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To charge or not to charge the section 14(7) transfer debate

13 June 2007 Gareth Stokes

The Life Offices' Association (LOA) presented to Parliaments' Portfolio Committee on Finance on 31 May 2007.

Their submission covered various aspects of the Pension Funds Amendment Bill, and included specific recommendations on trail fees on transfers from underwritten RAs to non-underwritten RAs.

Specifically, "the LOA has proposed that such fees, notably trail fees as percentage of the assets, should not be permitted to be deducted from the transferred retirement savings under the second fund where those fees by law are not permitted to be deducted from those retirement savings under the first fund."

FAnews Online has received a fair amount of feedback from concerned intermediaries who believe that the LOAs decision to prevent trail fees on these transfers is harsh. The argument goes that the intermediary is unable to receive fair remuneration, on an ongoing basis, for administering sophisticated products which require continual monitoring and review.

One of the LOAs main submissions was that excessive financial incentives would result in intermediaries recommending that clients switch to underwritten RAs regardless of the financial implications. A concerned intermediary submits: "Surely, as an industry we should be encouraging the policyholders to improve their position and surely that implies that the intermediary must be fairly rewarded in exactly the same way that the fund managers and platform administrators are as an ongoing percentage of the funds under administration?"

Staggering financial implications for retirement savers

The LOA responded that reports on their initial submission to Parliament did not adequately state their position. The document, titled: "LOA Submission: Pension Funds Amendment Bill, 2007 Section 14(7) transfers between retirement annuity funds," highlights a number of factors that were considered before the recommendation on trail fees was made. One of the major concerns was the cost implication to the retirement saving industry as a whole.

According to the LOA, the estimated value of funds in underwritten RAs in South Africa is R200 billion. The value of non-underwritten RAs is a comparatively small at only R26 billion. Should 30% of the funds in underwritten RAs be transferred, intermediaries would benefit from trail fees in the order of R300 million per year. This represents a cost the industry should not have to bear. To demonstrate the impact of transferring an RA, the LOA provided the following simple example:

"Consider an RA policy with a premium of R1 000 per month for a 25 year term, taken out 15 years ago. The total first plus second year commission on the policy was R12 000.  Assume the transfer value is R400 000, based on a growth in the fund of about 10% per annum.

"It will require an additional return of almost 1% per year over the remaining 10 years to make up for the cost of transfer.  So, other things being equal, the policyholder will be worse off. The intermediary, on the other hand, will be able to start receiving a trail fee of up to 1% on the accumulated fund.  Assuming he negotiates a trail fee of only 0.5%, he will receive an income stream starting at R2 000 per year, and growing with the fund. 

"To enjoy the same maturity value in the new fund, the out-performance would have to be 1.5% per year (1% to compensate for the charge at transfer, and 0.5% to compensate for the trail fee).  If there is no out-performance in the new fund, the client's maturity value would decrease by 12.5%."

Treasury adjusts initial stance

In Treasury's initial response to the LOA submission, Jonathan Dixon indicated that the LOAs fear of an exodus from underwritten funds was exaggerated, and that the FAIS Act would provide protection to the consumer. However, in Treasury's submission to the Portfolio Committee on Finance on Wednesday, 8 June 2007 Dixon's view had changed.

"National Treasury believes that this risk will no longer be an issue in a few years time because of Treasury's plans to level the playing fields."

"While the FAIS Act provides a legislative framework, it is still fairly new and there are some gaps in enforcement (to be addressed in the FAIS Amendment Bill hopefully to come before the committee later in the year).

"Treasury therefore believes that there is merit in removing the risk, while not interfering with the principle that advisers be remunerated for advice. Since the proposed amendments do not prevent this as payment can be made directly by the client to the adviser for "fee based advice", this is considered the preferred method as it is completely transparent."

With Treasury and the LOA in agreement, it appears trail fees on transfers between underwritten and non-underwritten RAs will be written out of the Pension Funds Amendment Bill. Intermediaries will have to be content with charging clients for their advice. The LOA believes "that intermediaries who advise on such a transfer should be entitled to fair remuneration, but that the fee-for-advice model should be sufficient."

Editor's thoughts:
It appears that intermediaries will have to be content with fee-for-advice based commission for the transfer of RAs. Do you share the LOAs view that trail based fees on transferred RAs are unfair and represent a threat to the performance of clients retirement funds? Send your comments to
gareth@fanews.co.za

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