Our Operating Context

Economic environment

Alexander Forbes is in the business of creating, growing and protecting clients’ wealth and managing their financial risk, ultimately assisting our individual clients in securing their financial well-being, now and into the future. As such, the health of the economy can significantly impact our performance.

In recent years, growth in the South African economy has slowed; quarter-on-quarter change at the end of Q1 2016 was -1.2% according to StatsSA. While finance, real estate and business services account for the largest portion (20.9%) of nominal GDP, the government represents a close second at 17.4%, having grown by R40 billion during the year.

In the last three calendar years, the standard unemployment rate has increased steadily by 0.2% per year and reached a high of 26.7% at the end of March 2016. The increase in unemployment has a strong correlation with cash being withdrawn from pension savings and member numbers in the retirement funds administered by the group – significant cash flows paid to employees who leave the formal employment sector has given rise to reduced revenues.

Wage inflation generally has a positive impact on a number of our businesses whose fees are derived from the related increase in pension contributions. The wage inflation trend over the past nine months has declined and, more importantly, the gap between wage inflation and consumer price inflation has narrowed, placing pressure on consumer spending.

Business confidence fell sharply in 2015, with confidence among manufacturers declining to levels last seen during the 2009 recession.

The South African Reserve Bank has increased the benchmark prime interest rates by 2% after it hit an all-time low of 5% in 2013. This rise in interest rates should help savers but more might still be needed to solve the structural problem. Household debt as a percentage of household income now stands at approximately 80% and, according to the Old Mutual Savings and Investment Monitor, only a quarter of those between the ages of 18 and 30 are saving for retirement. Low disposable income growth, paired with sluggish job growth, a rising tax burden and an inflationary environment are likely exacerbating the challenge. As a result, only 6% of South African retirees are currently financially secure for retirement – a daunting proposition to say the least.

Year-on-year growth of the all share index (ALSI) and the SWIX to 31 March 2016 was 3.2% and 2.7% respectively. Volatility in the equity market has fuelled the switch to lower-margin products. More than one-third (34%) of the group’s African revenue is asset-based and this component of revenue fluctuates not only with markets, but with trends related to asset classes, product mix shifts and default choices.

The weighted average rate for the GBP/ZAR exchange rate increased by 17% to 20.8 during the financial year. This impacted on results due to the translation of revenues and expenses from its international operations and, to a smaller extent, countries in Africa. In addition, certain costs, including technology-related licence fees on US systems, increased based on the 21% depreciation of the ZAR against the USD during the same time.

Regulatory and legislative environment

Retirement reform

In South Africa the National Treasury’s initiative to reform the retirement landscape creates new opportunities to advise employers, individuals and trustees of funds, providing financial education and guidance, as well as appropriate retirement products. Current and anticipated changes to governance; default preservation, annuitisation and investment strategies; compulsory annuitisation and the harmonisation of the tax treatment of various types of retirement funds aim to ensure that those who benefit from retirement tax incentives and fund membership go on to secure an income for life.

The group has engaged with National Treasury and other regulatory bodies both directly and through industry groups. Internally we have devoted significant resources to understanding potential implications and adjusting our advice, systems, products and processes accordingly in anticipation of the changes. While the implementation of certain portions of the reform has been delayed, these preparations nevertheless mean that the group is ready for their eventual introduction.

It is anticipated that the reforms will result in a consolidation of funds, both as clients move from standalone retirement fund arrangements to umbrella retirement funds and as hybrid funds or multiple funds within an employer group are consolidated. We expect that umbrella funds will continue to see growth due to the increasing responsibilities on trustees and the search for improved costs and charges; however the overall consolidation of multiple or hybrid funds may be slower than expected as pension to provident fund transfers will remain taxable until 2018.

With the exception of high income earners, individuals are now generally able to contribute more to their retirement in a tax-efficient manner. As a result, contribution rates could increase over time, leading to a growth in assets under advice, administration and management. An increase in contribution rates would, however, be competing with base expenditure and commitments our individual clients have which continues to be under pressure with rising inflation, interest rates and administered prices. For high net worth clients, the absolute value capping of tax-deductible contributions may require further advice and alternative strategies and products.

In addition, treasury has published a discussion paper specifying that all funds have default strategies with regards to investment, preservation and annuities. While these requirements are not yet signed into law, Alexander Forbes is already well positioned to meet them and will be launching innovative changes to its umbrella retirement funds from August 2016.

