All savings plans are not created equal
If reform of the retirement and savings industry is to be successful, it needs to tackle the existence of complex and expensive savings products. Thus far regulation has been focused primarily on advice, resulting in the Financial Advisory and Intermediary Services Act, but there has been little scrutiny of the products that advisers are selling.
Once an adviser has neatly ticked the required boxes for a “needs analysis”, there is nothing stopping him or her from selling an education policy with a reduction in yield of 5.9%, as is the case with one of the large product providers. The fees on this product, which is created through an endowment structure, essentially result in the underlying investment having to perform at about 11% just to match a cash return after costs.
Considering this product is aimed at the mass market, there is neither a tax benefit on the endowment structure, nor does its estate planning aspect offer any advantage.
In fact, there is absolutely no product benefit in an endowment structure for a lower-income earner other than that it creates a forced savings plan.
In another case, a client of one of the large insurance houses discovered that he was paying 3% a year in annual management fees on his retirement annuity. Given that retirement funds are limited in their exposure to equities, this fund would be doing well to deliver a 10% return before fees. The best return this customer could hope to receive was 7% – barely above inflation and certainly not enough to secure his retirement.
It is not necessarily the price of advice that is driving these costs but the product design. In the case of the education policy, the 10-year product is invested in a guaranteed structure, which is expensive.
Lack of transparency
In its discussion paper, “Strengthening Retirement Savings”, the treasury highlighted the need to “limit the inappropriate use of guaranteed and smoothed bonus funds in retirement funds”.
“Guaranteed products are inappropriate for long-term investments. It is not clear what that guarantee is worth and what it costs. There is a lack of transparency,” said David McCarthy, a retirement policy specialist at the treasury. He said a long-term investor was better off in a conservative fund rather than a guaranteed one with high costs, low transparency and no disclosure.
There is increasing concern among independent advisers about product design and it is a particular hobby horse of Godfrey Nti, chief executive of the Financial Planning Institute of Southern Africa.
“Our members [certified financial planners] are well qualified and competent, but we need to make sure the products are suitable for consumers,” said Nti, adding that the complexity of product design made it difficult even for advisers to understand the full cost implications.
“It is very difficult to compare products. In most cases the product house only provides the marketing information and not the nitty-gritty. For the average consumer, even those who are educated, it has become a science to try to find their way around the product,” said Nti. He blamed the use of jargon and the deliberate poor communication of salient product information.
Nti said advisers often had to be locked into a contract arrangement with a product provider before the latter was willing to disclose additional information, so an adviser could not simply compare all the products in the market to make the best decision.
In the case of the 3% a year retirement annuity, the adviser had not been aware of the level of the annual management fee. According to the documentation, the adviser received an annual fee of 0.75%.
“We need product houses to simplify products so we can compare one life product with another and ultimately give their clients the most appropriate advice,” said Nti. In many cases, he added, the products were so complex that clients often just signed on the dotted line without understanding what they were signing.
Nti said the Financial Services Board’s Treating Customers Fairly programme would hopefully deal with the issue of product design, although it was not the only reason for its introduction. For example, both the retirement annuity customer and the investor in the education policy could easily argue that the product does not treat the customer fairly, because the fees make it impossible to earn a decent return on the investment.
However, Nti is concerned that the outcome may not be as tough as it needs to be and we may end up with watered-down guidelines – especially about what is required of product houses.
“It is important we get it right because we need to make the industry feel safe for consumers.”
Nti also believes that the Act, which has raised standards of practice and aims to protect consumers, needs further review. Despite the work of the financial advisory and intermediary services ombud, the Act can only interpret findings in terms of the law – and the law is the problem. “One can tick all the boxes as having followed the process for giving advice as defined in the Act, but still end up with shocking advice.”
Nti would also like to see more attention being paid to the quality of advice provided. The Act, which has a primary focus on products, treats advice as incidental to the process of selling a product. “We would like to see a review of the Act where more focus is placed on the planning and quality of advice, which may or may not lead to the selling of a product, because we believe that this will definitely be in the interest of consumers.”
The separation of fees for product and advice has been raised in the treasury paper. McCarthy said the current remuneration model created a conflict of interest because the intermediary provided two services, financial advice and a sales function, yet both these fees were paid by the product house.
But how should advice be paid for if not through the sale of a product?
Nti believes employers can play a greater role in paying for financial advice as part of a broader employee wellness programme. For employers who are already struggling under growing costs – and especially small businesses – it would be a challenge. But Nti believes the government can help by providing tax incentives.
The Financial Planning Institute is exploring the possibility of launching a pro-bono programme for its advisers to help consumers to put their finances in order. “Our members will participate and go out to communities to help for no fee. It is our way of giving back to the country,” said Nti.
The treasury, on the other hand, wants to create products that allow for disintermediation – products that individuals can purchase without using an adviser. The challenge they face is that, historically, products are sold rather than bought and direct sales of retirement and savings products have never really challenged the distribution model.
Although the Financial Services Board’s Treating Customers Fairly programme is a step in the right direction, Nti’s concern that it will not be far-reaching enough is a real one, because serious profits are made from product design and the industry will not walk away from them easily. As one industry insider said: “If one day South Africans woke up and saw a fully transparent financial services industry, they would scream.”