Life assurance RAs were, until the 1990s, the only way in which individuals who did not belong to an employer retirement fund could access a tax-incentivised retirement savings vehicle. Commissions were typically 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. These commissions were paid to advisers often without an awareness by policyholders of their existence.
Government is in the throes of proposing a range of retirement and social security reforms aimed at increasing the savings rate of the population. Fewer than 50% of the country's employees belong to any form of retirement fund and the country's savings rate at 16% falls well behind similar developing countries such as Russia (28%), India (34%) and China (53%).
Rowan Burger, head of Investment Strategy at Liberty, explains that at the lower end of the market, on-going commission paid on small policies (as opposed to upfront commission) would be such that regular servicing of clients would not be economically viable. This is exactly the segment government wishes to persuade to commence saving.
"In this important emerging market, commission needs to be paid upfront or the market simply won't evolve," he says. The reality is that people do not plan for the long term. This means savings products need these sales incentives as people don't readily buy them. The impact on the attractiveness of policies is that the life company paying upfront commission is out-of-pocket should the policyholder cancel, and this money therefore has to come out of the savings - or the returns to other policyholders be reduced.
Commission payment was previously reformed to ensure full disclosure and reduced penalty fees on early termination of a contract, and Burger argues that the current debate is not premised on an evaluation of comparable products.
For instance, while unit trust-based RAs apply only on-going commission, their comparison with underwritten RAs does not take into account performance fees often charged by fund managers. Unit trust companies criticise the old RA products without acknowledging life companies provide similar charging structures on their new generation products.
But it is too soon to throw the baby out with the bath water in terms of the historic charging structures. "The differentiator is therefore not based on performance but on the issue of the timing of the fees. The purpose of an RA is to encourage long-term savings, which is in line with government policy. It will be found that if a policyholder sticks to his plan for the full duration of the policy, he will not only find the RA a very attractive product but broadly similar to any competing product such as a unit-trust based RA," he says.
"Those policyholders who stick with their savings plan find real value in their RA. It is equally the case in the unit trust industry as much as the RA industry that the real destroyer of value is not the costs of investing but switching investments or early termination. We try to educate investors that if they are not satisfied with their investment performance, the solution is not to cancel the policy but to change the investment manager or strategy," adds Burger.
Following the initial paper on proposals for strengthening retirement savings released in May by the National Treasury, two further papers were released in September covering preservation and annuities, with a final paper on this costs issue expected in November or December.
Burger says the issue of upfront commission therefore goes to the heart of the argument, and is one that requires deeper analysis than to simply dismiss a product which has been a mainstay of the savings culture in this country for decades. For lower paid workers, the upfront commission is often the only way to incentivise an adviser to make the sale. For more sophisticated investors wanting regular feedback and investment strategy changes, the ongoing commission structure is more appropriate.
"The debate needs to focus on the quality and remuneration of advice, and whether consumers are getting true value for money. Secondly, there needs to be a discussion around the merits of active fund management compared to lower-cost passive investing, and whether we should not be having more of the latter. As an industry we all have an opportunity to play a pro-active role in bringing about reform and ultimately encouraging a better savings culture for all South Africans," he says.
