Presentation to Parliamentary Portfolio Committee on Finance

1
Presentation to Parliamentary Portfolio Committee
on Finance

• Bruce Cameron
• Editor Personal Finance
• (Personal Finance is an Independent Newspapers
  publication published in the Saturday Star,
  Saturday Argus, Pretoria News Weekend and the
  Independent on Saturday. Personal Finance is also
  published as a quarterly magazine.)

2
Rusconi Only the tip of the costs

• Simple facts of costs
• Brief historical cost perspective
• Costs A feeding frenzy
• Disclosure
• The red herrings
• Possible solutions

3
Simple facts

• No product can be cost free
• What matters is
• The quantum
• Whether the costs are justified
• Whether the costs are negotiable
• Whether the costs are fully disclosed
• Whether the costs are understandable
• Whether the costs are comparable
• Whether the consumer is placed in the most
  cost-effective and appropriate product taking
  all factors into account

4
A Brief History

• Once there were Defined Benefit Funds.
• Members contributed to the fund
• Members received a pension from the fund
• There were no additional costs to buy a pension

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And then the cost feeding frenzy started...

• The main driving factor in increased costs has
  been a consequence of the move from defined
  benefit pension funds to defined contribution
  pension and provident funds

6
Cost factor 1 Buying a Pension

• Employer-sponsored retirement funds
• Most funds now either outsource the provision of
  pensions to a life assurance company or
• Members are permitted to purchase their own
  pensions (annuities).
• (Note Annuity costs are variable and depend
  on factors such as type of annuity, commissions)

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Cost factor 1 Buying a pension

• Retirement annuities
• When a retirement annuity matures (age 55 to 69)
  at least two thirds must be used to purchase a
  pension (annuity)
• Even where the same life assurance company is
  involved there will be a second round of costs

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Cost factor 1 (Commission Eg)

• Commission on an Investment of R100 000
• Guaranteed Life Annuity
  Living Annuity
• Initial R3
  000 R2 500
• Over next 10 years (to age 70) R6 962
• Over next 10 years (to age 80) R13 275
• Over next 10 years (to age 90) R25 312
• Total Commission R3 000 R48 049
• Assumptions
• Guaranteed Annuity Commission is the three
  percent maximum permissible.
• Living Annuity Based on
• .Average inflation rate of five percent.
• .Average annual investment growth rate of 12
  percent.
• .Initial commission of 2,5 percent.
• .Annual commission of 0,5 percent.

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Cost factor 2 Preserving

• Options on resignation, retrenchment,
  dismissal before retirement
• Become a deferred pensioner (no cost)
• Transfer to fund of new employer (no cost)
• Transfer to a preservation fund (costs)
• Transfer to a retirement annuity (costs)
• Very few advisers or companies recommend the
  first two options

10
Cost factor 3 Umbrella funds

• The intention of financial services industry
  sponsored umbrella retirement funds
• To provide cost effective retirement vehicle for
  small employer.

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Cost factor 3 Umbrella funds

• Massive mis-selling taking place
• Induced by commissions of R millions, which will
  ultimately be paid by fund members in lower
  benefits
• Employers being encouraged to side-step Pension
  Funds Act
• Unmanaged conflicts of interest and therefore no
  incentive to control costs

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Cost factor 3 Umbrella funds

• Employer No. of Contribution Costs Liberty
  Momentum Old Mutual Sanlam TCS
• Employees Monthly
• Sales 11 R18491.00 Admin
  charges 1559.00 602.00 586.00 1800.00 751.00
• Commissions/Fees 1230.00 1230.00 1230.00 1230.0
  0 322.00
• Total 2789.00 1832.00 1816.00 3030.00 1073.00
  
• Percentage 15.08 9.91 9.82 16.39 5.80
• Roofing 12 R 3106.00 Admin
  charges 369.00 670.00 639.00 1800.00 788.00
• Commissions/Fees 273.00 272.00 274.00 274.00 33
  8.00
• Total 642.00 942.00 913.00 2074.00 1126.00
• Percentage 20.67 30.33 29.39 66.77 36.25
  
