Old Mutual has a little secret, which, like the fairy-tale heroine Cinderella, it keeps undercover, while trying hard to push the ugly sisters to the forefront.
Cinderella in this case is the Equity Linked Retirement Annuity Fund (Elraf), which is marketed by the unit trust division of Old Mutual. Until now, we have only been able to speculate on how attractive this retirement savings product actually is. Today, Personal Finance can provide you with the full details.
Instead of telling you about its "Cinderella retirement annuity" (RA), Old Mutual continues to strongly promote its new range of what it calls "lower- cost" Max products. Before Max, Old Mutual punted its high-cost, high-penalty Flexi range.
There is now the Max Select RA ugly sister and the Max Committed RA, which is an even uglier sister. (Ugly when compared with Elraf, not the Flexi range on which Max is a significant improvement.)
Considering that RAs are so much in the news and Old Mutual is promoting its Max retirement products while staying virtually stumm on the "Cinderella RA", we decided to find out as much about Elraf as possible
It has been something of a battle to get Old Mutual to disclose everything to us, but eventually we managed to get the Big Green to answer most, but not all, of our questions.
I have no idea what "lower cost" Old Mutual is talking about when it refers to its Max products in its current advertising campaign. I can only assume Old Mutual is comparing Max with its now-discontinued and very expensive Flexi range of products.
What I can tell you is that the Max RA product comes at a much higher cost than the Elraf unit trust product.
In addition, Old Mutual is not only spending a lot more money on advertising the "higher cost" Max product, but it is also paying financial advisers a lot more of your money to sell you the Max product in preference to the Elraf product.
What we wanted to know
Personal Finance based its questions about the costs of the Max product on a fairly simple structure, with no fancy investment choices that would push the costs of the Max products even higher.
Based on a recurring premium contribution of R500 or R1 000 a month, and with an assumed return of 10 percent a year over terms of five, 10 and 20 years, we wanted answers to the following questions:
- The annual reduction in yield as a result of total costs;
- The annual reduction in yield in respect of commissions/fees paid to advisers only;
- The reduction in maturity value in percentage and rand terms for total costs; and
- The reduction in maturity value in percentage and rand terms as a result of commissions.
(Calculations exclude taxes, including income tax, capital gains tax and retirement fund tax.)
The answers to our questions show that the Elraf unit trust product wins hands down on costs and commissions (see the tables).
The question is not whether you should pay costs. When actuary Rob Rusconi exposed the high cost of retirement saving in South Africa in a research paper he delivered at the annual meeting of the Actuarial Society of South Africa last year, his main argument was that without high costs you would be better off in retirement.
Your savings growth in an RA is mainly based on the compounded returns you receive (in other words, the investment returns on the investment returns).
In the same way, costs have a compounding effect on the final amount of money you will take into retirement. So, although the amount you pay each year in costs may seem small, the end result can be enormous.
For the purposes of this exercise, we only asked about the effects of costs over 20 years. The reason for this is that a number of Rusconi's critics lambasted him for working out the reduction in maturity value (what is known among actuaries as the expense charge) over 40 years. His critics said very few policies were for this period. Rusconi found that costs could reduce your ultimate benefit by almost 50 percent on life assurance RAs after 40 years. Well, on 20 years, the situation is also bad. And remember that the Max RA product range has lower costs than Old Mutual's now-discontinued Flexi range.
Based on the above assumptions, if you pay a premium of R1 000 a month for 20 years, your best possible final maturity value on a Max product will be a whole eight percentage points less than the Elraf unit trust product. That translates into R60 000. At current guaranteed level annuity (pension) rates that could mean you will receive about R5 400 less every year.
The question has to be, why Old Mutual, if it is putting you first, sells and promotes the Max product in preference to the Elraf product?
What Old Mutual says
Here are the answers supplied by Steven Levin, who is the Max product actuary at Old Mutual:
- The Max RAs provide access to Old Mutual investment funds, as well as to those of other companies (for example, Investec, Coronation, Allan Gray, RMB), whereas Elraf gives you access to only Old Mutual's unit trust funds, Levin says.
My comment: This is not necessarily an advantage as there are additional costs involved. This will make the reduction in yield and reduction in maturity values even worse. And how do you or your financial adviser predict the next best manager or product? Old Mutual Unit Trusts has a good long-term investment record. Have a look at how well its battleship Investors Fund has performed over the long term.
- In the case of the Max RAs, switching between Old Mutual's funds and those of other companies is free, Levin says.
My comment: Old Mutual may not charge you, but the asset managers of the underlying funds will charge you an average of 0.25 percent of the rand value of the amount being switched for each switch. Again, this will reduce your final benefit. With Elraf, there is no charge for switching between funds managed by Old Mutual Unit Trusts.
