Contractual A case against retirement annuities

“It’s good to have money and the things that money can buy, but it’s good, too, to check up once in a while and make sure that you haven’t lost the things that money can’t buy.”

George Lorimer

INSURANCE contracts are necessary for the protection of both the insurer and the policyholder. But there is another type of financial contract that is essentially unnecessary: one that forces you to save.

Contractual investment products – endowment policies and contractual retirement annuities (RAs) – force you to contribute an agreed amount over a fixed term, often with a built-in annual escalation, ostensibly to offset inflation.

Worse, their commission structure presents a glaring conflict of interests: the broker receives the bulk of the commission due over the term of the policy in one large, upfront lump sum. If you break the contract, an amount is deducted from your savings as a penalty, largely to cover the pre-paid commission.

Although endowment policies may have certain benefits under a narrow range of circumstances, contractual RAs have largely been superseded by RAs offered by unit trust providers. In a unit-trust RA, you are under no contractual obligations: you can increase or decrease your contributions, make ad-hoc lump-sum contributions, or stop contributing at will.

Yet the old-style contractual RAs are still being sold in large numbers across the country. The Association for Savings and Investment South Africa Asisa reports that 543 561 individual recurring-premium savings policies (endowments and RAs) were taken out in the 12 months to the end of December last year.

Most of the traditional providers now offer investors a choice between contractual and unit-trust RAs, but still

appear to favour the former.

THE CASE OF MR C

Charles McAllister, who has the Certified Financial Planner accreditation and is the executive director of Centric Wealth Advisory in Cape Town, has taken up the case of a client, Mr C, who, in 2018 was sold a Discovery Invest RA by an “independent” brokerage that happens to sell only Discovery products.

Mr C was approaching age 61 when he signed the contract committing him to contribute R10 000 a month, escalating at 10% a year, for 10 years. The contract set out that, at an escalation rate of 10% a year, by year 10 he would be paying R23 579 a month.

It also spelled out that the broker would receive an upfront commission of R28 388 and an ongoing commission of R287.50 a month, and it gave a table of the penalty charges as a percentage of the investment: if Mr C exited the contract after a year, the penalty would be 12.31%; after two years, it would be 9.63%; and it would reduce to zero by year six.

When Mr C consulted McAllister recently about the poor returns on the RA, McAllister was amazed that a 61-year-old could have been sold a contractual product that bound him for 10 years. Mr C cancelled the contract, upon which he was charged an exit fee (read “penalty”) of R21 308. Together, they drew up a complaint directed at the brokerage, requesting that the exit fee be refunded.

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McAllister says: “The essence of the whole thing, for me, is suitability – what is suitable for the client? When we look at suitability, we look at the best outcomes under the Treating Customers Fairly (regulatory regime). And I think we can all agree that, no matter where you are or who you are, at the age of 61 should you be in a 10-year committed RA? The answer is no.

“You can retire from an RA at the age of 55, so why would anyone put you in a committed 10-year product when you can retire from it tomorrow? The natural best practice in these circumstances should be a flexible unittrust RA.”

McAllister then looked at the record of advice, which all advisers must be able to produce under the Financial Advisory and Intermediary Services Act, and “this was where it all started falling apart”.

“It was actually just a tick-box for Discovery. They’ve literally got every Discovery product listed, and advice pertaining to each product, and then you tick what you’re selling. So that’s when it came to me that no one actually did anything here except sold a product. There was no full analysis or risk profile done. This despite the client listing a number of concerns.

“It also emerged that the client didn’t opt for extra benefits, because he had an affordability issue. So that’s a big warning bell. If he had affordability issues, surely the adviser would realise that a R10 000 premium escalating at 10% a year might be a problem in four or five years’ time?

“And then the broker states in her disclosure that she will provide alternative quotes. Where’s the alternative here?” McAllister asks.

DISCOVERY RESPONDS

When asked about this case by Personal Finance, Discovery Invest said it took such complaints seriously and was investigating the matter. On the annual 10% escalation, it said: “Clients can stop any increase, at any stage, without adversely impacting the policy. Upfront commission does not depend on the increase chosen; it is only paid if and when an increase actually occurs.”

It’s unfortunate that Mr C was not made aware of this fact – there is no mention of it in the quote or record of advice.

When asked whether it offered a unit-trust RA, the company responded: “Discovery Invest does offer an as-andwhen [unit trust] option with a different commission structure.” So why was Mr C not made aware of this option and offered it as an alternative?

Personal Finance then asked why Discovery’s systems had not flagged the application.

“The adviser house which sold the contract is an independent contractor with Discovery Invest and has its own in-house compliance, so we would not have flagged the case on our side. That said and based on our investigation, we do not believe one can simply make the assumption that the contract was mis-sold. A 61-year-old earning sufficient income that warrants purchasing an RA, to take advantage of reducing their individual tax rate and saving towards retirement or for some other reason, is not unreasonable. It’s not uncommon to see individuals retiring at age 70 and beyond, given increasing life expectancies,” Discovery Invest said.

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