Jack Smith* is 36 years old and took out a Sanlam retirement annuity (Cobalt for Professionals) at the age of 25 in 2005.
The premium on this retirement annuity (RA) is R6 430 with a 10% annual escalation rate. The fund value is R679 289 and the product is set to mature in February 2036.
INVEST IN LINE WITH YOUR PROFILE AND TIMELINE
When Smith was sold the product, he should have also been given a risk profile assessment to determine whether he was a cautious or aggressive investor.
The Financial Advisory and Intermediary Services Act requires that when an adviser sells a financial services product, he must carry out an analysis of the client’s needs and should invest the client’s money in line with their risk profile.
Smith’s adviser should also have taken into account the fact that Smith, at the time of buying the initial product, had 40 years to go until retirement age.
The asset allocation on the underlying investments in this particular retirement annuity product is as follows:
. 10% – Absolute return fund (CPI + 3%): cautious
. 30% – Allan Gray Balanced Fund: moderate
. 20% – Coronation Strategic Income Fund: conservative
. 40% – Investec Managed Fund: moderate.
Henry van Deventer, wealth strategist for Old Mutual Wealth, says this is a conservative allocation for a client who is 36 years old.
“In practice, many advisers tilt their client portfolios towards a more conservative solution because clients [and advisers] react more emotionally to volatility, leading to conversations that many advisers are uncomfortable with as they feel these conversations could increase the risk of clients leaving,” he says.
WHO REALLY PAYS THE BONUS?
Smith’s adviser recently offered him the option of switching from his current RA to a new RA product, (Cumulus Echo retirement plan for professionals), which will include the Sanlam Echo bonus benefit – apparently at no cost to Smith.
However, products with bonuses usually carry higher fees and, at the end of the day, the client or investor is the one “rewarding” themselves with a bonus.
Van Deventer says Smith should try to look at exactly how this bonus works and is funded.
City Press approached Sanlam with this question and received the following response:
“Roughly two years ago, a conversion option was made available from older Sanlam retirement annuities to the new Cumulus Echo RA. With this conversion option the fund value (and not the termination value) of the existing plan is transferred to the new plan.
“The reason for the transfer should not be for the bonus alone, but rather because the overall fees or investment choices on the new plan are better.”
WHAT DOES THE NEW PRODUCT OFFER?
The recurring premium on the new product will remain at R6 430 with an annual 10% escalation.
The underlying investments on the new product would be:
. SMM cautious fund of funds: cautious – 50%
. SMM moderate fund of funds: moderate – 50%
Van Deventer comments that this new asset allocation appears to be even more conservative than Smith’s current portfolio, which is already questionably conservative.
The new product does allow the client to make four free switches to the underlying investments per year – however, the quote does not say what the investment options are.
UNDERSTAND YOUR FEES
The quote states that the “reduction in yield” is 3.08% before the change and drops to 2.65% after the conversion to the new product.
We questioned why the fees were not more clearly laid out as the chances of a lay person understanding what a reduction in yield means are slim.
Smith, for example, has a degree in chartered accounting, but he was unable to explain this concept.
Sanlam responded that the use of reduction in yield figures is as per a Code on Policy Quotations, an Association for Savings and Investments SA (Asisa) standard, which prescribes that life insurance companies calculate reduction in yield for any investment policy written on a life licence. Code on Policy Quotations specifies how the reduction in yield should be calculated.
“The calculation is a forward-looking measure that includes all charges levied on the policy (including those levied for asset management).
It therefore also includes charges levied for advice and administration, which are excluded from the total expense ratio.
“Reduction in yield effectively shows the total impact of all the fees on the growth of the plan, so a reduction in yield of 2.65% implies that the return will reduce from say 12.65% a year to 10% a year if the client remains invested for the full term.
"There have been lots of debates between unit trust companies (which preferred total expense ratio) and the life insurance companies (which are compelled to use reduction in yield) around which of the two is the most appropriate measure,” Sanlam said.
Van Deventer says reduction in yield is a popular way for product providers to get past their required cost disclosure (total expense ratios as prescribed by Asisa).
“Product providers now commonly tend to highlight reduction in yield [which they can define in a way that suits them] at the expense of total expense ratios.
"Total expense ratios are a [backward-looking] indication of average investment management costs investors can expect to pay based on what clients actually paid in the past [including performance fees].
“Reduction in yield is forward-looking and usually makes assumptions that exclude performance fees and some other likely costs,” he says.
The quote goes on to tell Smith that switching investment products will see his fees reduce as follows:
. Asset management and fees reduces from 0.84% to 0.74%; and
. Administration and advice fees reduce from 2.24% to 1.91% (this apparently includes charges for smoothing/guarantees if applicable).
Admin fees on non-commission platforms are usually about 0.6%, and advice fees typically range between 0.5% and 1%, so although there will be a reduction, the fees still seem high. It’s hard to say if the numbers from the quote are good or bad without knowing how much of this is funding the Echo bonus.
TERMINATION CHARGES OR PENALTIES
The product Smith was offered includes a termination charge for early retirement or termination of the plan before retirement date.
This means that he is being sold an “old-generation” RA product, where the financial adviser is incentivised to sell the product because he will receive a hefty upfront commission fee.
The client is then “locked” into the product and has to pay a penalty or termination fee if his circumstances change and he wants to reduce the monthly premium or stop payments on this investment altogether.
“The termination charge after conversion is what was left on the old plan, and will run off over a period of between five and 10 years, typically.”
However, the “old plan” was purchased more than 10 years ago, so the termination charge should have fallen away by this stage, which implies that the client is being sold a product with large, upfront commission.
The adviser in this case adopted dubious business practices. He only sent Smith a risk profile assessment questionnaire after Smith had approached City Press for advice, and after he had gone back at least twice with queries about the new product and his current underlying investment strategy.
Smith says he had not been given that type of questionnaire before, which implies that a financial needs analysis and a risk profile assessment had not been done.
If Smith has an extra R6 000 discretionary amount to invest each month, he would be better off taking out an entirely new RA investment product that is not linked to his current investment, does not carry any termination fees or penalties and will allow him the flexibility to reduce or stop premiums at any stage.
*Not his real name