- The Max RAs provide access to multi-manager funds. Old Mutual Unit Trusts does not have any multi-manager funds, Levin says.
My comment: Multi-manager solutions have not proved themselves. There are some multi-manager funds, including unit trust funds of funds, that have done fairly well. There are others that have produced little value. And multi-manager funds cost more.
- The Max RAs provide access to smoothed bonus funds and other guaranteed funds, Levin says.
My comment: This is a definite advantage, but as the Elraf product operates under an Old Mutual life assurance licence, I see no reason why this choice cannot be offered, even if it comes at a higher cost. After all, Old Mutual is one company.
- The waiver of premium assurance on disability is only available on the Max RAs, and is not available with Elraf. This can be an important feature for people saving for retirement. If they become disabled, the waiver of premium benefit will carry on paying contributions to the RA for the client and retirement savings will continue to accumulate, so you will have sufficient capital to retire at normal retirement age, Levin says.
My comment: As I said above, Old Mutual is Old Mutual, and it could also offer the premium waiver assurance within Elraf.
- The minimum monthly investment amount is R250 for Max and R500 for Elraf.
My comment: The premium on Elraf could and should be reduced.
Why I favour Elraf
My arguments in favour of the Elraf unit trust product are:
- Obviously, the lower costs and better maturity values will result in a better pension.
- Lower commissions.
- You can reduce your premiums at any stage of the investment without incurring a penalty; and importantly, increase them temporarily without facing a penalty if you want to reduce the contributions in the future.
- There is no need to be befuddled by a wide spread of investment choices, which will cost you more and expose you to far greater investment risk, as well as the risk of receiving bad advice.
And, finally, did you know that Rusconi saves for his retirement using the Elraf unit trust product?
Old Mutual deserves a big pat on the back for having Elraf in its product offerings. None of the other life assurance companies and only a few unit trust management companies have a similar product.
Old Mutual is not providing FAIS-required appropriate advice
Previously, when Personal Finance raised the issue of why Old Mutual does not promote its cheaper Equity Linked Retirement Annuity Fund (Elraf) unit trust product as actively as it does the more expensive Max product, Paul Hanratty, Old Mutual's deputy managing director, argued that Max's higher cost is justified because you do not need financial advice about the unit trust product, whereas Max is an "advice" product.
Well, Mr Hanratty, according to my reading of the Financial Advisory and Intermediary Services (FAIS) Act, Old Mutual's intermediaries must provide appropriate advice. That advice should include telling policyholders and members of retirement annuity (RA) funds about the cheaper unit trust investments. And, Mr Hanratty, if you do not want to take my word on the matter, here is the view of Gerry Anderson, who heads the FAIS department at the Financial Services Board.
Anderson says a financial adviser must act in your best interests, and this includes informing you about which products he or she is authorised to sell.
He does not think it is sufficient for an adviser to tell you which products he or she is authorised to sell without explaining the advantages and disadvantages of all those products.
Anderson says his view is supported by a recent ruling against Nedbank by Charles Pillai, the Ombud for Financial Services Providers. Pillai ruled that Nedbank had given a client inappropriate advice, had misrepresented certain investment products and had not fully disclosed all the information about the products to ensure that the client could make an appropriate choice.
So, if an independent financial adviser or an Old Mutual agent is attempting to sell you a Max product without telling you about the unit trust product, you must ask why.
This week, I telephoned the Old Mutual call centre. In a pre-recorded message, I was told that Old Mutual is a licensed Financial Services Provider. In other words, it has to abide by the FAIS Act when it sells products to you. This, in turn, means it must provide appropriate advice and information.
I asked the call centre representative to provide me with a list of all Old Mutual's RA products. Guess which product he did not tell me about? You got it: the Old Mutual unit trust RA.
Old Mutual needs to explain why it is not meeting the requirements of the FAIS Act.
To make matters worse, Steven Levin, the Max product actuary at Old Mutual, claims that one of the advantages of Max over Elraf is that the former allows you to choose from a wide range of underlying investments. Not only can you select from Old Mutual's range of investment products, but you can also select from a wide range of investments offered by other companies. If you invest in Elraf, Levin says, you have a limited choice of investments - namely, only Old Mutual's range of unit trusts.
Levin's comments are interesting in light of the fact that for many years, Dave Hudson, one of Old Mutual's senior managers, has toured the country telling anyone who will listen about the folly of trying to time the markets by switching investments. And research has shown that Hudson is 100 percent correct.
The question for Old Mutual is why it keeps promoting the idea that you should obtain advice on investment choices from financial advisers who, on the whole, have extremely low investment management skills?
