Francois Marais & Gerhard Joubert10 November 2004

PCOF: Hearing on cost associated with retirement savings

instruments in South Africa

Cost of Savings for Retirement

Mandatory vs voluntary funding

Saving vs investment

Costs vs charges

Up-front vs as-and-when commission

Actuarial paper vs newspaper articles

Disclosure of charges

RIY vs “charge ratio”

Some issues

Actuarial Paper

Survey of National Systems

128 pages, 70 references

International context

Measuring charges

Lifetime charges internationally

Analysis of SA charges

Occupational pension funds

Unit Trusts

Individual RA policies

Excellent quantity and quality of research

Newspaper Articles

“Costs ravage your RA benefits”

“..high cost are reducing the benefits from RA’s by

almost 45%”“There is lack of transparancy in the life insurance industry”

“Sales people prefer to promote life assurance products because they receive commission up

front.”

“Time for life industry to come clean about costs”

Serious negative perceptions created

Quotes from actuarial paper

””Individual policies appear to be the most Individual policies appear to be the most expensive,expensive,but even here a blanket statement is but even here a blanket statement is dangerous and misleading.”dangerous and misleading.”

””There are a number of reasons that these There are a number of reasons that these figures should not be regarded as directly figures should not be regarded as directly comparable.”comparable.”

””Life policies … are (hopefully) sold under the Life policies … are (hopefully) sold under the umbrella of sound, holistic advice in the best umbrella of sound, holistic advice in the best interest of the policyholder, the cost of which interest of the policyholder, the cost of which is covered by commission.”is covered by commission.”

Mandatory vs Voluntary Funding

Mandatory vs Voluntary Funding Mandatory retirement systems (16 countries)

Economies of scale

No distribution cost

Occupational pension funds

Voluntary for employer, compulsory for employees

Very little individual advice or choice

Voluntary individual contributions (RA’s)

High level of personal advice and choice

Unit trust RA funds ?!

Main difference : need for and cost of advice

Investment vs Savings

Investment = lump sum business

Older clients, shorter terms (5 years)

Unit trusts, LISPS, single premium policies

Savings = recurring contributions

Younger clients, longer terms

Endowments; RA policies

Are Unit Trusts Cheaper?

On lump sum investments

Life policy often cheaper (short terms)

On recurring contributions

Policies with up-front commission more expensive

Comparison with unit trusts inappropriate

Unit Trust Industry

Total industry assets 30/09/04 303

R’bn

Annual cash flow

Total inflow 252

Total outflow 202

Net inflow 50 Sanlam Collective Investments

Total inflow 14

Regular investments 241m (1,7%)

Investments, not savings

Almost exclusively lump sum investments

Unit Trust RA Funds?

Insignificant volumes

Limited provision for distribution cost

Unrealistic as solution to problem

Serious flaw in actuarial paper

Up-front vs as-and-when Commission

Life industry (Regulated)

Up-front commission on most recurring premiums

Endowments, RA’s, life cover

As-and-when commission on single premiums (max 3%)

Unit trust and LISP’s (Unregulated)

Only as-and-when commission (no maximum)

Mainly lump sum investments

Recurring contributions = series of lump sums

Trail fee as % of assets

Costs vs Charges Costs ( = what institution pays)

Commission Marketing management cost Underwriting cost (on life cover) Administration cost Claims cost

Charges ( = what the client pays) Premium charges Fixed policy fee (e.g. R10) % of premium (e.g. 3%) Buy / sell spread (e.g. 2%) Fund charges

% of assets (e.g. 1,5% p.a.)

Reasons for different charges

Fairness between policies with different terms and size

Example of 1% fund charge

Fund size R1 000 R100 000

Fund charge R10 R1 000

Premium charge : more effective over short term

Fund charge : more effective over long term

Fixed charge : affects small policies

Disclosure of Charges In terms of FAIS and PPR:

Full disclosure of all charges required

All commission must also be disclosed

In terms of new LOA Code on Policy Quotations:

All charges must be discribed and quantified in one section

RIY must be calculated on full actual expense charges

Required Investment Return = Projection rate + RIY

RIR must be printed immediately below projected values

Full clear disclosure

RIY vs Charge Ratio Reduction in yield (RIY)

Same as fund charge as % of assets

Easy to understand

In line with way charges are recouped annually

Charge ratio

Equal to reduction in maturity value

Highly dependant on term

Exaggerates effect of reasonable RIY over long term

Should be used responsibly

Comparison of measures

RIY

Term

10 20 30 40

1% p.a.

2% p.a.

8%

16%

16% 23% 30%

30% 41% 51%

Charge ratio

Stakeholder pensions in UK could not work Stakeholder pensions in UK could not work on 1%on 1%

Charge ratio over 40 year term?

Distribution of RA policy terms

Average unit trust investment term

Term

% policies

<19 20 - 29 30 - 34 35 - 39

22% 49% 20% 7%

<40

2%

Money Market 1,3 yearsEquity Funds 2,1 yearsOffshore Funds 3,5 years

Fundamental policy choice

Compulsory contractual saving with limited advice and low cost

Voluntary savings with personal advice at reasonable cost

or

Thank you!