The danger with lower early termination values : PPS Investment CEO responds

We published a newsletter regarding The National Treasury's recently released a document containing proposals which will have a significant impact on the life insurance industry. In a paper titled: “Contractual Savings in the Life Insurance Industry.” Treasury suggests a number of changes to Part 3 of the Regulations under the Long Term Insurance Act (1998). And these changes will require significant sacrifices from both life assurance companies and insurance intermediaries.  The newsletter invited comment from readers and we detail below a comment received from Mr Nick Battersby, CEO, PPS Investments.

Any car dealer will tell you that panel beating yesterday’s model and putting on some new mag wheels won’t turn it into a new beauty overnight. Similarly, Treasury’s proposals this month [eds: March 2008] on commissions structures and reduced penalties on transfer of retirement annuities will not change the old under-written retirement annuity (RA) product into something more desirable than the new generation RAs already available in the market place.

Nick Battersby, CEO of PPS Investments (PPSI) – the investment arm of the last remaining mutual in South Africa – warns that the positive spin and hype being placed on these proposed changes to the underwritten products need to objectively assessed. They should not be misconstrued and this certainly does not mean that investors should now just recklessly go and buy the new beauty without weighing up the pro’s and con’s.

There are two very different product structures within the broad category of retirement annuities, in the current context. On one hand is the traditional under-written RAs provided by life offices, and on the other the new generation unit trust based RAs provided by linked product companies and asset managers. This is an important distinction to make, since the issues addressed in the Treasury reform paper are only relevant to the old products. If approved, the proposals would come into effect in August this year.

The proposals, in a sense, make it easier to now migrate from the old products to the new RA range. They address commission levels payable and the timing of these payments, as well as significant reductions in the penalties that traditional funds have been able to charge members to move their assets to the new generation funds.

While the penalties to migrate have not been done away with in its entirety, the drop from 30% to 15% is a step in the right direction. Up front commissions will now be limited to 50% of the full commission. This still falls short of the arrangement with the new generation unit trust based RAs where fees are only paid at the time of the premium payment, i.e. “as and when”. The broker is paid to provide a service and is paid monthly for as long as they continue to provide that service, as well as an ongoing fee based on the accrued asset value of the client’s investment.

The announcement of these proposals has certainly led to an even greater number of investors seeking to transfer to the much less expensive and simpler model (up to 2% p.a. cheaper in fees) of the new generation RA. A relatively simple calculation can illustrate to members what the break-even point is when it makes sense for them to incur a short-term penalty in the interest of a lower cost environment for the rest of their contributing period. With the reduction in the maximum penalty, the barrier to leaving an under-written fund has been halved.

Battersby offers the following advice, for people looking for a new RA. “The traditional product has become more attractive to investors than it was before, but a comparison with the new generation product is essential and a thorough understanding of the subsequent charges that may exist i.e. can you switch your investment options, are there heavy annual policy costs etc”. For those in traditional RAs; a reduction in premium will still incur a penalty, but the penalty will be less. For those looking to transfer their RA, find out what your penalties would be and assess the cost differential with your financial advisor.