In my view, 99 percent of Old Mutual RA members would be far better off selecting a prudentially managed Old Mutual unit trust fund (whether in terms of Max or Elraf) and sticking with it, rather than attempting to switch between a multitude of companies and their products. After all, Old Mutual Asset Managers has done a pretty sound job over the years.
The main reason financial services companies offer you a multitude of underlying investment choices is because they earn extra money by doing so. And you will not even know how much extra money they earn, because, when they offer you other companies' underlying investment products, they demand kickbacks from those companies for doing so, and they do not pass the kickbacks on to you.
Requests to Old Mutual for details about the kickbacks it is paid by other asset management companies on the Max product were met with the response: "This info is not available." Asked whether Max policyholders, including the RA members, are told about the kickbacks, the reply again was: "This info is not available." And then Old Mutual still claims it discloses all?
When it comes to disclosure, Old Mutual also suggested that we cannot publish the names of the trustees of its RA funds. What nonsense.
Elraf wins hands down when it comes to low commissions
From a cost perspective, one of the reasons you are better off with the Old Mutual Equity Linked Retirement Annuity Fund (Elraf) is that commissions paid to financial intermediaries are lower (see "Commission charge only" in the tables).
The Max product has two commission structures. They are:
1. Committed Investment Plan.
Here, the commission on recurring premiums is structured in the traditional perverse way, with most of the commission paid upfront on the entire term of the retirement annuity (RA), as follows:
- Commission paid in first year = three percent x annual premium x premium-paying term; and
- Commission paid in second year = one-third of the first year's commission.
On top of this, penalties will apply if you reduce your premiums at any stage before maturity. However, the penalties on the Max product are dramatically lower than the confiscatory penalties Old Mutual levied on its now-discontinued Flexi RA products.
The effect on your accrued value if you invest with the Max Committed Plan are outlined in the table Effect of penalties with the Max Committed Investment Plan.
The other significant problems with upfront commissions (and therefore with the Committed Investment Plan) are:
- There is an incentive for financial intermediaries to get you to make an RA paid-up after two years and take out a new policy. This will result in a new set of commissions for the intermediary and in you paying exit penalties and a new round of entry costs.
- There is no incentive for an intermediary to provide you with ongoing service and advice.
2. Select Investment Plan.
You pay commission as and when you pay your premiums. The commission is 2.5 percent of your premium, as-and-when it is paid, plus an annual 0.5 percent of the accrued value of your investment. On this option, you may pay less commission in total than with the Committed Investment Plan. However, at maturity, you may or may not have paid more commission. This will depend on how much commission is paid as a percentage of your assets.
It is beyond me why someone who more than likely will not have investment management skills should be paid a percentage of your assets.
There are no penalties for making your policy paid-up.
How Elraf compares
When it comes to commissions, the Elraf unit trust product is your best option, because the commission is three percent a year, paid as-and-when you pay your premiums. So, on a R1 000-a-month premium paid over 20 years, your maturity value will be reduced by:
- Nine percent with the traditional upfront commission structure of the Max Committed Investment Plan;
- Eight percent with the Max Select Investment Plan; and
- A mere three percent with the Elraf unit trust product. And to make the Elraf product even more attractive, if you feel you do not need financial advice, you can buy the RA directly from Old Mutual Unit Trusts without paying any commission. As a result, you will receive an even more meaningful payout at retirement.
Warnings
- It is imperative that you save for retirement. The sooner you start, the better, and the more you save, the better. The longer you leave it before you start saving and the less you save, the more likely it is that you will be among the people who are destitute in old age.
- It is imperative that you determine your financial requirements for retirement by having an intermediary conduct a comprehensive financial needs analysis. If you do not have a financial adviser, you can find one on one of these two websites: www.findanadvisor.co.za and www.fpi.co.za
- Demand that your financial adviser provide you with a full list of retirement annuity (RA) options and full details of the annual reduction in yield and reduction in maturity value caused by the total costs. Do not accept the life assurance industry's projections based on what it calls its Code on Policy Quotations. These quotations do not fully reveal the costs. In fact, the code camouflages the costs.
- Do not stop paying your contributions to an existing RA - at least not until there is clarity from the courts on the rulings by Vuyani Ngalwana, the Pension Funds Adjudicator, that the life assurance companies may not arbitrarily confiscate your retirement savings if you reduce your contributions. Only if Ngalwana's rulings are upheld by the courts and you are paying high costs on your RA, should you consider making the RA "paid-up" and taking out a new low-cost RA. You may face a significant penalty if you reduce your premiums before there is clarity on the adjudicator's rulings.
Definitions
Reduction in yield (RIY)
: The percentage by which the return on your investment may be reduced on an annual basis.
Reduction in maturity value
(also known as the expense ratio): The amount by which your total returns will be reduced by things such as costs or commissions.