KEEP UP TO DATE WITH ALL THE IMPORTANT COVID-19 INFORMATIONCOVID-19 RESOURCE PORTAL

FANews
FANews
RELATED CATEGORIES
Category Retirement
SUB CATEGORIES General |  Savings & Investments |  Annuties | 

Yet another RA investor cries foul

08 June 2021 Gareth Stokes

Back in 2020, or was it 2019, I had first-hand experience of the poor savings outcomes on offer from sales-driven financial advice when I chose to make one of my retirement annuities (RAs) paid up. I had, for many years, been contributing to a product that my financial adviser has since assured me was the ‘Toyota Corolla’ of RAs during the first decade of the new millennium. Everyone was driving them; and every adviser worth his or her salt was selling them. These Toyota Corolla’s have rewarded present day consumer journalists with thousands of column inches as they assist disgruntled savers in voicing their unhappiness. The latest article, published on Moneyweb.co.za, features a client commenting under the pseudonym Mr G. For full disclosure, this Mr G is not me, though I have been called by that moniker in the past.

Dismal returns over 16 years

FAnews has no intention of naming and shaming product providers in this newsletter. We will, however, point out that many of the country’s large life insurers are responsible for similar RA horror stories, with thousands of their clients locked into less than spectacular savings products. The client in question observed that his RA contributions, totalling R393 000 over 16-years, had grown to a mere R470 000 today. 

Among his comments was that he would “have been sitting with about R2 million” had he simply redirected his monthly contributions to an everyday bank savings account. Mr G was incensed by both the excessive fees charged over the life of the investment and the poor investment returns generated by it. He was also shocked by the insane termination penalties or aptly-named reduction fees that would be charged for making the RA paid up or transferring the investment balance to another provider. Making an RA paid up involves halting further contributions, but leaving the balance with the original provider until the fund can be accessed. 

The complaint contained various claims that are difficult to unpack without information about the timing and value of monthly cash flows. Moneyweb.co.za, with assistance from the named provider, made some efforts to correct and defend the outcomes. They observed, for example, that a fairer calculation of the bank savings account route would have yielded only (sic) R570 000 or so. The main thrust of the provider’s counter was that the bulk of the RA contributions had been invested for far less than 16 years and that the client had made changes to the underlying portfolios, contributing to the poor returns. But defend to what end? 

It makes no sense to obsess over the exact ‘rand and cents’ value of the losses or the missed opportunities in the investment, nor does it help to attempt to assign blame for the debacle. Product providers should be holding frank and honest discussions about how to address legacy products that deliver such consistently appalling outcomes rather than looking for ways to hang the result on asset managers, for poor returns, or financial advisers, for poor advice or charging high fees. Incidentally, per my understanding, advisers had little to no influence over the design or ongoing administration of the commission structures conjured up by the product providers. 

Ill-thought starting parameters have serious long-term consequences

Fees and commissions turned out to be the elephant in the room in this case, both during the back and forth between product provider and client, and in the layperson’s ability to assess the actual versus published performances of the underlying funds. Some confusion arose from the differing methods used by the asset managers and RA product providers in determining returns. In this case the product provider calculated returns net of asset management fees, as they should be; but the annual rate of return was calculated based on a lump sum investment made at the beginning of the period rather than by compounding monthly contributions… At least that is our understanding. 

Assuming then, that asset management fees did not make a big dent in the eventual outcome, attention turned to the financial adviser or life broker commissions and provider administration charges levied against the fund. According to the article, the product provider paid adviser commissions averaging around R200 per month over the 16 years, which amount was deducted from the net value of the investment account. The publication went on to estimate that “some 9.4% of the total contribution to the RA went to fees, in addition to asset management fees already paid to fund managers of the underlying funds”; but it was not clear if this included above-the-line deductions from the actual contributions, pre-investment. The split between advice commissions and product provider administration charges was also unclear. Hopefully our readers can assist with a better cost breakdown in the comments, below. 

Will we ever put the RA issue to bed?

The worst of these legacy RAs are no longer sold; but that does not mean that current products are above reproach. There are still questionable practices in the present day ‘sales’ environment, most notably building an annual escalation into the saver’s monthly RA contribution, commonly 10%. This is a ridiculous starting point in a country where income inflation has been pegged at 4% or lower for multiple years, not to mention the high rate of job attrition due to firm closures and restructuring. 

