finds wide-spread application in personal injury claims (Contingency Fees Act 66 of 1997). A range of courts exist, including Small Claims Courts, Magistrates' Courts, High Courts, and the Supreme Court of Appeal (SCA). The more recent addition is the Constitutional Court which is supposed to decide on constitutional matters, but is beginning to act more like a final court of appeal. In recent years, there has been a proliferation of specialized courts. The financial markets have each introduced less formal mechanisms to resolve disputes, the most common being the ombudsmen, typically a retired judge or senior


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lawyer (attorney or advocate). There are separate Ombudsmen for the long- and short-term industries. These appointments are in terms of a voluntary agreement between insurance companies which have agreed to abide by the decision made by the ombudsmen. The most recent appointment was the Ombud for the intermediaries, this time appointed, under the terms of the PAIS Act. A Financial Services Ombud Schemes Act 37 of 2004 has recently come into force to regulate the powers of the Ombudsmen who previously had no legislative standing. The retirement fund has a statutory appointed adjudicator, who has powers approximating that of a magistrate. The office of the Pension Funds Adjudicator falls under the FSB. The appointment of all these ombudsmen, have and will give rise to jurisdictional problems. As indicated below (the upfi-ont commissions saga), the long-term insurance market is currently in a state of crisis because of rulings by the Pensions Fund Adjudicator.

14.4

THE RETIREMENT FUNDING MARKET

The key to understanding South Africa's financial markets is to understand South Africa's system of retirement fiinding. Self-employed persons can save for a pension via endowment and retirement annuity policies, while employed persons save via occupational retirement fiands. The aggregate of retirement fiinds, estimated to be in excess of R 1,000 billion, is the single largest South African financial asset. In the absence of a state social welfare system providing pensions, this is not surprising. Much of the way retirement fiands operate are defined by law. The most important laws are the Pension Funds Act and the Income Tax Act. The definitions of the different types of retirement schemes (i.e., pension fiand, provident fiand, retirement annuities) appear in the Income Tax Act, not the Pension Funds Act. Occupational retirement plans are voluntary, but can be imposed by employers as a condition of employment. Employers may define different classes of employees, but having done so, it is compulsory for all employees of that class to join the ftind. Savings (contributions) are, in the case of occupational retirement plans, deducted from employees' salary and paid over to the retirement fiind. Most employers establish their own retirement fimd. These fiands are separate juristic bodies, controlled by a part-time management board (usually incorrectly but universally called Trustees). Trustees are appointed by the employer and elected by members of the frmd in equal proportions. Professional administrators are often appointed, as are professional fimd managers to manage the assets of the fimd. After collection, the savings are redistributed via the fiinds themselves (in the case of large employers), insurance companies, or fund managers as investments to equity markets, bond markets, or off-shore investments and other forms of investments. In attempting to get a clear picture of investments in South Africa, the problem of double counting must be borne in mind. Savings are owned by retirement fimds, but much of this is paid over to insurance companies and asset managers to invest. Thus, the assets of an insurance company may well primarily be the assets of retirement fimds. The market capitalization of the equity market largely reflects the assets of pension fiinds, insurance companies and other institutions. This chapter does not attempt to de-segregate these assets.

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The operation of each fund is defined by the rules of the fund. These have to be approved by the FSB and the South African Revenue Service (SARS). The approved rules are registered with the FSB. Individual funds have a great deal of discretion in defining the operation of the fund and thus wide variations in funds exist. However, as a general statement the following can be noted. The funds belong to the fund itself, not the employer, nor the employee. Since membership in a fund is a condition of employment, employees cannot make any withdrawals from the fund, unless they resign. It is possible for a fund to grant a member a loan for purposes of purchasing property (real estate) to live in. The modem tendency is not to do this, but for the fund to assist the member to get a loan from a bank, secured by a guarantee from the fund. The employer has very limited rights of recourse to the member's funds. The right of recourse is confined to off-setting any outstanding property loans (including securities) and losses suffered by the employer as a result of the admitted dishonesty of the employee or on conviction by a court of law. An employee may withdraw his savings if he resigns or transfer the savings to another fund or a preservation fund. If he or she withdraws the savings the withdrawal is subject to taxation. It is possible for rules to allow for the retention of the employer's contribution, but the Pension Funds Adjudicator has voiced his unhappiness with this and the tendency is for the employee to be entitled to the employer's and employee's contributions together with the investment income. A fund may not invest in the business of the employer without agreement of the members and the permission of the Minister of Finance. Notwithstanding this, there is a case on record where the entire fund consisting of R 80 million was invested in the business of the employer, which subsequently went under and the subsequent criminal prosecution did not succeed. Individual employees seldom have any direct control over their savings or investment choice, but rather elect trustees and receive regular feedback concerning matters of the fund. Retirement funds constitute 'the major provider of capital for the equity listed on the JSE' (Taylor Report 2002, §9.1.1). Savings, apart from those in retirement funds, in South Africa have diminished substantially in recent years. It has been estimated that savings constitute only 15% of GDP (SC 2004). Thus, the main source of savings available for investments is the savings generated by retirement funds. As explained above, due to exchange controls, the bulk of South African savings are trapped within South Africa. The government has not fulfilled its earlier assurances to abolish exchange controls. It maintains that its policy is to gradually abolish exchange controls, which it claims it is doing. The SARB is responsible for administering the exchange controls. It, in turn, appointed the major banks as its authorized agents (or authorized dealers). Any South African resident wishing to invest outside of South Africa must apply to a bank, as the SARB's agent for permission to take funds out of South Africa. The SARB communicates the exchange control prohibitions to its authorized dealers in terms of exchange control circulars. Until recently, the contents of the circulars were not available to the public. These circulars span several decades and would not be of much use to the average individual because of their complexity. A detailed summary of the exchange control requirements are now set-out in the exchange control manual (ECM) available on the


