A while ago FAnews Online reported on the Life Offices' Association (LOA) decision to remove projected maturity values from retirement annuity quotations. The move was lauded by the LOA as a landmark move to end industry-wide confusion over maturity values.
Despite LOA claims that financial services intermediary bodies had been widely consulted over a period of 18 months, FAnews Online readers were unanimously opposed to the step. The opinion expressed by our readers is that the LOA is wrong in assuming that financial advisors are better placed to estimate maturity values on these products than the insurance companies offering them.
The financial adviser has absolutely no control over the investment and expense decisions which are made by the insurance companies in the management of their clients' funds. What they are being asked to do is akin to asking a motor vehicle salesman to tell a potential client how well a motor vehicle performs without so much as a look at the vehicle concerned.
Use reduction in yields to compare products
Financial advisers were using the projected maturity value as a simple tool to demonstrate to clients which retirement product was likely to provide the best investment return over the investment period. Now that this illustration is no longer available, the adviser is left with the complex task of comparing products with different once-off, monthly or annual fixed charges, different charges as a percentage of payment, different performance charges and charges that vary according to premium and fund size. And on top of this, the adviser has to factor in inflation and return assumptions.
The LOA and insurance companies are rather unsympathetic about the predicament they have left the financial adviser in. Their stance at this time appears to be that the financial adviser should base advice on the reduction in yield (RIY) number which is quoted with insurance products. RIY is calculated by considering the total investment (premiums paid) and the total costs for a particular insurance product. Annual RIY and total period RIY figures are then calculated using these numbers.
The RIY is a number which illustrates the total effect of all charges levied on a product on the return an investor receives. It offers a simply cost-based comparison between different products. There is little guarantee that the different mix of charges at different companies and between products will allow for realistic like-for-like comparisons.
This raises the question whether a comparison of a long-term investment product on the basis of RIY is a sensible route to follow? Should investors be focussing on the cheapest product or rather on the product offering the best possible return? In our view the problem with RIY is that it strips out two important factors the ability of the fund manager and the expected investment return.
Reducing returns at a staggering rate
Regardless of how the RIY is calculated its impact remains significant. This example considers the impact of different RIYs on a 30 year old retirement saver. The individual receives an annual gross salary of R180, 000 increasing at 1% more than inflation per annum. His retirement contribution rate is 15% and he makes contributions to the age of 65. Inflation of 5% per annum and a real return of 6% per annum are assumed. The results are quite informative.
Were it possible to avoid all costs (RIY of zero) this investor would have amassed a total of R3.150 million at retirement. A RIY of 1.85% results in a total of R2.200 million, while a RIY of 3.99% results in a total of R1.500.
Investors are always told that compound interest is their best friend in the fight for adequate retirement savings. Unfortunately the principle is equally effective when applied to expenses. RIY rates of close to 4% place a huge strain on long-term retirement product performance. The result is that the cost ratio on a product with excessively high RIY ratios quickly reaches in excess of 50%!
Editor's thoughts:
The new battle for insurance companies is to quote reduction in yield numbers that are as low as possible. With projected maturity values out of the way, insurance companies can focus on tweaking a single indicator. Despite all the hype, the value of this number in comparing two different products is still in question. Do you believe that the reduction in yield number provided with insurance quotations is an adequate measure to recommend one product over another? Send your comments to gareth@fanews.co.za
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