This article was published in the second-quarter 2013 edition of Personal Finance magazine.
Members of the Professional Provident Society (PPS) have become the target of a significant battle between PPS and Sanlam that is part of a much wider war raging with increased intensity in the financial services industry.
The wider war, in which product provider adversaries are marketing more and more complex products, is leaving all investors – not only PPS members – befuddled, and many have become innocent victims. It is almost impossible for investors to make intelligible comparisons of these products, a situation compounded by a dearth of industry benchmarks that can be used as the basis for comparisons.
The current battle is focused on retirement annuity (RA) products. It was sparked by PPS seeking to break an association with Sanlam established more than 50 years ago.
The wider war started very quietly in 1965 with the launch of the first unit trust fund (the Sage fund). It heated up in the late 1980s with the aggressive entry of non-life assurance, institutional (mainly retirement fund) asset managers into the investment market for individuals, often using unit trust funds as a shop window for investment performance. Until then, the investment market for individuals had been dominated by the life assurance industry, which, under what were close to cartel conditions, decided for consumers what investment products they should have, while often misleading them on what returns could be achieved.
The life assurance investment and savings products were, to a large extent, opaque, inflexible and expensive, aimed more at rewarding the salespeople and company executives than providing true value for money for consumers.
The life industry still argues that its products, although not perfect, were suitable for the times, enabling many people to improve their quality of life and retire far more comfortably than they would otherwise have been able to do.
After the institutional asset managers entered the market, the life assurance companies fought back. But instead of putting customers first and fundamentally changing their products, more often than not they provided better – but perverse – incentives to their salespeople. The institutional asset managers, such as Allan Gray, The Board of Executors, Investec, Rand Merchant Bank and later Coronation, used unit trust funds to attract disgruntled investors.
Unit trust funds initially failed to get off the ground properly in South Africa because investors lost faith in the industry following the 1969 market crash and the implosion of the National Growth Fund in the 1970s as a result of poor regulation.
According to research done in 2005 by MC Meyer-Pretorius and HP Wolmarans of the Department of Financial Management at the University of Pretoria, by December 1980 there were only 12 unit trust funds available to investors, with a mere R682 million under management. Most of this money was the discretionary savings of investors.
Initially, unit trusts were marketed to individuals as an alternative to life assurance endowment (investment) policies. Unit trust funds were not provided as underlying investments for retirement savings products.
The first unit trust products were mainly equity funds, with South Africa lagging international trends. For example, banks, to protect their turf, doggedly resisted the introduction of money market funds.
The battle lines in the war between life assurance, bank and unit trust-based investment products are often blurred and confusing. For example, the big life assurance companies all have unit trust companies but often concentrate on selling their life products, downplaying their stand-alone unit trust products (see “Blurred battle lines”, below).
The significant growth in non-life assurance products aimed at individuals came in the 1990s on the back of substantial growth in the retirement-funding industry, mainly as a result of the unionisation of black workers, who had previously been denied access to occupational retirement funds, and the massive switch from defined benefit to defined contribution funds.
Defined contribution funds saw pension fund members wanting more control of their savings and better returns, both in the build-up stage and particularly in retirement.
Unit trust management companies provided products for individual investors that had many advantages over the life assurance products of the time. The most important was that individuals could select funds, such as pure equity funds, to suit their appetite for risk.
The armies of salespeople the life companies employ still focused on selling life assurance products, which pay upfront commissions, rather than the as-and-when commission paid when you invest in unit trust funds.
The war gained further impetus from the entry in the 1990s of linked-investment service provider (lisp) companies, which offered products that allowed investors to choose investments – mainly unit trust funds – from a range of different companies and to switch among them at low cost.
The war was truly on when the lisps saw an opportunity in the retirement market and offered RA products and introduced investment-linked living annuities (illas).
By December 2000, there were 334 unit trust funds managing R128 billion. By the end of December 2012, collective investment schemes, which include unit trust funds, exchange traded funds and mortgage participation bonds, accounted for R21.2 trillion in assets under management mainly from individual investors in 967 funds.
The PPS/Sanlam battle, which has been simmering for a number of years on the basis of the changes in the broader financial services industry, intensified last year, when the trustees of the PPS Retirement Annuity Fund announced that the fund was closing its traditional PPS (Sanlam-underwritten) RA investment option to new business. The fund continues for existing members.
The PPS (Sanlam) RA was launched in 1963, when the first RA funds were recognised in terms of the Income Tax Act as an avenue for professionals, mainly, to save for retirement. The RAs had tax incentives similar to those offered by occupational retirement funds provided by employers, trade unions and industrial bodies.
