Business model for contractual products puts investors last
MANY things contribute to disappointing investment outcomes, including market downturns and investors’ own behaviour. But a major factor is what you end up paying to invest – and withdraw.
It’s the traditional players in the investment space, the large life insurance companies, that have the biggest problem in this regard, because their business model depends on a large distribution network of intermediaries, who, in the case of contractual products, receive large upfront commissions that must be recouped from the investor over the term of the investment.
I suggest that, with the Financial Sector Conduct Authority’s Retail Distribution Review due to come into play this year, this business model is unlikely to survive. Yet the life companies still cling to their outdated model, which has served them so well for so many years and which essentially puts their intermediaries’ interests before yours.
I recently came across two cases of investors in contractual retirement products who had disappointing outcomes. They coincidentally both involve Sanlam.
The first was a reader, Mr N, who was employed by the SA Police Service. When he resigned last year, he transferred his government pension savings of about R4.5 million into the Sanlam Echo Bonus Preservation Fund. He almost immediately took a third as a lump sum, which for him was tax-free, on which he says he was charged about R18 800 as a withdrawal fee.
Because of the high annual costs on the portfolio (he says they are about 5%*), Mr N wants to transfer his remaining R3m to another provider, which is permissible under section 14 of the Pension Funds Act.
Mr N’s contract is due to run over five years. The policy mentions a “smooth marketing charge” of R952 a month over the five-year term.
The annual advice fee, according to the effective annual cost table in the policy, is 1.5% a year, and the broker received 1% a year over the five years upfront as a lump sum. So the R952 is the monthly amount Sanlam is collecting over the five years to recover this lump sum to the broker.
Mr N says he has been quoted a charge of about R36 000 to effect a section 14 transfer.
To be fair to Sanlam, the product gives you bonuses for staying invested over the term. I am sure the broker told Mr N about the bonuses. But did he fully explain the costs and penalties? Mr N says that had the broker done so, he would never have taken out the policy. This means the broker contravened the Financial Advisory and Intermediary Services Act regulations.
But Sanlam says it has no jurisdiction over the broker (see “Independent brokers versus Sanlam advisers”).
ADJUDICATOR DETERMINATION
The second case is in the form of a recent determination from the Pension Funds Adjudicator, Muvhango Lukhaimane.
Over 22 years, since 1996, Mr R contributed a total of R2 404 549 to a Sanlam retirement annuity (RA) fund. In April 2012, according to Sanlam’s response in the determination, he took out a new policy using the
R980 076 he had accumulated to that point, upping his monthly contributions to R13 680 with an annual escalation of 20%. His investment grew to R3 564 441, as quoted on January 24, 2018. According to Sanlam, the effective (after-costs) annual rate of return over the full 22 years was 6.9% a year.
To put this return into context, inflation has averaged about 5.5% over the last two decades and money market funds have returned about 8.35% (after costs), on average. (Admittedly, a large portion of Mr
R’s contributions were from 2015 onwards, when the equity market performed poorly.)
The crunch for Mr R was that Sanlam quoted him a “termination charge” of R330 701 for transferring his RA to another provider. This would have wiped out almost a third of his returns, bringing the average return down to 5.3%.
Again, the product provided bonuses, which Sanlam said would have kicked in over the term.