Comparing Apples with Peaches

The Retail Distribution Review is the fourth in a series of documents which aim to address unsatisfactory outcomes for contractual savers. The December 2004 National Treasury Discussion Paper on Retirement Fund Reform appeared shortly after Rob Rusconi’s benchmark paper, Costs of Saving for Retirement: Options for South Africa, was presented at the Convention of the Actuarial Society of South Africa in October 2004.

The publication in 2006 of a discussion paper on contractual savings in the life assurance industry was followed by a broader overview in 2011 called “A safer Financial Sector to serve South Africa better.”

A breakdown of costs on policies

The myth that commission alone is responsible for all the woes was very clearly shattered by the following comment in the 2006 document:

“The estimated cost of commission as a proportion of total charges is significantly lower than the empirical figure provided in submissions received from the Life Offices’ Association…”

This is confirmed by the following:

“Although commission is a substantial component of up-front costs affecting early termination values, the up-front acquisition cost of insurers is also a very important component. Insurance companies have considerable acquisition costs (including distribution, marketing, underwriting and issuing costs) other than commission.

To quantify the various cost elements of a typical recurring premium savings policy, a survey of the cost structures of the four large insurers was done (for endowments and retirement annuities combined). This provided the following breakdown of the present value of total costs over the lifetime of savings policies:

Commission 35%

Other acquisition cost:

  • Distribution infrastructure 13%
  • Life office cost (marketing, issuing, etc.) 16%

Total up-front cost: 64%

Ongoing costs

  • Profit 9%
  • Tax 3% (i.e. 25% of profit)
  • Maintenance cost 14% Guarantees and investment cost 10%

Total on-going costs and profit: 36%

There can be no doubt that the impact of commission on customer outcomes was for a long time, and is still even possibly today, used as a red herring to divert attention from the total picture.

Impact of Commission on RAs

Rob Rusconi’s paper, as well as research done by the National Treasury, compared the impact of fees versus commission on the cost of retirement annuities:

“Insurer-provided retirement annuities appear to be expensive, according to research carried out in 2004 on the efficiency of the South African retirement industry. This is of particular concern, given the heavy dependence of South Africans on private sector vehicles for their retirement savings. The research examined the aggregate working life administration charges for an individual saving for retirement in one of three tax-deductible vehicles and compares these costs with a wide variety of international benchmarks. The research suggests the following:

  • Collective investment retirement products provide reasonable value.
  • Occupational retirement funds appear slightly expensive, overall.
  • Insurer provided retirement annuity products appear to be very expensive when assessed both against local and international alternatives.

Despite this, conventional RAs are still flourishing, for two reasons:

  • Upfront commission helps intermediaries pay their bills at the end of the month
  • Marketing pressure from some life offices who insist on a minimum amount of commission in order for the broker to retain his contract.

Replacing commission with an advice fee, as suggested in the RDR document, should have a significant impact on the sale of the various products outlined above.

It is the stated intent of the Regulator to “…support sustainable business models for financial advice to deliver fair outcomes over the long term…” It also indicated that product providers will have to take more accountability for client outcomes than in the past.

Perhaps the approach to treating customers fairly should be to do unto others as you want done unto yourself.

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