OPINION: 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 Yet the life companies still cling to their outdated model, which has served them so well for so many years and which essentially puts their intermediaries’ interests before yours.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”).
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.
Mr R complained to Lukhaimane’s office that the miserable return on his investment, the high annual costs (of 5.61%, he says*) plus the termination charge he says he was not informed about* were contrary to the Treating Customers Fairly (TCF) principles that are now enshrined in financial regulation.
Lukhaimane, although unable to reverse the terms of the contract, had the following to say: “This tribunal notes that although lawful, the actions of [Sanlam] in this instance can hardly be described as being anywhere near the spirit of the TCF principles. The fact that the complainant was not initially provided with the [termination] charges on his fund value is an indication that the charges are obscure and excessive, and cannot be translated into value for members of retirement annuity funds. The imposition of [such] charges in instances where such information is not made apparent to members is nothing short of legalised theft.”
Costs and disclosure: Sanlam responds
In its response, Sanlam disputed the annual costs as quoted by the investors. However, Sanlam did not provide the actual figures. It also disputed that the early-withdrawal (termination) charges were not communicated to the investors.
“The [PFA determination] that refers to the fact that we did not initially provide the client with an indication of the termination charges refers to the original quotations of the 1990s. We did provide the client with an indication of the termination charges when he transferred these two policies and combined the proceeds in [a new] policy in 2012. This is explained in 4.2 to 4.6 of the determination.
“The high annual costs of 5.61% that is quoted is a number that the client calculated by adding up some of the charges on his current product. It is not accurate and bears no relation to the actual cost incurred over the term from 1996 to 2018 (which is the context in which this number is used in the article). Even if the number was correct, it also does not provide a true picture of how much of the fee Sanlam actually receives. At that point in time the client was investing in a combination of externally managed investment funds where part of the fee would accrue to them,” Sanlam says.
Independent brokers versus Sanlam advisers
Sanlam says a distinction needs to be made between independent brokers that sell its products and its own advisers.
“In the case of Mr N, he made use of the services of an independent broker, not a Sanlam adviser. The information below serves to clarify the distinction in terms of Sanlam’s duties and responsibilities.
“Sanlam contracts intermediaries to sell Sanlam’s products. Sanlam is responsible for the actions and omissions for such intermediaries in the course and scope of them exercising their functions under such a contract. For purposes of vicarious liability the courts consider such intermediaries as employees of Sanlam.
“In this instance the intermediary is an independent broker and not a Sanlam adviser. Independent brokers run their brokerages independently and must be registered by the Financial Sector Conduct Authority as an authorised financial services provider. They contract with various product providers to sell their products.
"These financial institutions have no jurisdiction over independent brokers and are also not considered vicariously liable for any advice and conduct of independent brokers.
“Sanlam therefore has no jurisdiction over the advice given and conduct of an independent broker. The client has the option to take the matter up with the broker directly. In the event that the matter cannot be resolved with the broker, the client is at liberty to lodge a complaint, in writing, with the office of the FAIS Ombudsman.”