Retail distribution review

The retail distribution review (RDR) proposes reforms to the regulatory framework for distributing retail financial products to customers in order to eliminate undesirable practices which exist in the industry. The reforms seek to remove conflicts of interest caused by product provider bias and inappropriate remuneration structures; improve transparency of product charges and service fees; and reveal the nature of the relationship between product providers and intermediaries. Conduct standards will create improved product provider accountability to clients and widen access to financial advice in a cost-effective manner in order to support the consistent delivery of fair outcomes to customers. The intention is for customers to be able to assess and select the types of services available to them, and the cost and value of those services. Remuneration structures will not be allowed to undermine suitable product advice and must be reasonable and commensurate with the actual services rendered.

Alexander Forbes strongly supports initiatives that will ultimately result in better outcomes for investors and has engaged directly with the Financial Services Board (FSB) as well as through the Association for Savings and Investment South Africa (ASISA) and the South African Insurance Association (SAIA). The group is already largely aligned with RDR principles. We already have a fee-for-advice model as opposed to offering purely commission-based products and services. Furthermore, we have removed performance fees from some unit trusts and portfolios.

While the changes will be implemented in phases and the extent has not yet been determined, the first phase is not expected to be implemented until January 2017 at the earliest. The threat of these changes alone, however, has already had significant impact on the industry, weeding out poorer practices that have developed over time. It is also anticipated to push further clarity on value proposition and intended market among financial services providers.

Solvency Assessment and Management framework

The Solvency Assessment and Management (SAM) framework continues to be rolled out by regulators through various stages of implementation. Key regulatory guidelines (released in 2014 and 2015) have now been fully embedded with the go-live date of the main legislation anticipated for after the enactment of the so-called Twin Peaks regulatory framework.

The FSB anticipates an ‘extreme workload’ facing insurers to co-ordinate the continued implementation of SAM. As far as the group is concerned, this will have an impact on our individual insurance entities as well as at a group level from a capital, governance and risk management perspective, as well as external reporting requirements. The current focus remains on the development of the group’s Own Risk and Solvency Assessment (ORSA), ensuring alignment amongst the different insurance entities in the group, as well as preparation for parallel capital and risk reporting during the coming year.

Investment Solutions has applied to be allowed to use an internal model (reliant on risk-based assessment) for the determination of capital requirements under SAM. The formal assessment and approval by the regulator of the internal model for purposes of determining regulatory capital requirements is only expected to occur some time after the formal introduction of SAM.

Protection of Personal Information Act

The Protection of Personal Information Act (POPI) is a comprehensive set of privacy and data protection requirements that apply to any organisation that collects or processes personal information (PI) about data subjects. POPI aims to protect the constitutional right to privacy of personal information. The compliance conditions associated with POPI are not yet in effect and we will have one year from the effective date(s) to reach compliance.

Where companies process PI, they are required to adhere to POPI’s principles, including the stipulation that PI may only be collected and used for a specific purpose. They must also ensure that adequate security safeguards are in place to protect PI and that they comply with requirements related to special PI, children’s PI, unsolicited electronic communications, trans-border flows of PI and account numbers.

Alexander Forbes has made significant progress in preparing for the requirements of POPI. A detailed analysis of processes has been performed to determine data entry and touch points across the group. Further analysis of the requirements has helped to develop a clear set of actions to address any gaps. Priorities will focus on high risk, high effort items, with a centralised project team driving activity through the group. In the meantime, we continue to implement immediate actions in order to comply with POPI in time. These include education and awareness, monitoring of our clean desk policy, encryption, procurement objectives, building security actions, mobile device management, and revised customer and third-party documentation.

Treating customers fairly

Treating customers fairly (TCF) is the FSB’s regulatory framework to regulate market conduct and centres on embedding fairness in all aspects of customers’ experience with the company.

Compliance with TCF requires companies to demonstrate that the TCF outcomes are firmly embedded at all levels (and at all stages of the customer relationship). Companies must also identify and manage the risks of unfair customer treatment and demonstrate improvements in customer treatment.

TCF is now fully embedded throughout the group but remains an important – and continual – area of focus. The TCF outcomes are tracked at business unit level, incorporated into individual scorecards, built into our product development process and ultimately, engrained into culture.

Competitive environment

Retirement funds

A stalled South African economy and slowed job creation continues to negatively impact the retirement fund industry. In the competition for market share, administrators are under pressure to deliver sophisticated solutions allowing trustees to address individual member-level outcomes and to provide the tools to enable financial literacy and sound decision-making. Increased financial literacy is resulting in greater awareness of the need to improve net replacement ratios on retirement – a key indicator of an individual’s potential for a financially sound retirement.