• Engineering 37 R 212282.00 Admin
  charges 2261.00 1851.00 2557.00 1840.00 1585.00
• Commissions/Fees 6754.00 6754.00 5000.00 4953.0
  0 679.00
• Total 9015.00 8605.00 7557.00 6793.00 2264.00
  
• Percentage 4.25 4.05 3.56 3.20 1.07
• SourceTotal Care Strategy (TCS)
• Note These costs exclude asset management
  charges.

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Cost factor 3 Use of own service providers

• Most umbrella funds, retirement annuity,
  preservation funds also insist that all their
  own services be used including
• Asset management
• Administration
• Group life and and disability assurance
• Actuarial consulting
• IE. There is no attempt to find the most
  cost-effective service provider

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Cost factor 4 Surrender penalties

• Life assurance policies including retirement
  annuities are issued for contract periods
• If a policy lapses in the first two years
  commissions are clawed back from the adviser but
  not passed on to the policyholder
• If a retirement annuity is made paid up or the
  premium reduced the cost factor remains much the
  same ie far lower maturity values for the
  policyholder.

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Cost factor 5 Investment choice

• Major trend towards giving maximum choice in
  build up and in retirement Consequences are
• Higher costs (and higher profits)
• Prudential investment guidelines (Regulation 28
  being ignored.
• Financial advisers becoming quasi asset managers
  without the necessary skills. Huge loses being
  suffered by consumers.

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Cost factor 6 Escalation clauses

• Automatic increases in premiums on retirement
  annuities to keep up with inflation Consequences
  are
• Can be reduction in investment value if cancelled
  
• Costs cannot be recovered in last two or three
  years.
• Policies will be made paid-up or have premiums
  reduced with consequent penalties for
  policyholders

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Understanding Costs

• Cost structures vary between companies.
• Cost structures vary between different products
  of companies.
• Costs may be disclosed as Rands and/or in
  percentages.
• Costs can be
• - Initial (as payment is made) and/or
• - On-going (monthly/annually) and/or
• - On exit (when an investment is made paid up or
  cashed in)

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Disclosure

• Companies are required in terms of the
  Policyholder Protection Rules (of the Long Term
  Assurance Act) and the Financial Advisory and
  Intermediary Services Act to disclose all costs.
  
• But....

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Disclosure Not everything (1)

• Not all costs are declared. Exclusions often
  are
• Asset managers actual costs (deducted from
  performance).
• Guarantee costs
• Feeder funds (often used offshore double
  management fees)
• Structured products.(Costs are embedded)
• Hidden rebates, including
• - Asset managers bulking cash of number of
  funds to receive a better rate from banks, which
  is not declared and passed on to funds
• - Loans arranged by consultants with neither
  commissions nor discounts passed on or disclosed
  to funds.
• - Rebates being paid between various parties
  ( See Attachment 1 2).

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Disclosure Not everything (2)

• Not all costs are declared. Exclusions often
  are
• Underlying costs. For example many products are
  multi-tiered. Layers include
• - Linked investments services product
• - Life assurance legal wrapper (e.g. Retirement
  annuity, preservation fund)
• - A risk-adjusted investment portfolio
• - A unit trust fund
• - Asset manager/s
• Surrender penalties. There is no formula for how
  penalties are applied for making an R/A paid up
  or reducing premiums.
• Early withdrawal/switching Penalties charged for
  changing living annuity provider (Lisp and life
  company)

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Disclosure Not understandable

• Costs are not presented in an understandable
  format (probably deliberately)
• Costs cannot be calculated as a single figure.
• Costs can often be changed at the discretion of
  the life company.
• (See attachments 3 and 4)

