The TCF regulations were introduced to raise the industry’s standard of conduct – morality, if you will – and restore trust in a sector that has a reputation for profiteering off the public’s financial knowledge gap. We safely predict that TCF will achieve neither, simply because the fundamental conflict of interest that underlies financial services cannot be resolved with woolly ideals.
The conflict arises because the industry and its customer must share the return that is earned off the customer’s capital. That rarely works out well for the client. To understand the dynamics involved, imagine having to share a piece of cake with your older sibling, when’s he’s got the knife and the cake, and he won’t let on how big the piece was.
To regulate a fair outcome under such conditions requires a more drastic measure, one that imposes a fiduciary duty to act in their clients’ best interest. We are far from that; TCF merely mandates fairness outcomes, by way of “products and services … designed to meet the needs of customers”, supported by “clear information” and a host of other vague intangibles.
“Clear information” requires context, and without it customers cannot judge whether a product is serving their need or merely exploiting their financial ignorance. It allows the industry to pay lip service to TCF.
In the Momentum saga, no one would deny the basic tenet of why the claim was denied: individuals cannot insure against a risk that has already materialised. The real issue is that the industry leaves the door open to such outcomes, by choosing to rely on the customer’s disclosure rather than medical proof, to sell its life policies. The customers think it’s to their benefit, when it may simply be more profitable for the insurer to repudiate claims than refuse cover.
It supports the distribution channel, and transfers some of the risk back to the client. Even if the premiums are refunded, the insurer keeps the return thereon, making this a source of free capital.
Brokers and agents are incentivised to sell polices, not to encourage full disclosure, or explain when a claim will be rejected, and to what length the insurer will go to repudiate a claim. But what their clients need is certainty. If the industry was intent on meeting the needs of its clients, it would insist on a basic medical examination, that alerts both parties to any existing conditions and lets customers know where they stand. That is a fair outcome.
The industry will argue that the cost is prohibitive. Yet it is nowhere near what the industry habitually recovers from customers for financial advice, without worrying about the cost impact. The life industry’s policy-based retirement annuities (RAs) are a case in point. The terms of these RAs are inflexible, fixing the number and level of contributions, sometimes for decades in advance. If those terms are broken, the customer risks a causal event charge, a euphemism for a truly outrageous industry practice.
These RAs are usually sold through a broker and most investors understand that the RA provider pays them a commission. What is not clear is that the full commission – perhaps calculated on 30 years of escalating premiums and valued at tens of thousands of rand – is paid to the broker upfront. And that this, along with other ‘selling expenses’, is recorded as a debt against their RA, attracting interest. And that the ‘causal event charge’ accelerates the recovery of this loan and can cost them up to 30% of their investment.
It is not just the practice that offends, or the lack of context in the disclosure, it’s that the industry sells these RAs knowing full well that a high percentage of RA holders will eventually default and suffer this charge.
Today, all these negative features can be avoided with new generation, unit-trust based RAs. Yet the life industry continues to offer the punitive old-style versions, and many advisers and brokers continue to advocate these products, not because they serve the customer, but because it is more profitable for them.
The Pension Funds Adjudicator is often forced to dismiss related complaints because the charges are in terms of the law and the contract, but she has made her feelings known, describing the practice as far removed from “the letter and spirit of the TCF principles”.
The same can be said for concealing the destructive impact of high fees on the long-term savings outcome.
To illustrate, a R100,000 RA investment, earning a nominal return of 10% pa, would be worth R5,5m in 40 years’ time. The Terms & Conditions may provide “clear information” on the fees, which are often as high as 3% pa, including the cost of advice. That may not sound onerous, as the investor keeps 70% of the return and should thus, on the face of it, get out R3,2m (70%).
The final pay-out would only be R1,5m however, because that’s how compounding works. But how many people appreciate how compounding works?
It’s a fairness outcome because the fees were clearly disclosed. But it is not a fair outcome, because the investor put up all the capital, took all the risk and landed just one third of the reward. And there are much cheaper options in the market.
“Clear information”, of the type the industry provides, is simply not enough. A fair outcome requires more than just disclosure, it requires context. It is not enough to specify all fees without also quantifying the long-term impact of fees. It is not enough to talk about the possibilities of active management without indicating that most investors are better off with index funds.
Without context, customers cannot make informed decisions, which means the industry will keep exploiting the knowledge gap.
For real change, the TCF acronym needs to be re-interpreted as “the customer first”. Only if the regulator imposes a fiduciary duty on the industry to serve the client’s best interests, rather than broadly align with the client’s need, can we expect fair outcomes. Until then, the onus remains on customers, to wise up to the industry’s profiteering, and vote with their feet.
The retirement industry provides thousands of options, but no simple solution. 10X Investments has one proven solution, which is underpinned by a simple formula for retirement savings success: Invest 15% of your salary for 40 years in a high-growth Index fund and pay fees of less than 1%.