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The ugly face of old generation savings product

24 October 2011 Gareth Stokes
Gareth Stokes, FAnews Online Editor

Gareth Stokes, FAnews Online Editor

Modern financial services legislation centres on the consumer. New laws such as the FAIS Act, National Credit Act and Consumer Protection Act are designed to protect Joe Average from often unscrupulous industry stakeholders. In the event legislation fails to protect their rights, consumers can turn to various industry Ombudsmen, or in the case of pension funds complaints, to the Pension Funds Adjudicator (PFA) for assistance. But the Ombudsmen and PFA are often bound by nonsensical practices from the dark ages of the life industry. One such case landed in my inbox recently as a “stand out” among a list of typical PFA determinations.

The case dealt with commissions automatically deducted on a so-called old style retirement annuity. S Van der Merwe (the complainant), was unhappy with the way commission was deducted from his South African Retirement Annuity Fund (first Respondent) by Old Mutual Live Assurance SA (second respondent). A closer look at the determination confirms unwillingness by the industry to tackle its shortcomings, and reluctance on the part of the PFA to overstep certain boundaries.

The facts were not in dispute

To get to grips with this case we have to wind the clocks back a number of years. On 1 November 1985 the complainant became a member of the SA Retirement Annuity Fund (SARAF) of which Old Mutual was the administrator and underwriting insurer. The complainant’s policy went in force with an initial monthly recurring contribution of R42.10, an amount that was increased on a number of subsequent occasions at the complainant’s request. Old Mutual provided a detailed history of the policy in their response to the PFA. Monthly contributions were increased to R145.00 on 8 July 1997. On 5 September 2001, the contributions were increased by an extra R100.00, and further instructions to increase the monthly contributions were made effective from 1 April 2004, 1 February 2005 and 1 July 2006. So far, so good!

The complainant discovered that commission was being deducted from the credit balance on this policy each time the premium was increased despite the fact these instructions were issued by the policyholder without any broker assistance. Van Der Merwe said that he was “dissatisfied with the fact that there was a broker commission fee still being deducted from his investment even though he was not receiving any advice from a broker. He also submitted that “he managed his investment directly with the second respondent and as such, no broker fee should be deducted from his investment!” We were surprised that a complaint of this nature reached the PFA in the first place… Surely Old Mutual could have adequately addressed the matter directly with the client?

A broker commission party (perhaps)

Why were additional broker commissions levied after each client instruction to increase his contribution? Old Mutual said the policy was issued under its Flexi Range of products, an older generation range of products. Old Mutual explains further: “These older generation products did not provide a prospect of variable commission, a concept introduced when the new generation products were developed. The nature and design of the older generation products did not make provision for the commission content to become a negotiable item. As the commission is an invariable feature of this product range, it is not possible to adjust or remove the commission payable, regardless of the circumstances. Therefore, although the complainant prefers not to involve the services of a broker, it does not necessarily imply that the commission will be waived, or that he would become entitled to the commission concerned.

“The ability to negotiate commission is a distinct feature of the newer generation products and the actuarial design thereof. In terms of the newer generation products, the benefit of commission that is not paid to an intermediary is credited for the direct benefit of a particular individual policyholder.” That sounds fair enough for the commission incurred at policy inception, but surely not for any commissions relating to premium increases?

We can see where this is going!

Would the PFA stand up to the insurer and strike this defence? Not likely! What followed were a few paragraphs of the PFA standing up for the insurer’s right to charge the commission regardless…. The PFA observes: “There are various costs which an insurer incurs in issuing and maintaining policies of insurance which are incurred at inception of the policy…” They went on to list marketing and distribution expenses, acquisition expenses, renewal expenses and commission… Fair enough – this is common knowledge in the industry. The PFA continues: “In order to render policies actuarially sound, it is necessary that insurers levy charges against the investments made by the policy holders in order to recover the expenses. Such charges are accordingly not deducted at the same frequency as the expenses were incurred.

“Policies generally provide for the deduction of specified charges over the full term of the policy on the assumption that it will endure to term. The deduction of commission is permissible in terms of Part 3 of the regulations of the Long-term Insurance Act No 52 of 1998. Upon inception of the complainant’s policy, the second respondent paid the broker fee upfront over a period of two years on behalf of the complainant. Thus, the second respondent has to recoup this cost from the complainant throughout the term of the policy as part of the monthly premium levy.” These comments don’t seem to address any additional commissions incurred when premiums were increased. Nor does the PFA determination take into account modern regulatory trends.

Following the letter of the law...

“For reasons submitted above, it therefore follows that the second respondent cannot cancel the broker fee that is currently being deducted on the complainant’s investment because in effect the complainant owes the second respondent,” concludes the PFA. “This tribunal takes note of the second respondent’s submission that the nature of the older generation policies, such as the complainant’s, does not make provision for the commission to be a negotiable item, making it impossible to adjust or remove the commission payable, regardless of the circumstances.”

How would, for example, the soon to be implemented Treating Customers Fairly legislation resolve this issue? We’ll have to wait and see… For the time being life insurers have Carte Blanche when it comes to old generation product. The best the PFA could do was to suggest that the complaint stop the increase on his Flexi product and take out a newer generation policy that allowed for commission scaling. The complaint – which was received in March 2008, was dismissed on 12 October 2011.