22
Disclosure Not comparable

• Example
• September 2003 Personal Finance published a
  report on life assurance endowment (include
  retirement annuities) to which a life assurance
  company took exception.
• Personal Finance asked for comparable cost
  details.
• Personal Finance was warned off and threatened.
• Attempts made to mislead Personal Finance (eg
  comparing a unit trust foreign specialist (high
  costs) with a life assurance money market
  portfolio (low cost)
• Report published July 2004.
• (See Attachment 5)

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How it all goes wrong

• Policy taken out seven years ago.
• Investment in foreign portfolio.
• Premium is R100 a month.
• Invested R8 400 to date.
• Current value is R6 559.
• Surrender/paid up value is R4 756
• Direct MSCI index value R8 478 (No costs)
• To match average inflation rate of 5.14 percent
  value of R10 089 required.
• R1883 has been paid in costs so far.
• Costs amounted to 22.4 percent of each monthly
  premium
• Costs disclosed as
• - a monthly charge of R4.70 which may
  increase over time, but not by more than the CPI.
• - a levy of 10 of the balance of the
  premium after deducting the monthly charge.
• - Portfolio-level charges Vary, were 1.5
  pa at the start of the policy, currently at 2.2
  pa.

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The Red Herrings

• The industry often makes false or misleading
  claims or denies what has not been said. Examples
  include
• Disciplined saving with life products.but look
  at the surrender and lapse figures. R billions
  lost every year.
• Distinction between single premium and recurring
  premium.but people dont save for retirement
  with single premiums.
• Benefit illustration agreement. Misleading,
  particularly on costs. Planned new option a big
  improvement (See Attachment 6)
• Distribution costs. Blame it on advisers when
  other costs are involved (See Attachment 7 - Note
  sent to a financial adviser from life company)
• Ombudsman for Long Term Assurance Very limited
  as is precluded from dealing with performance
  which will include costs)

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Possible solutions

• 1. The entire financial services industry must
  adopt common standards and formats for disclosing
  costs This should include
• Full break down of all costs (initial, on-going
  and exit).
• As a total in rands for the investment period
• As a percentage of the investment for the
  investment period.
• As a reduced yield This means that a Rand
  maturity figure must be provided on what benefit
  would be received if no costs are involved and
  what the figure is reduced when costs are
  involved.
• 2. Proper disclosure of commissions/fees so
  investor can ensure that commission is not the
  basis for advice. Should be disclosed as
• Initial and on-going.
• As a total in rands for the investment period
• As a percentage of the investment for the
  investment period.
• As a reduced yield If no costs are involved
  and when costs are involved.
• (See attachment 8)

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Possible solutions

• 3. Ban upfront commissions on life products and
  change to as-and-when as with the unit trust
  industry. This will
• Help reduce the high surrender and lapse figures
  as there will be no new commission incentive
  every three years.
• Help reduce the high surrender, lapse, paid-up
  and reduced premiums penalties.
• 4. Ban all non-cash incentives to financial
  advisers. This includes
• Foreign trips (What is the difference between Mac
  Maharaj accepting a free trip to Disneyland and a
  financial adviser accepting a trip)
• 5. Ban rebates (kickbacks), discounts, fees,
  commissions between service providers.
• 6. Create a standard formula for penalties on
  surrenders, paid up policies, reduced premiums
  etc.

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Possible solutions

• 7. Create low cost retirement saving options for
  low income workers either through the unit trust
  industry or a national government-sponsored fund,
  using independent trustees and private sector
  service providers.
• 8. Ban all incentives from service providers to
  retirement fund trustees.
• 9. Urgently approve draft legislation on umbrella
  funds.
• 10. Allow the Governments RSA retail bonds to be
  used as an underlying investment for living
  annuities. (Currently can only be owned by a
  natural person. By law the life office owns the
  assets invested in a living annuity.
• 11. Stop practice of forcing people into hands of
  advisers by charging a fee equal to maximum
  commission when going direct.