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What to do when your client faces a bad versus ‘less bad’ financial outcome

04 August 2020 Gareth Stokes

There are still thousands of South African investors and savers who are trapped in legacy retirement annuities (RAs), unable to switch to something more appropriate for the 21st Century due to the punitive exit penalties built into the product by life insurers. To make matters worse, most of these products have produced dismal net returns, spanning decades. Savers are damned if they take the exit penalty on the chin to set off on a product replacement journey, and equally damned if they stay in the RA to its term. We thought to muse on the topic of RA replacements after commenting on a LinkedIn post that drew dozens of insights from irate annuitants, financial advisers, and CFP®s.

Committing financial suicide

Comments in the chain typically took the following form: My client, Mr X, has been invested in an RA offered by Insurer A. He has been contributing to the product for more than a decade and the fund value is approximately equal to the total contributions made over that time. Fees and charges on the RA run to as much as 6% per annum. To stay the course until retirement is akin to financial suicide; but if Mr X, through me as his adviser, initiates a product replacement via a section 14 transfer, Insurer A will demand an early termination fee of approximately 15% of the fund value. Does this sound familiar? Many legacy RAs concluded in the late 1990s and early 2000s allow an insurer to take up to 30% of the accumulated capital upon the annuitants early exit, which they invariably do. 

Another solution, often touted by the life insurer, is to move the long-suffering annuitant into another product in its product stable. This amounts to a ‘next best’ outcome for the insurer who can trumpet a ‘fair treatment of customers’ and public relations victory by waiving the termination fee. In reality it retains the client in a new product, continues to generate servicing fees for the intended terms, and anyway keeps the early termination penalty ‘on file’ in the event the client wishes to exit pre-term.

A united stand against abuse

Many financial advisers have weighed in on the thread, with the common response being that advice professionals should take a united stand against this type of insurer-led abuse. “In an industry where clients should be at the centre of everything we do, how can insurers still get away with this?” asked one adviser. It is fair to single out life insurers for the fee-based products that they foisted on investors and savers all those years ago. It is also fair to criticise how they structured their distribution centres and incentives to contribute to yesterday’s culture of churning and mis-selling; but there is another side to the coin. 

The incentives offered by large life insurers to financial advisers in the form of commissions coupled with the book-building exercises that were commonplace in the early 2000s and beyond have caused significant harm to consumers, whether conducted legally or not. One or two advisers admit as much on the thread, saying that the advice process and incentive structures in place in the industry at the time were part of the problem. What outcome would you expect, for example, if a financial adviser is taking 3% up front and 1% ongoing commission on a retirement saving product? A counter argument from incensed advisers is that most insurers will clawback adviser commissions upon early termination, the suggestion being that the insurer is double-dipping by punishing both annuitant and financial adviser. 

Taking the hit, today

There are numerous other considerations that occur around the product replacement theme. For example, countless individuals who are stuck in poorly performing RAs are dissuaded from making additional retirement-funding contributions: Why pour good money after bad? “You would be foolish to increase your investment in a fund that fails, over decades, to beat inflation,” laments one commentator. From an advice perspective the consensus seems to opt for the ‘least bad’ outcome, with most of the comments on the LinkedIn thread suggesting that the client takes the hit on the early termination and set out on a new journey in a more suitable financial product. Of course, the decision will hinge entirely on an individual’s financial circumstances. 

The Financial Sector Conduct Authority (FSCA) has been heavily involved in stamping out poor advice practices. It initiated the Retail Distribution Review (RDR) in 2014 and has, since then, been implementing its 50-plus proposals via frequent changes to the regulation. It addressed the highly charged issue of churning and replacement early on; but countless other improvements have since been made. Many remain concerned that the authority has not done enough to tackle issues that crop up at the coalface of product design, by making sure that insurers truly integrate the concept of treating customers fairly into their insurance and investment product offerings. 

Time for a radical rethink

The preceding paragraphs merely reflect on the suitability of financial advice and legacy RAs at a point midway through 2020. There are other considerations too; such as whether the current regulatory environment still makes sense for South African retirement savers in the prevailing socioeconomic context. “We are starting to heavily debate the value of investing in retirement annuities in South Africa, even with the tax benefit,” mused one LinkedIn contributor. Regulation 28, introduced to prevent local savers from being overexposed to riskier assets, has become a drag on portfolio performance due to the shrinking South African equity market; the looming threat of prescribed assets; and the inability of investors to take appropriate offshore positions in their portfolios, among other challenges. 

Writer’s thoughts:
My comment on a recent LinkedIn thread lamenting high termination or exit fees on so-called legacy retirement annuities was as follows: “This is just one of countless examples of shocking product design that is 100% engineered by insurers to extract punitive fees from clients; they should never have been built this way. Agree or disagree? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts [email protected].


