The life assurance industry is going to have to rethink its investment products to ensure that they meet the demands of modern times and are at the same time more cost-effective.
The PPS Retirement Fund trustees are to be congratulated on closing the fund’s life assurance retirement annuity (RA) option to new business from the end of the month.
It is a lead that the trustees of other life assurance RA funds should follow. The trustees are there to act in the best interests of fund members – not the sponsoring company.
The PPS move not only underscores the faults with most life assurance RA products but with endowment policies in general, which, in effect, are the investment vehicles provided for the RAs.
Life assurance RAs, introduced in South Africa in the 1960s, were, until the 1990s, the only way in which individuals who did not belong to an occupational retirement fund could access a tax-incentivised retirement savings vehicle.
RAs can also be used by members of occupational retirement funds to supplement their retirement savings.
The life assurance companies set up RA funds with the underlying investment in what was effectively a life assurance endowment policy with very little investment choice.
Commissions were paid upfront and were based on the premium amount multiplied by the number of years of the contract, so the greater the premium and the longer the term, the higher the commission.
The life companies and their armies of salespeople cynically and untruthfully told consumers they were compelled by law to contribute to an RA until at least the age of 55, whereas 55 is only the minimum age at which you may mature an RA so you can draw a pension.
Once you had been signed up, you were locked into paying the contributions. If you stopped paying for any reason, including losing your income, the life assurance companies could penalise you up to 100 percent of your savings.
The penalties were based on “secret” loan accounts that the life companies attributed to every RA member and endowment policyholder. The upfront commissions make up the main element of the loan accounts, but these accounts also include the present and future costs for the life assurance company, and even its future profits. And the life companies charged – and still charge – interest on the amount at a rate that is not disclosed to RA members and policyholders.
Another consequence of the upfront commissions was that they removed the incentive for salespeople to provide you with ongoing service.
In the 1990s, non-life assurance asset management companies started to introduce more flexible products on which commissions and costs were deducted only when the contributions were paid.
And more and more people started to see the poor performance of the life companies’ products or suffered the consequences of the confiscatory penalties when they were unable to pay the contributions.
The life companies effectively protected themselves by prohibiting their industry-appointed adjudicator from hearing complaints about the performance of their products, and until 1998 there was nowhere that retirement fund members could take their complaints.
When the government appointed the first Pension Funds Adjudicator in 1998, complaints about life assurance RAs started to roll in, reaching a peak when Vuyani Ngalwana was the adjudicator from 2004 to the end of 2006.
Ngalwana made numerous determinations in which the life companies were ordered to pay back the penalties. The life companies went to court and had Ngalwana’s rulings overturned.
However, the life companies had won the battle but lost the war, because public indignation grew, and then Finance Minister Trevor Manuel intervened.
In 2005, Manuel in effect levied a R3-billion admission-of-guilt fine on life companies by ordering paybacks to fund members, and he limited future penalties on RA products to 30 percent on those sold before January 1, 2009 and 15 percent on those sold after January 1, 2009. He also limited penalties on life assurance endowment policies to 40 percent on those sold before January 1, 2009 and 20 percent on those sold after that date.
In terms of a Statement of Intent signed by Manuel and the life industry, upfront commissions were reduced to a maximum of 50 percent of the total contribution paid, and the intention of the Financial Services Board (FSB) is to reduce upfront commissions to zero.
At the same time, then independent actuary Rob Rusconi revealed that South African life assurance RAs were among the most expensive retirement-savings products in the world and, in a worst-case scenario, costs could reduce your end benefit, after saving for 40 years, by almost 50 percent. By comparison, Rusconi found that unit trust RAs were considerably cheaper, reducing the end benefit by less than 20 percent after 40 years.
Since then, National Treasury has repeatedly expressed its concern that the tax advantages of contributing to an RA are cancelled out by the cost structures of the life companies.
Even with the agreement between the life industry and Manuel, both Sanlam and Old Mutual have attempted to duck the agreement by levying penalties more than once on a policy when what is termed a “causal event” occurs – for example, when a policyholder defaults on contributions and then again when the policyholder transfers to another product provider before maturity date.
The FSB has warned the life industry that it cannot double-dip on penalties. And the Pension Funds Adjudicator recently ordered Sanlam to repay a second penalty it levied on a policyholder.
The life companies have adapted their RA offerings by widening the underlying investment choices to include unit trust funds and by offering products that do not have penalties, but these come at a higher cost.
Research by Personal Finance in 2005 showed that Old Mutual’s Max products, which Old Mutual at the time was promoting as its cheaper RA option, were in fact the most expensive RAs available, whereas the cheapest and most versatile products were the RAs offered by Old Mutual Unit Trust Management Company and Allan Gray.
Old Mutual, until October 2010, attempted to block sales of its own unit trust RA, with its agents denying the product’s existence and the company claiming it was a “non-advice” product. It also upped the minimum contribution to R500 a month.
Now is the time for all life assurance RA fund trustees to rather offer the Old Mutual unit trust-type RA structures to their members; and for the life companies to actively market them.
DO YOU KNOW?
1. You do not have to sign a life assurance retirement annuity (RA) contract that will last until you turn 55. However, in terms of the Income Tax Act, you may not withdraw any benefits from an RA before 55.
2. You may contribute to an RA for as long as you wish. You are no longer required to mature an RA at the age of 69.
3. No one can foretell the future. You could lose your source of income tomorrow for various reasons. If, as a result, you can’t keep up the contributions, it is likely the life assurance company will confiscate a portion of your savings.
4. You are entitled to switch RA product providers at any stage, either because you want to go into another RA product or because you want to purchase an annuity (pension) after the age of 55 – but you may incur costs or penalties.
You can complain to the Pension Funds Adjudicator if, when you want to transfer, a product provider bogs you down in red tape and creates unacceptable delays.
Sanlam recently introduced numerous bureaucratic requirements that RA members have to meet when transferring to another provider, even when their RA has matured. However, Sanlam makes it simple and easy to transfer from the PPS RA Fund to one of its life assurance RA products, and does not levy a termination charge.
5. Be very wary if a financial adviser suggests that you should switch RA policies, particularly if this will result in a life assurance company imposing a penalty. Demand that you are provided with a breakdown of all the penalties, costs and commissions that will become payable on a switch. Then check these with the provider of your existing product, or if you are a member of the PPS RA Fund underwritten by Sanlam, with PPS.
Members of the PPS RA Fund are being offered an alternative Sanlam life assurance RA product, which, Sanlam claims, is cheaper than PPS’s unit trust RA option, but this claim is based on numerous assumptions, including an investment term of 40 years or more.
PPS members must also be aware that PPS is a mutual company and PPS RA Fund members receive a share of the “profits” declared annually. The amount is added to their accumulated savings. Sanlam has attempted to match this by offering a loyalty bonus that becomes payable when its alternative life assurance product matures.