Meanwhile, rising operating costs and increased governance and compliance obligations have led employers to shift from standalone retirement funds to umbrella schemes. Significant industry consolidation continues as a result. Fee pressure on administration, consulting and investments continues to be a significant factor in the umbrella fund market.

The shift from a defined benefit to defined contribution funding model has moved the focus from the fund to the individual members themselves. Trustees are now expected to be far more accountable for these members’ outcomes and whether their needs are adequately and appropriately met by the solutions provided. In the future, this will extend beyond the member’s contributory years.

The consulting approach to retirement funds has evolved in line with member expectations for focusing on their financial well-being, now and into the future.

Notwithstanding the muted growth in public sector employment levels, the government remains the largest single employer in South Africa. Even though real government consumption expenditure decelerated significantly in 2015, the government remains a core contributor to the South African economy, with overall spending representing more than 20% of the national GDP.

As the fiscal space narrows and growth remains subdued the National Treasury has introduced cost-cutting measures in the public sector to curb spending and this is expected to impact employment levels in the sector over time. Though National Treasury forecasts that the economy will improve over the medium term, the current economic climate has implications for AF’s business, placing pressure on administration business and retirement fund assets. The majority of new administration and asset management opportunities are currently coming from funds seeking to switch their administrators and/or asset managers. It follows that this increasingly competitive environment calls for differentiated solutions and agility to retain and grow business.

In the sub-Saharan countries in which we have an established presence, economic growth is more robust and individual access to employee benefits, including provision for retirement, is gaining momentum.

In the UK, while defined-benefit funds remain a significant part of the industry, new joiners to employers are typically joining defined-contribution funds.

Medical schemes

The number of registered medical schemes in South Africa declined 42% from 2000 (144) to the end of 2014 (83). This consolidation appears to be slowing, however, with no amalgamations in 2015 and only one announced in 2016 at the time of publication.

The Competition Commission inquiry into the private health sector has entered its second year. This is a general investigation to establish if the sector contains features that prevent, distort or restrict competition. Various stakeholders including medical schemes, administrators, intermediaries and regulators have appeared at the public hearings conducted by the Commission, and the inquiry report and recommendations are expected to be published in December 2016.

The white paper on national health insurance (NHI) was released in December 2015 and once more affirmed the desire for all South Africans to have access to quality healthcare as articulated in the Bill of Rights. The country commenced with the phased implementation of NHI in 2012, with implementation expected to be complete in 2025. Medical schemes will co-exist with NHI, but will focus on providing complementary services.

Retirement investment funds

Today, three-quarters of South African pension funds are defined contribution (DC) schemes, effectively shifting responsibility for the individual’s post-retirement well-being from the employer to the individual. In the past decade the South African savings pool has grown marginally ahead of GDP, driven solely by exceptional growth in capital markets (primarily equities). There is a marked shift of assets from traditional savings schemes to unit trusts, which offer greater control for individual members, transparent fees and portability. Investment Solutions has been a direct beneficiary of these shifting preferences; between 2012 and 2016, Investment Solutions’ retail assets under management increased from R29.7 billion to R43.4 billion.

The South African Reserve Bank estimated the market for savings and investments at R7 trillion in December 2014. Retirement funds have experienced outflows to pay benefits for retiring members, retrenchment and general redemptions of retirement savings by individuals when they change employers. The trend is not expected to change in the short term.

The selection of investment options and managers has become increasingly wide and daunting for investors. At the same time, their needs and goals have also become more varied. The challenge lies in developing investment solutions that can address highly variable financial planning needs for these savings. In this respect, the multi-manager investment framework is ideally positioned to address rising demands.

Short-term insurance

Despite the significant growth of direct insurers the short-term insurance sector is largely characterised by extensive interrelationships and dependencies, with most distribution still being done by agents and brokers, whether tied or independent.

The short-term insurance market continues to grow, driven largely by the entry of previously uninsured individuals, most particularly those in the emerging black middle class. Given the fact that some 65% of vehicles on South African roads are still uninsured, the scope for growth is obvious and considerable. The market remains extremely competitive on price and the introduction of niche and differentiated products is seen as a key driver of premium growth.

The impact of the weakening of the rand has put pressure on average loss per claim, which impacts general underwriting performance of the industry. We have also seen a reduction in vehicle sales year on year. It is anticipated that the tough economic environment will result in client lapses due to affordability.

Political environment

The upcoming South African municipal elections due in August 2016 may have the effect of slowing decision-making on tenders from municipal employers and associated retirement funds.

The National Treasury has introduced a central supplier database registration system to manage procurement across all government departments and entities. This is expected to provide a clear and complete overview of tender activities and the nature of services required in the public sector and will generally improve governance across the spectrum.