Editor’s thoughts: It seems the so-called old generation policies on the books of South Africa’s life insurers kick sand in the face of modern consumer protection legislation. While the complainant in this case rues having to pay commissions each time he increases his contribution, we couldn’t help but wonder whether the broker in question actually benefited from these unassisted policy changes. What are your opinions on the commission treatment of so-called old generation products? Please add your comment below, or send it to gareth@fanews.co.za

Comments

Added by Lepooy, 18 Nov 2011
If you bought a diesel car or pickup 10 years ago you had to service it every 7,500km at your own expense once the motor plan ran out. Now, with modern technology, you only have to service new generation diesel engines every 15,000km. Why is no one accusing the car manufacturers of fleecing their customers by expecting them to service older vehicles every 7,500km? The reason is simple, the client bought a product at a point in time, it is not a "dynamic" product and hence the reasonable expectation is that there will be certain improvements in future models. The client has the option to trade the old vehicle in (take out a new generation product) and to buy a new vehicle, this means that s/he will lock in any depreciation (pay surrender penalties) and pay for the improvements on the vehicle (increased management fees) by paying the full retail price of a new vehicle unless there is a special running at the time. As you can see, we are complaining about the insurance industry and its practices but it is simply because there is not a clear understanding of the products and how they operate - many people claim they understand the products but in reality they are clueless. If the above direct client had an understanding of the products he wouldn't have complained in the first place since the terms and conditions are clearly outlined in his policy documents (user manual if we follow the above analogy). I won't be surprised if this client complains about a lower than expected payout at maturity. Growing contributions by inflation annually means that he should now be paying at least R317 p.m. to make the same real contribution as in 1985. Interest rates, and hence growth rates in general, also changed significantly since the 1980s and contributions have to be adjusted accordingly. Salary increases and current expenses should also drive the contribution rate. If the client doesn't understand the basic product structure, chances are that the above considerations also fell through the cracks - perhaps appointing an adviser and paying him/her for advice is not such a bad idea after all.
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Added by Old Timer, 26 Oct 2011
Life Office's top management used to have "slush funds" derived from these commissions as well as the commssions on predetermined premium increase "benefits" attached to policies, where commissions were deducted in a similar way. These funds were known to be used to fund overseas trips as in "conflict of interest arrangements" luring advisors to sell with only one thing in mind - production targets. In those days this was generally accepted practise driven by the impact it had on annual bonuses.
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Added by Van, 25 Oct 2011
The biggest cover up job in Modern Financial times occurred when upfront commission was changed as it was "not in the clients best interests", I discovered a few interesting points when I did comparitive quotes on the old commission type versus thye current one. 1. If you keep your RA to term you would have a much lower reduction in yield on the old system as opposed to the new system. 2. Advisors are now liable for commission clawbacks over 5 years as opposed to 2 years. We all know these facts and yet the industry has sold it to the client base at large that they have made wonderful changes for their benefit. If Mr vd Merwe was so clever he would have known that he could switch to a newer generation product at Old Mutual free of charges and changed the commisiion structure going forward. But hey, he seems to know everything so he must accept the consequences. The Life companies are filling there boots at advisorsand clients expense, the sooner we the advisors take them on, the better. The only thing more irratable than what the life companies are doing is having clients who think that they know it all and then complain when their lack of knowledge costs them money.
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Added by Chuck, 24 Oct 2011
And that can be only part of the story! I am not saying this is the case in the instance of Mr van der Merwe, but given that it is now 26 years since the policy started it certainly could be. What tends to happen is that, if the life office / product house finds that the original broker who arranged the contract has left the industry, or retired, or died, they will "nominate" some fortunate new tied agent to be the agent of record, and this person, who in all likelihood has never even met the client (in fact, may not even have the client's name other than on a commission statement) begins to receive the new additional commissions! Even worse - some of the product houses continue charging for the commission, but because the original broker is no longer involved, they effectively pocket the additional amolunts deducted from the unfortunate policyholder.
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Added by Linz, 24 Oct 2011
Reading the article my first thoughts were identical to Chuck's comments. Can you imagine the amount of money in the coffers of the assurers who have been collecting commissions where there is no active broker!!! The consumer loses and the broker who no longer receives a benefit has a tarnished reputation regardless. Thank goodness we have unit trusts based RA's and endowments now that don't penalise the consumer should they wish to stop or reduce contributions. As and when commission for investments is the fair way to go.
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Added by Cynic, 24 Oct 2011
