Separated from other life insurance by the 2004 Pension Reform Act, group life policies have been the most successful product class driving penetration in recent years and now represent the largest pool of investment assets domestically. With the regulator, the Pensions Commission (PenCom), driving consolidation in the insurance sector in 2012, new rules on where pension funds can be invested will serve to unlock part of this significant pool of domestic institutional funds for long-term investment.
PENSION REFORM: The 2004 act radically transformed the sector by establishing a rigorous regulatory framework for the transparent aggregation and investment of formal and public sector workers’ pension contributions. Moving from a defined benefit scheme to a contributory pension scheme, the reform based on the Chilean model requires all enterprises with more than five employees, as well as all public organisations, to provide individual retirement savings accounts (RSA) with a licensed pension fund administrator (PFA). The employees appoint a pension fund custodian (PFC) independent of the PFA to hold the funds, while the PFA invests and manages the assets, creating a strong system of checks and balances. Funded through equal contributions of a minimum of 15% of the salary, which will be split equally between employee and employer, this represented a significant improvement on the previous opaque system of public pension administration. The armed forces are an exception, with employees contributing 2.5% and the federal government providing the remaining 12.5%. Although states are not required by law to enact pension reform, a growing number have shown interest. If each state provided coverage for 50,000 employees, this would add a total of 1.8m new accounts. PenCom’s ultimate aim is to extend coverage to an estimated 50m Nigerians thought to be employed: some 15m of these are currently employed in the formal sector – 9m in the public sector and 6m in private business. BGL Securities, a Nigeria-based stock brokerage, estimated in a 2011 report that it expected pension assets to grow to $47.32bn by 2015.
COMPLIANCE: Although penetration progressed slowly at first, with just N121bn ($774m) in assets under management (AUM) in 2005, contributions grew substantially from 2006, with the first 1m formal sector workers covered by the middle of 2006. By the second quarter of 2008 when the number of registered contributors exceeded 3m, the majority of federal government workers had been covered, with compliance growing among larger corporates as well. “Market growth has been below expectations, primarily as efforts to get the informal sector on board have yet to pay off,” said Adeniyi Falade, the managing director and CEO of Crusader Sterling Pensions. “Weak enforcement on the formal sector and macroeconomic challenges are also an issue.” By the start of 2012, total monthly pensions contributions reached N20bn ($128m) and were growing at 30% year-on-year. The number of contributors exceeded 5m in the first quarter of 2012, with some N2.45trn ($15.68bn) in AUM at the close of 2011. Enrolment is expected to rise going forward, albeit at a slower rate, according to Tunde Hassan-Odukale, the executive director of Leadway Assurance. “Growth in the enrolment side of the pension industry is expected to be linear, at a rate of 2-5% for the foreseeable future,” he told OBG.
ENFORCEMENT & INCENTIVES: While compliance is highest among larger companies and the federal government, challenges remain at the level of small and medium-sized enterprises (SMEs), as well as state and local governments. As a result, PenCom has stepped up enforcement efforts. In 2011 it started requiring all companies doing business with the federal government to provide proof of pension provision as a prerequisite for awarding a contract. Over the longer term, it will be crucial for PenCom to find ways to incentivise informal structures and SMEs to establish pension schemes. Larger PFAs, such as Crusader Sterling, have already started making inroads with SMEs, which account for 35% of its business. But with roughly half of all private sector employees working for SMEs, the room for growth is significant. While past attempts at establishing such schemes have failed, the improved solvency of the industry and its good track record since 2004 will gradually engender confidence. ongoing consolidation should serve to further cement the leadership of the top PFAs.
CONSOLIDATING MARKET: PenCom held three licensing rounds yearly from 2005, which served to create three “generations” of PFAs on the market. Minimum capital requirements were set at N150m ($960,000) for PFAs, and at N5bn ($32m) for PFCs (all of which are banks). A total of 26 PFA licences were awarded, as well as five PFCs and seven closed PFA licences to large corporations, such as Shell. While RSAs are individual and can theoretically be switched between PFAs up to every year, this has not been allowed in practice, thus creating a clear lock-in effect for established PFAs. “There has been a massive first-mover advantage for PFAs that were licensed in the first tranche, but we expect to see a more level playing field once the transfer window is implemented by PenCom,” said Falade. The first seven licensed PFAs are clear sector leaders: IBTC Pension, Premium Pension, Pensure, Sigma Vaughan Sterling, Pensions Alliance, First Alliance Pensions & Benefits, and ARM Pension Managers. While the next five licences awarded in 2006 have become mid-sized firms, the last 14 have faced challenges in growing their contributor bases.
The largest PFA is Stanbic IBTC, a subsidiary of South Africa’s Standard Bank, which holds roughly 20% market share. Other large administrators, such as ARM, Crusader Sterling, Sigma Pensions and Leadway Pensure, have covered a majority of federal government staff, the single largest group of contributors to the industry, accounting for roughly 40% of those paying into the system, as well as the employees of some larger firms. Meanwhile, competition in the SME segment has heated up, although price discipline has largely been maintained without excessive discounting.