691

SARB's website.^^^ The SARB works closely with the South African Revenue Service. A South African resident may not invest more than R 750,000 outside of South Africa (ECM (2005), Rule 6.1.1) and this limit has not changed for several years. South African institutions (retirement funds, insurance companies, fund managers etc.) may not invest, directly or indirectly, more than 15% of their assets outside of South Africa (ECM (2005), Rule 6.1.4.2). In terms of a recent policy ruling, once the 15% is reached, any investment growth must be repatriated back to South Africa. Over the past year, the South African Rand strengthened against the dollar (after consistently weakening for twenty years before that). Consequently, from a South African perspective, non-South African investments are not currently attractive. Therefore, there is currently little incentive for South Africans to invest outside of South Africa. The present time would have been ideal to abolish exchange controls since it is unlikely that massive outflows would take place. Persons who had emigrated were not allowed to take more than a prescribed maximum out of South Africa. What was left was kept in what are called blocked rand accounts, accounts maintained at a local bank under the strict control of that bank. Once so deposited, ftinds therein could only be used for purposes specified in the exchange control circulars. The total amount kept in blocked rand accounts was not disclosed. Recently, the government announced that amounts kept in these accounts could be taken out of the country, subject to a forfeit penalty. Many South Africans had taken money out of the country in violation of the exchange control regulations and the government announced an amnesty to those who came forward to regularize their affairs. In contrast to South African residents, non-residents are free to invest and disinvest at will. Over the past few years there have been substantial inflows of foreign capital into South Africa in the form of the so-called portfolio flows. Increasingly, South African equities are being bought by foreign investors and major South African companies are listing on other stock exchanges. Thus Sasol, South Africa's coal-to-oil company and Sappi, a paper manufacturer, are listed on the New York Stock Exchange. Anglo-American, the mining company. The Old Mutual, South Africa's largest life insurer, and SABMiller are listed on the London Stock Exchange. Presently, South Africa's current account is running at an unprecedented deficit which is being supported by the capital account surplus. The purchase of ABSA by Barclays will, for example, result in a fiirther inflow of R 32 billion on the capital account. The details of the ftinding have been kept secret. The aggregate assets of the pension funds are indicated in Table 14.2. South Africa with retirement fiinds equal to 73% of GDP has one of the largest pre-ftanded pension-assets in the world. Considering that the unemployment rate is 40%, the level of ftinding is impressive. In the absence of a meaningful state social security system, this is however not surprising. Most countries have poor-relief schemes, and South Africa is no exception. It can be argued that there is a constitutional duty for the state to provide some income to the destitute elderly in terms of the social assistance obligation set-out in §27 of the Constitution. The poor-relief scheme is an unftinded scheme paid from current taxes and, as of November 2004, pays an amount of R 740 per month (about $120 per month). In order to understand the extent of this

www.reservebank.co.za. The manual can also be downloaded in pdf format or a zip file.

692


assistance, it should be compared with some items of household expenditure. It is of the same order as a monthly telephone bill, or half the amount of the monthly local authority rates & taxes, including the utility bill (water and electricity).^^^ It is hardly sufficient to provide food for a single person. The payment of the amount is also conditional on passing a means test. Accordingly, most formally employed persons will not be entitled to this grant until they have reached specific levels of destitution. It is clear that this amount cannot be regarded as an old age pension sufficient to support a previously employed person at any level commensurate to that during employment. An employed person must on reaching retirement age ensure that he or she has an income from another source. South Africa does not have a pay-roll tax funded state social security system. The South African government is thus not facing pension crisis most other countries are facing. In the absence of a meaningful social security system, each individual must save for retirement and the norm is to do so via occupational pension schemes. Since occupational pensions are, as the name implies tied to employment, in law, the rights and obligations of the employer and employee are, in theory, defined in the employment contract. However, in reality, the usual employment contract says virtually nothing about pension funds, other than to note that the employer has such a fund and it is compulsory for the employee to be a member of the fund. The precise legal position is thus unclear, which is unsatisfactory (Hunter 2004). Since the rights and obligations are not well-defined, it has been argued that the employer may, at its discretion, change its involvement in pension funds. This view was tested in court, but the court did not agree, maintaining that indeed a valid and enforceable contract exists. The matter has been taken on appeal. Two types of funds exist: defined benefit pension schemes and defined contribution funds. In a defined benefit pension scheme, as the name implies, the final benefit due to the pensioner is defined. There is a risk that insufficient funds will exist to provide the promised benefit and this risk rests with the employer. This is one of the reasons why there has been a movement away from defined benefit pension schemes. In a defined contribution system, it is the contribution and not the benefit which is defined. This is usually defined as a percentage of the employee's remuneration. The risk that the accumulated funds of the member are insufficient to provide an adequate pension rests with the employee. The older schemes (private and public sector) were almost exclusively defined benefit pension schemes, but there has been a marked movement in South Africa's private sector towards defined contribution schemes over the past two decades. The public sector however continues to have largely defined benefit schemes (RFR 2004, p. 10). What should a pension fund provide? Generally this question is not answered. As a rule-of-thumb, for every year that a person works, a defined benefit pension

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