Be it fair or not, the LO's are contractually bound to pay this commission and failing enabling legislation, they are bound by these rulings. The bigger issue is that in most cases these automatic increases, with their high product provider costs [relative to say unit trust RA options] and additional commission, make most of these increases unviable. The LO should be communicating to clients to advise them to remove the auto increase and, where applicable, to rather look at a unit traust RA option. However the cynic in me makes me believe that this 'concern for the clien't will only be shown once auto increases become unprofitable to the LOs. When it comes to Section 14 transfers of AUM away from eg Old Mutual, they are quick to show 'client care' and contact the client directly to enquire whether the IFA had discussed the benfits of retaining the product with Old Mutual, notwithstanding that the IFA has to have on record sound justifification for such a section 14 transfer. Interesting that it requires just a letter to remove this auto increase, which incidentally generates a charge debited against FV and not seen by the client [interestgingly I have found few agents aware of this charge]. For an IFA; however, to meet his FAIS responsibilities, he must first opbtain a quote from the LO to show the impact of the removal of the auto premium increase [which shows the impact of the LO charge debited against FV-this charge can be waived, but they will not], ensure that it is signed, safely filed and then draft a letter and send it to the LO.Then begins the normalsong & dance routine of following up as the instruction is not processed etc. Bottomline,it is not easy to render this basic service to the client whilst the LOs place admin impediments in the way and it is very costly to the IFA in time and potential liability in processing this service change. Net result, the LOs retain this profitable income stream. This is where the regulators and TCF need to focus. That all said, I remain a cynic in my belief that the regulators will succeed with low proifile easy targets but that the LOs, who render the greatest threat to policyholder return, will for years to come, remain 'Royal Game"
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Added by Ben, 24 Oct 2011
Fully agree with both Linz and Chuck. I wrote an article about this issue 5 years ago. What happenned to this particular complainant is a classic example of the pitfalls when policy holders go the DIY route. If he seeked advice from the right source, he would most certainly have been guided to use a more appropriate product. Having said that, did the insurer offer the complainant advice at the time of premium increase? If not, it would have been highly opportunistic of the insurer not to have referred the complainant for advice. The commission structure of the assurers' investment products is still totally skewed IMHO, yet I have very little empathy for the complainant in this case.
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Added by TheFinancialCoach, 24 Oct 2011
This is yet another classic case of the authorities paying lip-service to "consumer protection". If they were serious about cleaning up the industry, contractual savings policies would have been cleaned up ages ago...it is morally wrong to contractually bind people to long-term products and then to penalise them when they cant stick to the contract (when we all know that the chances of anyone being able to stick to it are slim). By all means "lock" people in but change the pricing so that there are no penalties when they need to alter the term and/or premium. The pricing of these (life insurance) products is archaic and they should have been scrapped ages ago...but it goes to show how powerful the big insurers really still are. Surely a case could be made against them with the FAIS Ombud for offering inappropriate products...?
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Added by Cynic, 24 Oct 2011
Referring to Linz's comment. I was an Old Mutual manager and was able to sell my wife a policy. I received no commission.When my wife lost the right to deduct her 15% from tax, I made the Flexipension PUP and incurred penalty costs. I queried the fact that not only had OM received the commission and had continued to receive the premium update commissions once I left, that they were now charging pemalty fees for loss of future commission and costs of past commission payment. I escaleted this to OM acturial who confirmed that in terms of their contract they could debit for lost commission [ regardless of the fact that they had lost none] and that insofar as the commision credits were concerned, they stated that this is credited to another account and is irrelevant to their right to recoup in terms of the policy contract. In short, they received all the commission and recouped it again via the PUP penalty charges. They received this income twice!!!!! Imagine the regulators reaction if an IFA did this. Linz perhaps doesn't realise that with the staff turnover via death, resignation etc that the biggest commission earners on a LO's books are probably the LOs themselves and they have zero responsibility to advise or service and no FAIS advice/service liability. They never credit it to new agents. Where are the regulators or TCF? As an aside, I decided to make a section 14 transfer to Allan Gray and then faced a secound round of penalty costs.This I believed was at variance to the SOI, but Old Mutua linsisted that they could debit penalty costs again as it was a 'secound causal event'. I was unsuccessful in getting this waived and decided to simply leave this with Old Mutual to maturity. About a year later the regulators ruled against the LOs for this debiting of penalties twice via this 'secound causal event' trick as it was clearly a breach of the SOI agreement-but too late for my wife. For information to other IFAs --at maturity, as it was at age 55, I decided rather than mature the RA, to transfer it to an Allan Gray RA. Notwithstanding constant follow-ups and escallations, this took 6 months whilst the market ran. The OM keeps it in a cash portfolio and the opportunity cost to the client, as they dilly dallied in processing the transfer, was in the region of R100000-00. They deny liability notwithstanding that part of the delay was due to the fact that the file was transferred to a department whose duty was to contact the client and query why she was moving it and whether I had advised her that she could be better off remaining with Old Mutual. What a challange to an IFA's advice and clearly it knocks his credability with the client. The learning for me is that although the 'appropriate advice' with an Old Mutual product in these circumstances is to transfer to another RA, the practical and best advice is simply to mature and pay to a living annuity with minimum draw down. Legally incorrect, but in terms of return it is at the end of the day, the right advice. I remain a cynic
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Added by Five, 24 Oct 2011
Please people that was then .. this is now ... I too have a policy that I would love the comm to disppear .. but accept that through legislation FSB and client friendly ones ... we are a far cry from there .... So be it .. .. it took that client who thinks he is doing a WONDEFUL job of self "managing his investment directly " ... if he was so bright he should have spotted this at the 1st increase ....
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