Francois Marais & Gerhard Joubert 10 November 2004 PCOF: Hearing on cost associated with retirement savings instruments in South Africa

Cost of Savings for Retirement Mandatory vs voluntary funding Saving vs investment Costs vs charges Up-front vs as-and-when commission Actuarial paper vs newspaper articles Disclosure of charges RIY vs “charge ratio” Some issues

Actuarial Paper Survey of National Systems 128 pages, 70 references International context Measuring charges Lifetime charges internationally Analysis of SA charges Occupational pension funds Unit Trusts Individual RA policies Excellent quantity and quality of research

Newspaper Articles “Costs ravage your RA benefits” “..high cost are reducing the benefits from RA’s by almost 45%” “There is lack of transparancy in the life insurance industry” “Sales people prefer to promote life assurance products because they receive commission up front.” “Time for life industry to come clean about costs” Serious negative perceptions created

Quotes from actuarial paper ”Individual policies appear to be the most expensive, but even here a blanket statement is dangerous and misleading.” ”There are a number of reasons that these figures should not be regarded as directly comparable.” ”Life policies … are (hopefully) sold under the umbrella of sound, holistic advice in the best interest of the policyholder, the cost of which is covered by commission.”

Mandatory vs Voluntary Funding Mandatory retirement systems (16 countries) Economies of scale No distribution cost Occupational pension funds Voluntary for employer, compulsory for employees Very little individual advice or choice Voluntary individual contributions (RA’s) High level of personal advice and choice Unit trust RA funds ?! Main difference : need for and cost of advice

Investment vs Savings Investment = lump sum business Older clients, shorter terms (5 years) Unit trusts, LISPS, single premium policies Savings = recurring contributions Younger clients, longer terms Endowments; RA policies

Are Unit Trusts Cheaper? On lump sum investments Life policy often cheaper (short terms) On recurring contributions Policies with up-front commission more expensive Comparison with unit trusts inappropriate

Unit Trust Industry Total industry assets 30/09/ R’bn Annual cash flow Total inflow 252 Total outflow202 Net inflow50 Sanlam Collective Investments Total inflow 14 Regular investments 241m (1,7%) Investments, not savings Almost exclusively lump sum investments

Unit Trust RA Funds? Insignificant volumes Limited provision for distribution cost Unrealistic as solution to problem Serious flaw in actuarial paper

Up-front vs as-and-when Commission Life industry (Regulated) Up-front commission on most recurring premiums   Endowments, RA’s, life cover As-and-when commission on single premiums (max 3%) Unit trust and LISP’s (Unregulated) Only as-and-when commission (no maximum) Mainly lump sum investments Recurring contributions = series of lump sums Trail fee as % of assets

Costs vs Charges Costs ( = what institution pays) Commission Marketing management cost Underwriting cost (on life cover) Administration cost Claims cost Charges ( = what the client pays) Premium charges   Fixed policy fee(e.g. R10)   % of premium (e.g. 3%)   Buy / sell spread(e.g. 2%) Fund charges   % of assets (e.g. 1,5% p.a.)

Reasons for different charges Fairness between policies with different terms and size Example of 1% fund charge Fund size R1 000R Fund charge R10 R1 000 Premium charge : more effective over short term Fund charge : more effective over long term Fixed charge : affects small policies

Disclosure of Charges In terms of FAIS and PPR: Full disclosure of all charges required All commission must also be disclosed In terms of new LOA Code on Policy Quotations: All charges must be discribed and quantified in one section RIY must be calculated on full actual expense charges Required Investment Return = Projection rate + RIY RIR must be printed immediately below projected values Full clear disclosure

RIY vs Charge Ratio Reduction in yield (RIY) Same as fund charge as % of assets Easy to understand In line with way charges are recouped annually Charge ratio Equal to reduction in maturity value Highly dependant on term Exaggerates effect of reasonable RIY over long term Should be used responsibly

Comparison of measures RIY Term % p.a. 2% p.a. 8% 16% 23%30% 41%51% Charge ratio Stakeholder pensions in UK could not work on 1%

Charge ratio over 40 year term? Distribution of RA policy terms Average unit trust investment term Term % policies < %49%20%7% <40 2% Money Market1,3 years Equity Funds 2,1 years Offshore Funds 3,5 years

Fundamental policy choice Compulsory contractual saving with limited advice and low cost Voluntary savings with personal advice at reasonable cost or

Thank you!