Presentation on theme: "Presentation to Parliamentary Portfolio Committee on Finance Bruce Cameron Editor: Personal Finance (Personal Finance is an Independent Newspapers publication."— Presentation transcript:
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.)
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
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
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
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
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)
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
Cost factor 1 (Commission Eg): Commission on an Investment of R 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)R Over next 10 years (to age 90):R Total Commission: R3 000R 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.
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
Cost factor 3: Umbrella funds The intention of financial services industry sponsored umbrella retirement funds: To provide cost effective retirement vehicle for small employer.
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
Cost factor 3: Umbrella funds Employer No. of ContributionCostsLibertyMomentumOld MutualSanlamTCS Employees Monthly Sales 11 R Admin charges Commissions/Fees Total Percentage15.08%9.91%9.82%16.39%5.80% Roofing 12 R Admin charges Commissions/Fees Total Percentage20.67%30.33%29.39%66.77%36.25% Engineering 37R Admin charges Commissions/Fees Total Percentage4.25%4.05%3.56%3.20%1.07% Source:Total Care Strategy (TCS) Note: These costs exclude asset management charges. Costs of employee sponsored funds (two real examples): Provident Fund 1172 employees 0.61% of every contribution Pension fund 896 employees 0.57% of every contribution
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
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.
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.
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
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)
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…....
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).
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)
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)
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 (See Attachment 5)
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 R 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 R 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.
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 don’t 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)
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)
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.
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 Government’s 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.