Last year R20,5-billion worth of individual life investment products were surrendered before maturity. This represents a staggering 26% of the R74-billion the life companies received from total individual premium income last year. When one compares this figure with the R39-billion of individual premium income from new business last year, for every R2 of new business written, R1 was lost to surrender.
Historically, the percentage of surrenders is similar, although there are variances when surrender values are lower simply because of poor market performance.
When one considers the fees that are being bandied about in the recent high-profile cases, which are before the Pension Funds Adjudicator, one can assume that people cashing in their policies early will have a positive effect on life companies’ profits, to the detriment of their own nest eggs.
The Pension Funds Adjudicator has made several recent findings against the life industry for exorbitant fees and penalties.
Unfortunately, it is impossible to calculate the actual total loss that policyholders have incurred through the costs of surrendering early as it all depends on the length the investment has left to maturity.
Analysts, however, do argue that the total percentage of penalties is unlikely to be as high as the cases that are currently being tested, as these would represent the worst case scenarios.
Even if one had to assume an average 10% penalty cost this has still resulted in R2-billion in lost returns for policyholders that have been retained by the life companies.
At 26% of total premium income, South African surrenders are higher than the international norm. “It is hard to draw direct comparisons, however, it would seem that in South Africa the surrender levels relative to premium income are on the high side,” says an insurance analyst.
This is not necessarily good news for life companies. Although surrenders may have a positive impact on profits in the short term, analysts say that over the long term it has a negative impact because the cost of retaining a client is far lower than the cost of signing a new one.
Gerhard Joubert, executive director of the Life Offices’ Association (LOA) says that the industry is concerned about the high level of surrenders and a study was undertaken six years ago. The finding concluded that “most people who surrender, or allow their long-term insurance policies to lapse before the policy has reached maturity, do so because of changes in their personal circumstances, which result in temporary financial problems”.
Approximately one third of policies sold did not continue past their third year. Joubert says that eliminating or restricting the writing of business that will most likely not reach maturity will result in significant savings for both policyholders and insurers.
Chris Stewart, portfolio manager at Investec Asset Management, says the recent high surrender levels and, in particular, the recent court cases are directly attributable to the poor equity market performance from 2000 to 2004. “In the 1990s the strong equity markets and high inflation rates hid the high-cost structure of these products. However, once the market performance began to fall, the fees started to have a marked impact on performance.”
Stewart adds that historic life products are under threat and that the recent court cases will accelerate the process of change that is already under way to make fees more transparent and less onerous. “A major problem in South Africa is that intermediaries have a disproportionate amount of power and this is a major problem in trying to address cost reductions.”
Stewart says the practice of commissions for the entire period of the investment being charged upfront has a major impact on performance values. Typically a retirement annuity (RA) is sold with a life term of 30 years and the intermediary receives a large upfront payment.
“The life industry needs to move from ‘as and when’ commission structures to a situation where commissions are paid over the period of the investment. This will also ensure that the correct investments are sold to clients who can afford them so that the client is more likely to hold on to the policy until maturity.”
Stewart says this can only be done in a consolidated manner. If one life company changes their commission structure the intermediaries would simply take their business to another company. Stewart says a governing body like the Financial Services Board (FSB) would have to introduce legislation that forced a change in the way that commissions were paid.
The FSB says that commission structures in the industry are under review as well as the high level of surrenders. This ties in with Minister of Finance Trevor Manuel’s very vocal concern over the costs of retirement products.
Retirement savings is a critical issue in South Africa, which has one of the lowest rates of savings in the world. RAs — which have received a great deal of bad press recently and because of long investment periods are the major casualties in surrenders — are a key product for retirement savings. The bad press will only give people a further incentive not to save for retirement.
Zozo Owen of Wan and Associates, an independent financial advisory company, says she welcomes the highlighting of the cost structures and the fact that the government is taking an active role. “The state cannot afford to care for people in their retirement and it is critical for them to encourage people to take out retirement products. If pressure from the government brings down the costs of RAs, more people will be able to afford them and they will become more attractive as an investment vehicle,” she says.