A report done by the World Bank in 2018 shows that Kenya’s population is aging and the number of the elderly as a percentage of the population is expected to hit 7% by 2050, from the current 3%. This is as a result of an improvement in life expectancy from an average of 49 years in 2006, to 59 years in 2016, and 64 years in 2018.
The reducing birthrate has not helped as we have seen the average number of children per family fall sharply, from 8.1 children in 1978 to 4.6 children in 2008, and it is projected to possibly reach 2.4 children by 2050. These changing demographic trends reinforce the need to ensure that some form of old age protection is provided to the elderly and ensure security against destitution during old age. This note will review the regulatory changes that the Retirement Benefits Authority has enforced over the years to ensure continuous improvement in the Retirement Benefits Industry.
Role of the RBA in regulating the retirement benefits industry
Prior to the formation of the Retirement Benefits Authority (RBA), the Retirement Benefits Industry did not have effective regulation and supervision, and the interests of members were not sufficiently protected. This era was characterized by poor administration, mismanagement of scheme funds as well as outright misappropriation of funds. Consequently, confidence in the sector was low. This necessitated the enactment of the Retirement Benefits Act in 1997 and a comprehensive framework of regulations that was implemented three-years later, in 2000. The RBA was formed in 2000, to strengthen the governance, management and effective running of the Retirement Benefits Industry. This marked the beginning of a regulated, organized and more responsible retirement benefits sector in Kenya, which led to;
Improvement in protection of member’s benefits. The legislation required that existing schemes be registered by the RBA and a transition period given for the schemes to comply with the regulations. The new regulations included the separation of the roles of scheme sponsors, trustees and service providers. In addition, in-house investments and custody of schemes funds was no longer allowed and the RBA required that each scheme appoint a professional fund manager and an external custodian approved by the RBA. The RBA also imposed investment limits for various asset classes to ensure diversification and protection of funds.
Improved governance of schemes. The legislations provided guidelines on the election and appointment of trustees as the legal owners of the scheme. It also made explicit requirement for schemes to perform annual audits and service providers to submit various documentations regularly to the RBA for inspection and to track the compliance levels with legislation and exposure to risk. This resulted in better governed schemes.
Challenges facing the retirement benefits industry that have defied regulations
It is quite clear that our retirement benefits industry is growing, having hit Sh1.2 trillion as of December 2018, from Sh0.6 trillion in December 2013, representing a compounded annual growth rate of 13.0% in the last 5 years. In comparison, the unit trust market has grown by a compounded annual growth rate of 11.8% over the same period, indicating the strong growth in pensions. Even with this growth, there are still some challenges that regulations have not been able to effectively handle and these include coverage and adequacy of pensions. These challenges are not unique to Kenya but are faced by most retirement benefits industries globally;
Low Penetration Rate: Despite RBA’s initiatives to boost pensions coverage, penetration by retirement benefits schemes is still low at 20% of the labour force, and poses the biggest challenge in Kenya’s pension system, with the Authority having a target of increasing this to 30% by 2024 according to their strategic plan. One of the causes of this is the structure of the industry as it is highly biased towards formal employment where employees generally contribute from source at the salary level and employees adhere to legislations issued compared to those in the informal employment sector, where there are no regulations requiring contributions to a pension scheme. However, this gap is slowly narrowing, with the formation of individual schemes such as the Mbao Pension Plan targeting the informal sector. The RBA has also continued to invest in member education and to demystify pension schemes and making them an ordinary service that is not a preserve of the privileged few. The RBA has also continued to challenge service providers in the industry to come up with innovative products that will tap into the large population in informal employment whose coverage is under 1%, by leveraging on technology to provide them with flexible and efficient modes of saving for retirement, and,
Pension’s Adequacy: Even for those who are in a pension, adequacy exacerbates the already low penetration, with studies showing that currently, the income replacement ratio for retirees in Kenya is at 34% compared to the desired target of 75%, according to research done by Zamara. This means that for Kenyans earning Sh100, 000 per month they are only saving to earn Sh34, 000 per month during their retirement years as opposed to Sh75, 000, which is recommended. This low adequacy has been attributed to; lack of legislation that prescribe minimum contribution or benefit levels for retirement schemes, and; frequent access to the benefits before retirement by members.
Studies show that 95% of members who leave employment withdraw the maximum allowable benefits every time they change employers. It was therefore imperative that the RBA comes up with checks and balances that would enhance benefits preservation and reduce old age poverty.
Budget changes affecting the industry
Various trends and changes in the operating environment necessitate that the RBA continuously reviews its regulatory framework to keep pace with the emerging developments in the sector. Amendments to the Retirement Benefits Act and Regulations go through a rigorous review process to ensure that the changes being made will result in an improved industry and ultimately benefit the members. The process involves;
Proposals for amendments are originated by players in the industry, through their umbrella bodies such as the Fund Managers Association, Association for Retirement Benefit Schemes and the Association of Pension Administrators;
The proposals are then submitted to the Retirement Benefits Authority for review and consideration;
The RBA then forwards the final proposals to the National Treasury for consideration, and to be included in the Budget, and;
The Budget, including all the proposed changes, is then tabled in Parliament for approval. Once approved, the regulations are amended and the same are gazetted with the effective dates for each change stipulated.