Until then, self-employed professionals, who did not have access to occupational retirement funds, did not receive tax incentives to save for retirement.
The first RAs were essentially life assurance endowment (investment) products tacked on as the investment vehicle under an RA fund umbrella. The structure was and is known as an underwritten RA fund.
With a life assurance RA, in effect, you become a member of an RA fund, and the fund trustees then buy an endowment policy from the RA fund sponsor (the life company) in the name of the fund. The fund acts as the conduit, paying all contributions collected from members into the endowment policy.
In most cases, the life assurance company that sponsors the RA fund and appoints the trustees insists that your money is channelled into an underlying endowment policy that comes from its stable of products. Initially, the endowment policies used by the RA funds offered fund members little choice, limiting them mainly to a balanced fund. Now, you may have as much choice as in a lisp RA product, but the choice is still within the life endowment legal wrapper.
In the case of PPS, the society initially provided members with an RA that was a white-label version of a Sanlam product, namely the Sanlam Central Retirement Annuity Fund (CRAF), referred to as the PPS (Sanlam) RA option. Sanlam undertook to use its sales force to sell the products and consequently also to recruit new PPS members.
Over the years the arrangement worked well for Sanlam, but it was not so great for the PPS members.
When the PPS (Sanlam) RA fund was launched, all RA funds were underwritten by life assurance companies, with members’ investment choice limited mainly to one-size-fits-all balanced funds. The products were very opaque, hiding things such as very high-cost structures.
Worst of all, the products came with confiscatory penalties if members lowered or stopped their contributions. These penalties were (and are) levied even when the members lost their jobs or joined an employer where membership of an occupational fund was compulsory, resulting in combined contributions to both an occupational and an RA fund that may have been beyond what they could afford.
Until 2005, the penalties levied by life assurance companies could be the entire 100 percent of what members had saved in their RAs.
The penalties are based on secret “loan accounts” that the life assurance companies attribute to each RA member and endowment policyholder. The upfront commissions paid to financial advisers who sell the products make up the main element of the loan accounts. 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 outstanding “loan” at a rate that is not disclosed to RA members and policyholders. However, because an RA fund member or endowment policyholder is never contracted for the “loan”, if the allowable penalty levied does not meet the contractual requirements (outstanding “loan”) of the policy, the life company cannot claim any amount “owing” from the policyholder.
Over the years, there was a growing chorus of complaints from RA members generally against the penalties, which were ignored by the life companies. Even the industry-appointed ombudsman was excluded from hearing complaints about investment performance, including the effect of the penalties.
But an almost perfect storm occurred for the life assurance industry battleship, leaving it full of shell holes. The battleship blissfully (some would say arrogantly) steamed into:
Increased competition. The non-life assurance financial services companies grew stronger mainly because the life companies refused to change quickly and fundamentally to meet consumer demands. The factors that drove the move away from life assurance products included:
* Unrealistic investment performance claims. The life industry used what was called the benefit illustration agreement (BIA) to illustrate the benefits investors could expect when their policies matured. The BIA was a cartel-like agreement by the life industry to provide “illustrations” of how RA and endowment investments would perform. The BIA was introduced to prevent competing companies and/or unscrupulous salespeople from making outrageous claims based on unlikely future returns.
But the BIA itself was based on unrealistic assumptions, such as all companies having the same cost basis, while using high inflation rates to calculate returns over long periods.
By the late 1980s, these “illustrations”, which were seen by consumers as promises, started to be shown up as totally phony and unrealistic, mainly because of the use of high inflation rates in calculations and the low standardised average costs.
* Better products. The products provided by the unit trust industry were better structured for individuals. The advantages included:
– Versatility in contributions. Members can change or stop paying contributions without any penalties being levied. This versatility is far better suited to the lives of professionals, such as PPS members, who often have a variable income flow.
– Dramatically improved transparency, particularly of costs, which tended to be significantly lower than those of the life industry, although on some of their products some life offices have, in recent years, become a lot more competitive.
Independent research. Independent actuary Rob Rusconi highlighted the high costs of life assurance retirement products in a paper delivered to the 2004 annual convention of the Actuarial Society of SA. He found that the costs of life assurance RA products were among the highest in the world and could reduce maturity values by as much as 50 percent.
Research undertaken by Personal Finance in 2006 also showed that some life assurance companies were misleading investors about costs.
A toughening of regulation. In 1998, the government appointed the first Pension Funds Adjudicator. The complaints about life assurance RA penalties started to roll in, reaching a peak when Vuyani Ngalwana was appointed adjudicator in 2004.
Ngalwana made numerous determinations ordering life companies to pay back penalties they had imposed on RA members who were unable, for whatever reason, to maintain their contributions. The life companies went to court and had Ngalwana’s rulings overturned.