Added by Simeon, 11 Aug 2020
Poor Provider performance has us cancelling our commission for years already!
How do you take comm when the performance is so totally dismal??
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Added by James Brown, 09 Aug 2020
@Paul. I actually blame the advisors, first and foremost. The trusted person in this equation is that advisor. Knowingly looking a person in the eyes, taking their very very limited meager savings, then 'advising' of a product you know will fail the client but not the advisor nor the insurance company has to be akin to the ANCs looting from the the most vulnerable. Factoring in commission is laughable when financial literacy is non exiatant and so easy to put past average joe. My mother could not have the retirement she planned because, as her advisor put it, the market didn't perform,despite decades of prudent saving and 'investing' with her advisor. It's only when one explains that when you have real returns of 4-5%, 50-75% of those returns or 'profit' are eaten by fees. That's when the penny drops.

So, in a nutshell, to those very advisors who sold these products, I consider them the absolute scum of the earth. I view them with absolute disdain.
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Added by Ben Holtzhausen, 05 Aug 2020
Penalties are mostly a direct result of the perverse sales incentives associated with legacy type and some "new generation" financial products. Ultimately the client is the only person who pays for all the costs within a product. No matter what bonuses, boosters fake "100% Allocations" or other BS is built into the product.

In 2006 I wrote an article about the issue and in 2014 I wrote another one titled "Could A New Remuneration Model Stop The Farce About FAIS"

The fact of the matter is: Up-Front commissions IS a perverse incentive. Neither advisers nor product suppliers are prepared to let go of it. If one reads the comments of those participating in the RDR debate, it appears both parties are holding on to the up-front commission model for dear life.

We are all flooded with administrative paper work in what I would describe as a senseless over-regulated and cumbersome industry. I believe a large part of the current regulatory framework is the ultimate result of perverse sales incentives.

So I ask again. Will it not make more sense to totally BAN all forms of up-front commissions? Will the removal of such a perverse incentive not lead to far better outcomes for both adviser and client?

Lastly, I don't buy any of the arguments in favor of up-front commissions. If it was really so impossible to run a life practice on an "as & when" or appropriate fee-based remuneration, why are Health Only brokers successful?
Why do Short Term Only intermediaries get it right?
Why do EB only Intermediaries succeed? How did they start their businesses with no up-front commission?
Why do Intermediaries with as & when remuneration so often demonstrate better financial discipline in both their personal and business lives?

My biggest disappointment about RDR is that it has been hanging in the air for almost a decade. It appears the industry keeps on pulling all the stops to retain the old perverse remuneration system.

Perhaps we need to learn more about the behaviors that are stimulated by perverse incentives. Exploitation by selling inappropriate products is the most common one.
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Added by Gareth, 05 Aug 2020
That is a good question, Cynical Simon. I am not directly involved in the product universe either; but the sense that I get is that there are low fee RA alternatives offered by the likes of 10X, OUTvest, Sygnia and others.

The question becomes whether the reduced platform fee, and waiver of financial advice and associated fees, is guaranteed to produce a better outcome.
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Added by Gareth, 05 Aug 2020
Thanks for your thoughts Arshad. I would steer clear of conflating excessive termination costs in the life industry with the CBI issue playing out in the non-life insurance space at present.

There is certainly a case to be made for life insurers to stand up and abolish the practices mentioned in this article. The insurers, and their shareholders, should take the hit for structuring product with contractual provisions that are inherently unfair.
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Added by Gareth, 05 Aug 2020
I like this line of thinking, thanks Paul… It is always interesting to watch the dynamic that unfolds between product provider and adviser when things go wrong for the client.

I would be in broad agreement that the insurer carry the can for failings in product design, which in these instances would include allowing an adviser or agent to earn too much from selling the product.
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Added by Gareth, 05 Aug 2020
Succinctly put, Peter. The insurers certainly hold more power than the long-suffering savers.

Poring over insurance policy wordings reminds me of signing my first home loan; upon asking the mortgage assessor what would happen if I disagreed with the small print, he assured me that I was welcome not to sign … and forfeit the finance.
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Added by cynical simon, 04 Aug 2020
Are the present products ;"life annuities really that much better????
I am not in that market but I suspect that the "management" of the product to ensure that capital is not exhausted and that same performs as was promised is a very costly exercise.
Do these products afford sufficient security to outlast the annuitant?
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Added by Arshad, 04 Aug 2020
This is definitely on the Insurers.This idea of clawbacks of commission as well as high termination costs to clients is tantamount to state capture. Insurers must allow movement to new platform with revised fees immediately Incentives to brokers to assist clients with this without clawbacks must be looked at or else they will be forced to do so at a bigger costs to them.Similar to Business Interruption costs that many short term Insurers are absorbing.
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Added by Paul, 04 Aug 2020
Quite simple:
All insurers that still have these penalties must cancel the penalties with immediate effect.
Bad performance for no good reason whatsoever e.g, costs ,charges, bad product design etc :PAY BACK THE MONEY!
Oh and don't try to implicate the adviser ,if you have are marketed a product that allowed for large commissions as then you should have factored that into the product in the first place to still enable a decent return.

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Added by Peter Brown, 04 Aug 2020
Insurers just don't lose
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