In the 2019/2020 Budget, we saw several changes effected to the Retirement Benefits Industry, including;
(a) Access to employers portion of your retirement benefits before retirement:
Change: The umbrella regulations and occupational regulations have been amended to limit access to retirement benefits by members of defined contribution schemes, who have not attained the retirement age, to only 100% of their member contributions, with the employers’ contributions being inaccessible and locked in until the member attains the retirement age, or on early retirement or on immigration. Previously, members leaving the service of an employer could access 100% of their contributions and 50% of the employers’ contributions. The challenge with this was that it eroded the amount one would finally have at retirement as whenever one changes employment there was a tendency to access these benefits and start afresh reducing the funds that one will have at the point of retirement.
Implications: We are of the opinion that this amendment will be instrumental in increasing pension’s adequacy and improving the income replacement ratio for retirees and thus reducing old age poverty. For the industry, this will translate to; faster growth of assets, and; trustees through their fund managers will have more room to make long-term investments and hence to translate to better returns to the schemes.
(b) Transfer of funds from guaranteed schemes:
Change: The transfer period of schemes that invest in guaranteed schemes and wish to withdraw their funds and transfer them to another Scheme, (Guaranteed or Segregated) has been reduced from three-years to one-year, effective January 2020.
Implications: We are of the opinion that this change is favorable to trustees of schemes who are dissatisfied with their current approved Issuer/Insurance Company, as it will mean the assets starting to earn the more favorable returns of the new approved issuer/insurance company or fund manager earlier than having to wait for three years. For approved issuers/insurance companies offering guaranteed schemes, this would mean that they have to be more prudent in their investment decisions and make provisions for this shorter period allowed for liquidation of part of their guaranteed fund
In regards to reserve funds, we saw two amendments incorporated;
Distribution of reserves
Change: Occupational retirement benefits regulations and the Retirement Benefits Act make provisions for creation of reserve funds by defined contribution schemes. The main reason why schemes maintain a reserve is to help smoothen the returns in times of bad investment performance due to challenging economic environment. The Schemes are however not required to distribute these reserve funds on the exit of a member from the scheme. This in effect means that departing members exit without accessing their total entitlement from the Scheme. The amendment of the regulations is to ensure that Members receive their appropriate share of the reserves on leaving the Scheme.
Implications: We are of the opinion that this change will make the retirement benefits schemes more attractive as it increases the members’ confidence that the regulations are protecting their interests and it makes it fair for people leaving the scheme as they have access to the entirety of their savings and investment returns.
Maximum allowable size of reserve fund
Change: The Occupational Retirement Benefits Schemes Regulations have been amended to limit the amount of funds held in reserve to a maximum of 5% of the schemes assets. Initially, there was no limit of reserve funds stipulated by law and this was left to the discretion of the trustees to determine the level of reserves to keep.
Implications: This move will see enhanced member protection by increasing member benefits as it limits the returns that can be directed to reserves by trustees, and thus fund managers have to attribute the rest of the income to members. The members will therefore have better returns.
Post-retirement medical fund
Change: The amendment made is to allow members of Umbrella Schemes to make additional voluntary contributions towards funding a post-retirement medical fund. Initially this provision was available for members of Occupational Schemes and Individual Schemes. The amendments have also made a provision that allows members to transfer a portion of their retirement saving, up to a maximum of 10%, into the medical fund to achieve the desired level of medical funds.
Implications: Studies done by the RBA show that medical expenses constituted the biggest expenditure for retired people, and in addition, most insurance companies often decline to cover elderly persons, above 65 years old, as they are considered high risk. This change will play a major role towards the achievement of universal health coverage and allow members to fund their medical needs after retirement. For the members this shall play apart in lengthening the life expectancy.
Income drawdown option at retirement:
Change: The amendment has made it mandatory for schemes’ rules to provide for income drawdown, as an alternative to an annuity or a lump sum, as a channel for members to access their retirement benefits at the point of retirement. Initially, it was at the discretion of the founder to include income drawdown as an option at retirement in their trust deeds and rules, and this meant that if the trust deeds and rules of your scheme do not have this provision, you could not transfer your retirement benefits into an income drawdown fund.
Implications: This amendment increases flexibility and gives retirees more options in which they can access their benefits at retirement as opposed to the traditional annuities. This will also allow retirees to benefit from income generated from investing their lump sum benefits and thus translating to higher regular payout to the retirees. For the industry, we expect this to result in increased registration of income drawdown funds, currently we only have five registered income drawdown funds, consequently beefing up competition and thus better service to members. (The five registered Income Drawdown Funds are; Cytonn Income Drawdown Fund, Enwealth Kesho Hela Income Drawdown Fund, Octagon Income Drawdown Fund, Platinum Drawdown by Britam, and Milele Income Drawdown by GenAfrica.
Of the six changes in the 2019/2020 budget covered above, we are of the opinion that all are positive and will go a long way in promoting the retirement benefits industry and protecting members’ interests, with the primary goal being to secure their retirement years. With the industry growing, we expect the RBA to continue amending the regulations to accommodate the changes that might come by. When comparing our industry with those around the world, there are similar challenges. Global coverage and adequacy of pensions is a challenge even in advanced economies, and there is need for regulators to continuously enforce reforms and regulations that enhance the industry by smoothing the distribution of consumption spending over an individuals’ life, i.e. in both productive years and least productive years.
Report by Cytonn Investment