With the court victory, the life companies won the battle but lost the war, because public indignation grew, until Trevor Manuel, the Finance Minister at the time, intervened.
In 2005, Manuel levied what was, in effect, a R3-billion admission-of-guilt fine on the life companies by ordering them to pay back certain penalties to fund members. In an agreement with the life industry, he limited future penalties to 30 percent on RA products sold before January 1, 2009 and 15 percent on those sold after January 1, 2009.
The 2005 Statement of Intent signed by Manuel and the life industry led to new commission regulations being implemented in 2009, whereby upfront commissions were reduced to a maximum of 50 percent of the total commission paid. The intention of the Financial Services Board (FSB) is to reduce upfront commissions to zero.
In 2004, the first Financial Advisory and Intermediary Services Ombud, Charles Pillai, set up office. The office has, in its determinations, made it clear that consumers must be properly advised and sold appropriate products suited to their needs.
Separation of risk assurance and investments. From the 1980s until the early 2000s, nearly every life assurance policy, including RA policies, was what was called a universal life policy. This meant that you bought an investment policy combined with a risk policy that insured you against death and disability.
This structure was very convenient for life assurance companies because, if you stopped paying your premiums or contributions, they applied their confiscatory penalties on the total premium. You could not, if you ran into financial trouble, for example, stop paying only the investment portion of the policy while maintaining the risk side.
And if you did reduce or stop paying the premiums, whatever money was left after the penalty was levied would be used to continue to pay the life premiums until your money ran out – and then everything lapsed.
In other words, the life assurance companies took absolutely no business risk.
This structure led to a call from consumers and the more responsible financial advisers, strongly supported by the non-life assurance asset management companies, that risk assurance should be separated from investments.
The argument made sense because the risk assurance requirements of individuals change over time as they increase their wealth and as their personal circumstances, such as the number of dependants they have, change.
When a pure risk policy is cancelled or altered, the life companies cannot levy a penalty, because there is no pot of savings that they can attack.
Retirement reform. In 2004, Manuel launched the comprehensive reform of the retirement-funding industry that is still ongoing. This followed:
* A growing number of retirement scandals, including:
– The confiscatory penalties of the life assurance industry;
– The stripping by employers, with the collusion of some in the financial services industry, of surplus funds in defined-benefit retirement funds;
– Trade unions using their sponsored occupational funds to fund their activities;
– Secret profits, exposed by Personal Finance, made by retirement fund administrators who were, among other things, bulking the bank accounts of the funds; and
– Faulty administration, which led to higher costs.
* Concern about high costs, as revealed by Rusconi.
* The inappropriate sale of products. For example, the inappropriate sale of illas has undermined the ability of many pensioners to have a financially sustainable retirement. Major problems with illas were that financial advisers played asset manager, giving totally inappropriate advice, and pensioners drew down excessive pensions that ravaged their retirement capital.
* The limited use of retirement-savings products by employed people, with the majority of people not saving for retirement.
* The poor preservation of retirement savings for retirement. When retirement fund members change jobs, for whatever reason, most cash in their accumulated savings and use them for other purposes.
These factors have combined to force the life assurance industry to alter its retirement products. Gradually, the life companies introduced changes such as offering investors greater investment choice, but many of the changes have been limited.
All these factors form the background to the PPS/Sanlam battle. Sanlam, like most life companies, stubbornly stuck to selling its inflexible, high-cost PPS (Sanlam) RA option to PPS members, who became increasingly fed up – this despite the fact that Sanlam was putting better products on the market.
In 2010, as a result of member pressure, PPS offered an additional option to members, providing them with a choice of two PPS RA products, namely:
* The PPS (Sanlam) RA option. This was the existing life assurance investment option, underwritten and extensively sold by Sanlam. By December 31 last year, about 115 000 PPS members had about R26 billion invested through this option.
* The PPS Investments RA. This is offered by PPS Investments in conjunction with Coronation Fund Managers. The PPS Investments RA is a non-underwritten product, which costs less and is more versatile than the PPS (Sanlam) RA option. The newer option allows members to increase, decrease or stop paying their contributions without incurring a penalty.
Many of the existing members wanted to switch from the Sanlam option to the PPS Investments option, but in doing so faced the prospect of the confiscatory penalties levied by Sanlam.
With the writing on the wall, Sanlam has since tried to poach PPS members over recent years by selling them improved life assurance RA products outside of the PPS arrangement. Sanlam has offered members the option of transferring their existing PPS (Sanlam) RA option to its CRAF, waiving any penalties that would apply if they switched to the PPS Investments RA option.
