The risks of Section 14 transfers

Financial intermediaries must do their homework before advising clients on a Section 14 transfer, since completing the transfer is not always in the policyholder's best interest.

The Pensions Fund Amendment Act makes it possible for clients to complete a Section 14 transfer regardless of their Retirement Annuity (RA) Fund rules. New changes will even allow for the financial intermediary to receive ongoing advice fees on the transfer. These changes, says Old Mutual, were made "in the context of the increasing demand for customer choice and flexibility in retirement funding arrangements." But completing the transfer is not always in the policyholder's best interest.

According to Old Mutual, financial intermediaries must do their homework before advising clients on a S14 transfer. Risks that should be assessed include: the risk that the fund value of the current retirement funding vehicle may be reduced when the contract is cancelled or transferred; the risk of forfeiting valuable guarantees on the existing fund; the risk of forfeiting life, disability or other risk benefits on the policy when transferring; and the risk of missing viable options within the same retirement annuity fund. In light of these risks, Old Mutual believes policyholders can benefit from moving their 'old generation' policies to new policies within the insurer stable.

1% is a big difference over 10 years

Old Mutual illustrates this with an example. Joe Public, a member of SARAF whose benefits are funded by an Old Mutual Flexi Pension Retirement Annuity policy, decides to move his retirement benefits to a Sanlam Retirement Annuity offered by CRAF. At transfer date Joe's fund has a value of R123 082, premium contributions of R275 per month, a remaining policy term of 10 years and effective ongoing annual charges of 3.1%.

Assuming a return of 11% per annum (before costs) he would receive retirement capital of approximately R312 867. If Joe decides to transfer these funds he incurs contractual fees and penalties which reduce the fund capital to R104 589 on transfer. To achieve the same retirement capital under similar conditions Joe's new retirement annuity fund should levy annual charges of 1.5% per annum or less.

We spoke to Hendrik Janse Van Vuuren, a CFP and director of HL Group for his views on the subject. "I agree with Old Mutual in the sense that I cannot see the benefit of transferring a life company retirement annuity to another; but it certainly is in the interest of investors to transfer their retirement annuities to Lisps and/or Unit Trust retirement annuities where no penalties on early retirements, reduction in premiums, stopping premiums, etc., exist."

Do the sums

Andrew Ruddle, Investment Product Manager at Old Mutual, responds: "Transfers between RA funds are very often not in a client's best interest. This applies to all types of RAs after transfer, including UT or LISP RAs. A careful consideration of the actual facts in each case is needed to determine what is best for the client."

What is not in dispute is that penalties on transfers can be staggering. Janse Van Vuuren shared a real-life example to demonstrate how quickly a policyholders' capital 'disappears' when making changes. He started contributing to an Old Mutual retirement annuity in 1998, paying premiums totalling R63 000 over a period of four years. During the third year he requested that his R2 500 monthly premium be reduced to R1 000. "Old Mutual deducted a penalty of R30 700 – and after various unanswered requests about what happened to my fund value, I cancelled the premium 12 months later." Upon cancelling the premium Janse Van Vuuren incurred another R18 700 penalty. He notes that the fund value at 1 March 2007 stood at R10 300. "After once again requesting details I received the first reply from Old Mutual in March 2007."

We'll charge what we charge!

Old Mutual subsequently added R49 000 to the fund, in accordance with the changes to Long-term Insurance regulations, commonly known as the "Statement of Intent" agreement between the industry and National Treasury, which means the total penalty was in the region of R19 000. "After a lot of correspondence between myself, the Pension Funds Adjudicator and Old Mutual (with no success) they eventually transferred some R38 000 to Allan Gray. The fund value reached R60 000 after their enhancement in 2007."

It must be added that the funds were invested in a Worldwide Equity fund, which was hit by the perfect storm of falling overseas equity markets and a depreciating Rand just prior to the transfer to Allan Gray.

Nevertheless, how is it possible that penalties on premium reductions and fund transfers are so high? We asked Ruddle to comment on the capital depletion in the 'Joe Public' Old Mutual Flexi policy example mentioned earlier.

"All Flexi policies are 'discretionary participation business' which means that charges are set at a level designed to recover the costs associated with issuing and administering these policies as well as the required profit margin.

"The charges are generally expressed as a percentage of the premium, a flat rand amount per annum and a percentage per annum of the assets. Many of the actual costs relating to the policy are incurred 'up-front' at the inception of a policy (e.g. marketing and distribution costs and commission) but are only recovered over the lifetime of the policy via the various charges given above.

A third of your fund value up in smoke

"The size of any fund value reduction is determined by the actuarial rules governing the RA policy. In the case of a Flexi RA the actuarial basis provides for the recovery of incurred expenses that have not yet been recovered.

These incurred expenses would include commission paid to the intermediary, as well as the initial distribution and administration expenses incurred by Old Mutual with respect to the RA policy."That's not great news for policyholders. And they won't be too impressed with Ruddle's observation that the fund value reduction "can never be more than 30%" for policies sold before 2009.

Despite advances in cost transparency and improvements to capital values on transfer, surrender and early terminations, insurers still apply up to the maximum 'legal' penalty, where the actuarial basis would have resulted in a higher fund reduction. Ruddle says that "fund reductions are designed to recover actual incurred costs only, and as per long-term insurance regulations, are in accordance with signed-off actuarial rules."

Janse Van Vuuren observes: "There is just no way that the insurers can justify these products. The question is: can any life company provide us with one policy number where the net return on the gross premium of any client has beaten inflation up to the point where 10 years remain to maturity date?"

The lack of transparency where charges are concerned remains a bugbear. "Plan alteration charges like cancelling premium growth, adding nominees and removing nominees are also not acceptable. In 99% of these cases the clients are not even aware of these fees being deducted from their fund values," said Janse Van Vuuren.

The parting shot

"Why is there always a discussion about commission of intermediaries which amounts to more or less a third of the total costs on policies, but never about the other two thirds paid to the insurers?" asks Janse Van Vuuren. "Sure – commissions need to be reduced or spread – but the same aggressive reduction policies should apply to the insurers' costs too!"