Cost of Retirement Savings in South Africa: Actuarial Paper vs Newspaper Articles

2. PCOF: Hearing on cost associated with retirement savings instruments in South Africa Francois Marais & Gerhard Joubert 10 November 2004

3. Cost of Savings for Retirement Some issues • Actuarial paper vs newspaper articles • Mandatory vs voluntary funding • Saving vs investment • Up-front vs as-and-when commission • Costs vs charges • Disclosure of charges • RIY vs “charge ratio”

4. 128 pages, 70 references • International context • Survey of National Systems • Measuring charges • Lifetime charges internationally • Analysis of SA charges • Occupational pension funds • Unit Trusts • Individual RA policies • Excellent quantity and quality of research Actuarial Paper

5. Newspaper Articles “Costs ravage your RA benefits” “Time for life industry to come clean about costs” “..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.” Serious negative perceptions created

6. Quotes from actuarial paper ”Individual policies appear to be the most expensive, but even here a blanket statement is dangerous and misleading.” ”There are a number of reasons that these figures should not be regarded as directly comparable.” ”Life policies … are (hopefully) sold under the umbrella of sound, holistic advice in the best interest of the policyholder, the cost of which is covered by commission.”

7. 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 Mandatory vs Voluntary Funding • Unit trust RA funds ?! Main difference : need for and cost of advice

8. 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 Investment vs Savings

9. 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

10. Unit Trust Industry Almost exclusively lump sum investments R’bn • Total industry assets 30/09/04 303 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

11. Unit Trust RA Funds? • Insignificant volumes • Limited provision for distribution cost • Unrealistic as solution to problem • Serious flaw in actuarial paper

12. 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

13. Commission • Marketing management cost • Underwriting cost (on life cover) • Administration cost • Claims cost Costs vs Charges • Costs ( = what institution pays) • 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.)

14. 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

15. 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

16. 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

17. Comparison of measures Term 10 20 30 40 RIY Charge ratio 1% p.a. 8% 16% 23% 30% 2% p.a. 16% 30% 41% 51% Stakeholder pensions in UK could not work on 1%

18. Term <19 20 - 29 30 - 34 35 - 39 <40 22% 49% 20% 7% 2% % policies Charge ratio over 40 year term? • Distribution of RA policy terms • Average unit trust investment term Money Market 1,3 years Equity Funds 2,1 years Offshore Funds 3,5 years

19. Fundamental policy choice Compulsory contractual saving with limited advice and low cost or Voluntary savings with personal advice at reasonable cost

20. Thank you!