Anton Gildenhuys, head of actuarial at Sanlam, says that since Sanlam Life is the underwriter of both the underwritten section of the PPS (Sanlam) RA option and its CRAF, and the RA policies sold to members of both funds are basically the same, it is possible to transfer the RA policy (instead of a monetary amount) from the one fund to the other. The policy owned by the fund is not terminated, but simply transferred to the new fund. The policy remains unchanged, therefore no early termination charges are payable, Gildenhuys says.
The Sanlam/PPS battle stepped up a notch when PPS announced in September last year that it was effectively breaking its more than 50-year association with Sanlam by closing the PPS (Sanlam) RA option to new business, leaving only the PPS Investments RA option on offer to PPS members.
The PPS (Sanlam) option will stay open for current members until all existing investments mature. Members who make monthly contributions will be able to continue to do so.
Sanlam, with its access to PPS members, is now going all out to lure these members away from PPS.
BLURRED battle lines
Sometimes the battle lines in the financial services war are confusing. Two good examples of the blurred lines are:
Old Mutual. The company insisted for years that its unit trust retirement annuity (RA), the Equity Linked Retirement Annuity Fund (Elraf) was a “no advice” product, with its life assurance salespeople even denying the product’s existence. This despite the fact that Personal Finance research in 2004 showed that Elraf was one of the best RA products on the market because of its low costs. In October 2010, Old Mutual renamed the product the Old Mutual Unit Trusts Retirement Annuity Fund and started marketing it more aggressively.
Sanlam. In common with other life companies, Sanlam has a linked-investment services provider company, called Glacier. However, investors using Glacier are not offered access to Satrix exchange traded funds that, at low cost, track various indices. Instead, Glacier prefers to force investors to use higher-cost, actively managed unit trusts that cannot guarantee out-performance of the indices.
BRIEF HISTORY OF THE PPS
In 1941, a group of dentists got together to form the Professional Provident Society (PPS) of South Africa with the aim of ensuring that if any of them were unable to work as a consequence of disability or serious illness, they would still have an income.
The reason, then and now, that such a society is viable is that professionals, such as dentists, have a much lower risk profile and therefore lower claims ratios than the general population. The reason is that they are well educated, which, in turn, means they tend to be in higher income brackets. Their higher earnings enable them to lead healthy lifestyles, and they have a lower propensity to run out of money and cancel their policies.
Over the years, the membership of PPS has expanded to well beyond dentists, with the only stipulation for membership being a four-year degree. In 1998, this was expanded to include certain technikon-conferred degrees. There are now about 225 000 members.
The lower claims ratios mean that PPS can offer lower premiums and/or better benefits on its risk insurance products than an ordinary life assurance company, which must take account of the general population.
PPS is a mutual company. In other words, it is owned by its members through the PPS Holdings Trust, which, in turn, owns 100 percent of PPS Insurance Company.
As a mutual company, PPS distributes its profits every year to its members, who have a right to those profits tax-free when they retire or if they die before retirement.
In 2011, R1.7 billion was allocated to the surplus rebate accounts (SRAs) of individual members, bringing the cumulative allocations over the past five years to R7.8 billion. The money held in the PPS SRAs earns investment returns for members.
Currently, only PPS members with PPS assurance products (PPS Provider policies) receive a share of the profits. From this year, based on the 2012 PPS financial results, a share of the profit bonus will be based on the number of PPS products each member uses.
But members who hold a PPS Investment Retirement Annuity (RA) will still need to have a PPS assurance product to qualify for a higher bonus. A member who owns only a PPS Investment RA will not receive any profit share.
It all started with the PPS Sickness and Permanent Incapacity Benefit. Now the products offered by PPS include investments, a medical scheme, life assurance risk and investments, short-term insurance, RAs, investment-linked living annuities and retirement preservation funds.
The one product PPS does not offer is a guaranteed annuity (pension) for retirees. The reason is that whereas providing assurance to working professionals means a much lower claims ratio than is the case for the general population, the opposite is true when professionals retire – they tend to live for longer in retirement than the general population, meaning a life assurance company must pay out for a longer period.
So if a PPS member wants a guaranteed annuity, the member receives a better deal by being included in the general population. It is a case of the less well off and less healthy subsidising the better off and healthier members of society.
HOW ADVISERS MAY SECRETLY EARN MORE
A key tactic in the financial services war is for product providers to entice financial advisers to sell their products by paying them additional amounts in excess of declared commissions/fees.
The additional incentives are often not declared at all, or are declared in the vaguest terms.
These tactics are not limited to life assurers – they pop up throughout the financial services industry.