Imagine, for example, a young professional who started saving 10% of his or her R40 000 monthly gross salary in a life insurer RA, beginning January 2016, with a 10% escalation. By January 2021, this individual would be lucky to be earning R46 500, assuming 3% annual increases; but paying a debilitating R6 450 per month, or 13.9% of monthly gross, to the RA. This gets worse over longer periods and becomes untenable over two or three decades. It is a product design flaw that results in many savers stopping contribution increases or making the RA paid up, with associated penalties, of course. 

Mr G’s story received dozens of reader comments, mostly critical of life insurer practices and financial adviser remuneration. There is widespread agreement that the penalty fees for exiting these RA products are punitive; that the advice and administration fees are too high; and that the investment returns are often inadequate. Of even greater concern is that the pre-retirement ‘fee fleecing’ continues in retirement. The standout reader comment to the Moneyweb.co.za article was that financial advice fee structures in the linked annuity space often result in the advice practice drawing out as much in fees as their clients take in pension! 

But I digress. Allow me instead to offer my concluding remark on the original issue: I stand in awe of the financial engineering that delivered a savings product capable of handsomely remunerating advisers and product providers while undoing the combined power of compounding & time in the market! 

Writer’s thoughts:
Imagine a world where Treating Customers Fairly (TCF) was built into the financial sector regulatory environment… Oh wait! We have that in South Africa. My view is that under TCF the life insurers, perhaps led by their association, should gather together and create a funding pool to compensate victims of poorly designed / implemented products, perhaps by abolishing so-called reduction fees. Could this work? We would love to hear from you. Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts [email protected]

Comments

Added by Gareth Stokes, 15 Jun 2021
Thanks for the comment, Andre. I agree with your observation re hindsight. Commission is drawn into the debate, I guess, due to its influence on product distribution / sales.

I have always been of the view that product providers should be overall accountable for product design, especially if the design makes it impossible for the product to deliver on the outcomes that are promised through the advice process…
Report Abuse
Added by Gareth Stokes, 15 Jun 2021
Great question @Nicholas. How is this legal? The industry will claim that the life RA holder has accumulated a lump sum they would not have had to begin with; but that lump sum has done nothing to fight the ravages of inflation due to the impact of fees on the average annual return.
Report Abuse
Added by Andre Kruger, 12 Jun 2021
Why is the commission always the elephant in the room? Would like to see sensible suggestions to remunerate intermediaries in these cases.
Commission on RA's has been halved over the years and is not all payable upfront anymore for a very long time already.
Hindsight has never given anybody useful insight since nobody knows what the future will be.
I am sad that reversionary bonuses fell by the way side, at least the gains vested and could not be taken away.
My question is simply what else could be done to ensure more people retire with enough funds, the stats is dismal and I believe it is not because of the remuneration intermediaries receive at the moment. It is just so easy to blame the intermediary and the product houses (big business) simply get away with it.
Just my 2 cents worth opinion with 40 years experience in the industry...
Report Abuse
Added by Nicholas De Villiers, 08 Jun 2021
I have seen a statement from a well-know Life House which doesn't even disclose all the fees. It shows investment management fee only. However, it shows monthly contribution from client and what ends up invested. I calculated this and the actual fee was more than 5%! The internal rate of return on that fund was about 2%.
Another two clients have had RAs for more than 10 years with another life house (who are always in the news for their clever products and medical aids and their CEO's share sales). Client's internal rate of return since inception is also 2%. Again full fees not disclosed.

How is this legal?