CAPITAL REQUIREMENTS: The regulator increased capital requirements to N1bn ($6.4m) for PFAs in 2011 and set a deadline of June 2012 for compliance, which has spurred a flurry of activity for fresh capital among PFAs. In addition, a number of banks with PFA subsidiaries have moved to divest themselves from their subsidiaries, in line with new CBN regulations on core banking structure. Only Stanbic IBTC will preserve its equity links to its PFA, opting for a holding company setup. These factors have spurred the 24 existing PFAs to consider mergers and acquisitions (M&A). According to Falade, “Following recapitalisation earlier in the year, the industry is likely to see some consolidation, with many of the acquisition opportunities centred in the third generation of PFAs.” First to move was ARM Pension Managers, which acquired First Alliance Pension & Benefits in June 2010. A number of deals followed, including Sigma Pension’s acquisition of Amana Capital Pension, Oak Pension’s take-over of Crib Pension Managers and Evergreen Pensions, as well as the liquidation of Standard Alliance Pension Managers and the transfer of its assets to Pension Alliance (PAL). There were 22 PFAs left in mid-2012, a number that is expected to drop further in the coming year, with Crusader Sterling Pensions moving to finalise an acquisition by late 2012. “We expect to see market-driven consolidation in coming years,” said Falade. “In the long term, we expect to have 14 PFAs on the market.”
Other PFAs have attracted recapitalisations through local and foreign capital injections. First Guarantee, for example, raised 30% of its equity from South Africa’s Novare Holdings in March 2012, although the troubled PFA was struggling to preserve its licence by mid-2012. With the number of PFAs set to reduce further and average capitalisation levels rising, competition is likely to intensify. Yet with relatively generic products on offer, competition has focused on service and accessibility, rather than product offering and price. A consensus is emerging in the industry that medium-term growth will be driven by PFAs’ ability to control costs by improving their technical capacities, while also maintaining an edge in customer service – a challenging balance to strike. Another crucial element will be returns on investment achieved by PFAs.
ASSET MANAGEMENT: With a dependency ratio of 22, Nigeria ranks in the middle of OECD countries – far lower than Italy’s 47 but higher than Brazil’s 13. Given the young age of the pensions industry in Nigeria, however, PFAs’ asset-to-liability mismatch remains manageable, as the split between contributors and retirees remains weighted in favour of retirees roughly 70:30. Indeed PAL, a PFA, estimates some 63% of contributors are younger than 40 years old.
Yet as the industry matures, PFAs will need to seek a closer match between assets and liabilities, finding longer-tenured financial instruments to invest in. Returns on investment, meanwhile, have proved to be favourable in the past five years, at an average of 20% annually, with a heavy weighting in government bonds and money market instruments. Although countries such as South Africa have raised the limits on foreign investment, PenCom’s risk-averse regulations are widely credited for insulating the industry from the effects of the 2008 downturn. Indeed, a 2009 report by International Financial Services London, a think tank, found that those pension systems whose investments were most heavily weighted towards domestic government bonds were best insulated from the effects.
CHANNELING FUNDS: Yet the state is eager to channel some of these funds towards productive investments at home. Conscious of the need to preserve a risk-averse investment strategy, PenCom will be implementing new regulations by end-2012, opening the doors to infrastructure funds and private equity (PE). A careful balance between investments’ productivity and profitability will have to be maintained, however. Indeed, the African Pensions Association estimated in early 2012 that PFAs must achieve a return of around 8% annually to be viable in the long term.
NEW RULES: New rules in 2010 had already opened PE and corporate bonds rated “BBB” or higher to the PFAs for the first time. PenCom circulated a draft of new guidelines in March 2012 for public comment. The most fundamental shift will be the requirement for each PFA to establish four separate funds with varying exposure to different asset classes. The new rules will open sharia-compliant instruments for investment for the first time, while raising the ceiling for investment in PE from 5% to 10%, infrastructure funds to 5%, open and closed-end funds to 30%, and infrastructure bonds to 25%. They will also allow exposure of up to 50% to the domestic equity markets, up from 25%, and is likely to place a minimum level for PFAs’ exposure to equities. Ceilings for investment in federal government and central bank securities at 80% of AUM remain in place. For the first time, PFAs will also be allowed to buy foreign currency bonds issued by development finance institutions.
Although these revised guidelines represent a significant liberalisation of the asset management framework imposed by PenCom, strong risk management provisions remain in place, with a cap of 10% of AUM placed on investments in any one company and 35% for any one sector. Infrastructure, however, is clearly the priority area opened up by the new regulations. PFAs are allowed to invest up to 5% of their AUM in any infrastructure fund with over 75% of its projects in Nigeria, and up to 25% of their AUM in infrastructure bonds for projects worth more than N5bn ($32m). Priority areas earmarked include planned public-private partnerships in infrastructure, such as roads, railways, ports, airports, power plants and gas pipelines.
The larger economies of scale and higher technical efficiency among PFAs will drive penetration in the coming years. Although a balance in favour of prudence will have to be preserved, increasingly PFAs will be coaxed to place some of their assets in longer-term investments, such as infrastructure bonds and PE. This will go some way in resolving the traditional mismatch between its requirements for long-term investment and the availability of short-term funding.
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