For most people, financial advice is essential, and most financial advisers, particularly those who are not employed as representatives of product providers, try to best serve the interests of their clients.
In recent years, the Financial Services Board (FSB) has tried to slam the door on additional payments to advisers, particularly when they are not properly disclosed. The FSB views these additional payments as presenting a conflict of interest that sees consumers being placed in inappropriate products.
The classic example of how inducements may be a conflict of interest and affect the judgment calls of many unscrupulous or lax financial advisers has been the massive mis-selling, particularly to vulnerable pensioners, of property syndication investments. The commissions offered were anything between six and 15 percent of the amount invested. The norm on a single-premium investment is no more than three percent.
A more worrying issue is that of perverse incentives, which occur in the more formal and regulated financial services industry. Consumers are often switched from one product provider to another and even between products of the same provider because of perverse incentives.
You need to be cautious of any financial adviser who advises you to switch between financial products, be they investment products or risk assurance products; you could become collateral damage in the financial services war.
In recent years, many product providers have been side-stepping commission regulations in all manner of ways to get advisers to steer business to them, including:
Luxury incentive trips. These are now banned in terms of the Financial Advisory and Intermediary Services (FAIS) Act as presenting a conflict of interest. Even after the trips were banned, Sanlam set up a separate company to continue sponsoring trips to top-selling agents. The company was closed down after it was exposed by Personal Finance.
Netco structures. This is a practice started by Discovery Life and taken up by others whereby separate payments are made to companies linked to financial services providers to provide “administration” services.
These services, if they exist at all, are nominal or should be provided by the financial services provider anyway. The payments are linked to a percentage of premiums and not to a cost per service. The FSB also regards these structures as presenting a conflict of interest.
Sign-on incentives. This practice was also started by Discovery Life and taken up by others. These upfront incentives are used to poach sales agents from competing companies, and the agents are paid by way of lump sums and share bonus schemes. The incentives often come with sales targets. The product providers claim the upfront payment is compensation for advisers’ loss of future commissions from clients left on the books of their former employer. However, there is extensive evidence that one of the first things these advisers do when they change allegiances is to switch their clients across to the new company, so they are, in effect, getting double commission.
Fee structures of linked-investment service provider companies. Some of these companies are now structuring their offerings so that the commissions/fees to advisers are not paid by themselves but by the underlying unit trust companies at a fixed rate that may be challenged. This may make payments opaque. The annual default commission/fee is 0.7 percent, which is higher than the generally accepted 0.5 percent.
Double FAIS registration. This practice was invented by the property syndication companies, which are now imploding. The FAIS Act requires financial advisers to be registered to sell particular products. Many financial services providers were not registered or qualified to give advice on or sell shares and debentures in property syndication investments. The syndication companies simply registered as financial services providers and appointed the unqualified advisers as their representatives, claiming the agents were qualified to sell the shares and debentures. This has been taken a step further, with some financial services companies paying commission to an adviser both as a registered financial services provider and again as a representative.
Consulting services. This is also a new tactic. The adviser is asked by the product provider to serve as a consultant on a committee – for example, an investment committee. It is not that the adviser has any special skills.
It is simply another way to pay the adviser additional income that is not declared to you, the investor. The fee paid is directly linked to the value of the business directed to the product provider.
The consequences of inappropriate advice can be severe in the long term. For example, if you are switched between investment products, there may be disinvestment and reinvestment costs, including penalties on early withdrawal for not meeting contractual conditions; and you may pay commission on the same amount of money twice – once on the initial product and then again on reinvestment.
If you are unsure of the advice given, you need to get a second opinion, preferably from an independent financial services provider or its agent. You should be wary of an agent of a product provider.
You must always ask the person advising you to provide you in writing with details of all payments and incentives received from a product provider. If the adviser will not provide this information, you should avoid doing business with the adviser.
It is best to consider using a financial services provider who is a member of the Financial Planning Institute (FPI) and is an accredited Certified Financial Planner. These planners, who require a post-graduate diploma in financial advice and who must adhere to a strict code of conduct, are listed on the FPI website: www.fpi.co.za
You should always check on the credentials presented by a financial adviser. You can check on whether the adviser is registered in terms of the FAIS Act and the products he or she is licensed to sell and give advice on by going to www.fsb.co.za and clicking on the FAIS link at the top right-hand side of the home page.
An adviser is obliged to provide you with his or her FAIS registration number.
BAD ADVICE?
If you believe you have been inappropriately advised and sold a product that has resulted in financial loss, you can lodge a complaint with the FAIS Ombud. The ombud can be contacted by email at [email protected], or telephone 012 470 9080. Website: www.faisombud.org.za