Report Abuse
Added by Gareth Stokes, 08 Jun 2021
Thanks for the comment @Gob Smacked. Indeed. The EAC was what shook me to the core when reviewing my RA. Looking at near double-digit annual expenses on what is meant to be a retirement funder is very depressing viewing indeed. And the argument that the fees reduce over the lifespan of the product is of little comfort.
Report Abuse
Added by Gareth Stokes, 08 Jun 2021
Thanks for your participation Derek. I am sure many of our readers have interacted with SAIFAA over the years… Your 21 Due Diligence Questions initiative is praiseworthy!
Report Abuse
Added by Gareth Stokes, 08 Jun 2021
Thanks for the info, Ben. The up-front commission ‘upgrade’ sounds like a truly perverse selling incentive. Would love to engage further by email!
Report Abuse
Added by Gareth Stokes, 08 Jun 2021
Good point, thank you Paul Kruger. Perhaps the FSCA should do an audit of affected RA investors; there must be 100s if not 1000s of investors suffering serious financial damage each year… Not to mention those who have endured these fee structures until retirement date.
Report Abuse
Added by Gareth Stokes, 08 Jun 2021
Cynical Simon: The flaw, from my perspective, is the fee structure baked into the product from the start. It fails a reasonableness test in both quantum and application. A second flaw is the product’s inflexibility and the product provider’s refusal to address obvious shortcomings… It seems absurd to lock a client into a set-in-stone product / fee structure for a period often exceeding two or three decades.
Report Abuse
Added by Gob Smacked, 08 Jun 2021
The most astonishing element is the commission account within these policies, the commission was paid upfront to the advisor and a commission loan account was set up, this loan account attracted interest at 10% or more and the client paid the interest so what was e.g. R 13 000 in upfront commissions for first and second year commissions, became over time much more than that. It was only when the EAC reporting became mandatory that these charges started being disclosed. The quotations presented to clients at the inception of the policy did in no way detail the workings of the commission account and any interest charged.
Report Abuse
Added by Derek Smorenburg, 08 Jun 2021
Ben and Simon, don't hold your breath for action by ASISA Members or the Regulators to change this NON Treat Clients Fairly (TCF), it is not going to happen!
Public Education and Guidance is the only answer and as a first step every R/A and other Financial Product must ask 21 Due Diligence Questions of their so called Financial Advisor!
As a Public service SAIFAA has made available a set of Client/Advisor 21 Due Diligence Questions that covers aspects such as "are there any early penalty termination clauses" in any of my stuff? and what am I paying you for (i.e. R200 pm) and how often do we meet to review my ever changing circumstances during my journey of life?
No matter when this Due Diligence process is started it can only get better with steps like a Section 14 transfer of the old R/A to a new less costly product.
The Public and Industry SAIFAA 21 Due Diligence Ultimate Questions are available on https://saifaa.co.za/ultimate-questions/
Report Abuse
Added by Ben Holtzhausen, 08 Jun 2021
I strongly believe product providers should be taken to task about the up-front commission and cost structures built into their products, especially savings vehicles. "Many articles and debates about this subject have seen the light, yet the larger assurers cling to these perversely incentivised products for dear life. These perverse incentives are probably the major reason why we have become an industry almost debilitated by over-regulation, driving up the costs for advisers even more and in turn stimulating the need for higher perversely structured revenues.
To add insult to injury, one of the large insurers recently started a marketing campaign to target MY clients to directly sell their cost loaded, empty promise crap to them, offering me 50% of the commission which can be upgraded to 80% on condition I assist them in bulls**tting my client.
It's time for regulators to KILL up-front commission structures urgently.
This elephant will remain in the room until we remove the oranges and other tasty fruits from the room.
Report Abuse
Added by Paul Kruger, 08 Jun 2021
The root cause of these problems is the so-called Causal Event Penalties. Despite actuarial justification from life offices, all this really is is a way for the LO to recover future profits from the client's funds. The broker has commission clawed back. The LO? No damage, despite charging investment related fees on the so-called "loan" to the client. The regulators started addressing this in 2002, and hope to have it abolished in 2029. Is that fair treatment of the client? TCF should also be a regulatory obligation,
Report Abuse
Added by cynical simon, 08 Jun 2021
Being divorced from the life and R A Market since the nineties of the previous century, the information contained in this article really shocked me to the core.
Though I cannot make out exactly what the flaw in he design is [which fact probably is of no consequence] I am however convinced that a flaw like this has only one solution and that is a "total recall" of the product..
Report Abuse

Comment on this post

Name*
Email Address*
Comment
Security Check *
   
Quick Polls

QUESTION

The next year or two will continue to be a turbulent one with regards to regulatory change. Do you think…

ANSWER

What we need is less regulation not more
The industry has overwhelmed itself with its own excessive regulation
The industry is bracing itself to deal with the regulatory changes, and brokers and insurers need to stay well informed of the effects of these changes
fanews magazine
FAnews June 2021 Get the latest issue of FAnews

This month's headlines

Broker and insurer collaboration should not be a one-way street
Running on outdated systems… There's risks
Policy wordings with respect to COVID-19
Death or divorce... how best to split assets
Ethical investing… principles and moral codes
Portfolio positioning will serve investors well
Subscribe now