March 13, 2010
 By Bruce Cameron
This is the month in which most of the life assurance companies announce the bonuses on their capital-guaranteed smoothed/stable bonus products. These products proved their worth in the recent market turmoil, which, at its worst, saw the JSE lose almost 50 percent of its value against its record - and I would say exuberant - highs of 2008.
When the investment markets hit rock bottom, investors in smoothed/stable bonus products, who were prepared to stick with their contracts until maturity, earned returns that far exceeded those they would have received from market-linked products with similar underlying investments.
Metropolitan, Old Mutual and Sanlam are the biggest purveyors of smoothed bonus products. They are products that should be on your list of investment choices.
But beware when they are made available as the underlying investment in life assurance and particularly retirement annuity wrappers that have nasty penalties if you do not keep paying your premiums/contributions. The sooner the life companies scrap these unacceptable penalties, the better for everyone.
In most cases, smoothed bonus products have a capital guarantee, while your returns are smoothed: the life assurance company holds back some of the returns made in the good years so that returns can be paid out in the bad years.
The smoothing is generally managed to take account of market fluctuations of about 10 percent either way. The smoothing seldom takes account of extreme falls, such as the drop-off in values in 2008.
While the smoothed/stable product bonuses in 2008 were below inflation for the first time in a number of years, they at least did not provide any negative returns.
This was despite the fact that all the companies that provide these products had what are called negative bonus reserves. In other words, the total value of the actual assets held was lower than the value of the portfolios. The consequence of this is that when markets start performing well again, investors will initially receive lower returns while the capital value of the portfolio is built up.
So here is how the main purveyors of smoothed bonus products measure up with their latest bonuses announced over the past few weeks. The main smoothed/ stable bonus product ranges offered by Metropolitan, Old Mutual and Sanlam are:
Metropolitan. Metropolitan Individual Life Smoothed Bonus Fund, which is available in the FutureBuilder and FutureChoice product ranges. (There is R9.9 billion in assets under management in the Smoothed Bonus Fund. Metropolitan has a total of R26.5 billion in assets under management in all its smoothed products, including retirement funds.)
Old Mutual. Flexi Smoothed Bonus Fund (R35 billion in assets under management. Old Mutual has a total of R' billion in assets under management in all its smoothed bonus products).
Sanlam. Stable Bonus Fund (R33.7 billion in assets under management, which is included in the total of R61.7 billion in assets under management in all Sanlam's smoothed/stable products, including retirement funds).
Bonus declarations
There are various ways you can test the strength of a smoothed/stable bonus product before you invest in it. One obvious way is to consider the current and longer-term returns (bonuses). The bonuses are declared as taxed and untaxed.
The reason for the distinction is that interest, foreign dividend and net rental income returns on savings in retirement funds, including retirement annuity (RA) funds, are not subject to tax, whereas on taxed investments, such as endowment policies, income tax is payable by the life assurance company, on your behalf, on your investment returns, at a rate of 30 percent. As a result, the untaxed portfolios have better investment returns and therefore better bonuses.
The most recent bonus declarations for the main retail products after costs are:
Metropolitan (effective declaration date: December 2009):
* Taxed portfolio (for example, endowment policies): six percent (zero in 2008).
* Untaxed portfolio (for example, RA policies): five percent (zero in 2008).
Old Mutual (effective declaration date: December 2009):
* Taxed: six percent (five percent in 2008)
* Untaxed: 7.2 percent (6.2 percent in 2008)
Sanlam (effective declaration date: October 2009):
* Taxed: 7.25 percent (5.25 percent in 2008)
* Untaxed: 8.75 percent (6.75 percent in 2008)
However, you should also take account of the longer-term track record. The 10-year annual average returns for the products are:
Metropolitan
* Taxed: 11.2 percent.
* Untaxed: 11.4 percent.
Old Mutual
* Taxed: 10.7 percent for the Flexi Smoothed Bonus Fund; 11.7 percent for the Smoothed Performance Fund and Stabilised Investment Fund.
* Untaxed: 11.4 percent for the Flexi Smoothed Bonus Fund; 12.3 percent for the Smoothed Performance Fund and Stabilised Investment Fund.
Sanlam
* Taxed: 9.3 percent.
* Untaxed: 10.2 percent.
(Note: The average annual inflation rate over the 10 years to December 31, 2009 was 5.7 percent. You need to subtract this figure from the average annual return to calculate your real, or after-inflation, return.)
Other tests
There are other ways to look at the strength of smoothed bonus products. They include:
1. Bonus reserve account
These are the reserves primarily held to pay bonuses in bad years. If the reserve turns negative, going into the red by more than 7.5 percent of the capital value of the fund, this must be declared and reported to the Financial Services Board. If the reserve is in positive territory, things are fine. If not, there may be room for concern.
Metropolitan. On December 31, 2009, the effective bonus declaration date, the retirement annuity (untaxed) portion of the Individual Life Smooth Bonus Fund had recovered almost all the negative funding, and has remained very close to a 100 percent funding level since the start of the year. The taxed portion of the fund (in which endowment policies are invested) was positive at the end of December 2009 and has remained in a positive funding position since then.
Old Mutual. After being in negative territory early in 2009, the position recovered in line with the bounce-back of markets. On December 31, 2009, the bonus reserve account of the Flexi Smoothed Bonus Fund was positive, and remains so.
Sanlam. The bonus reserve account of the Stable Bonus Fund was positive on December 31, 2009 and remains so.
2. Vesting/non-vesting bonuses
Most bonuses are declared as vesting or non-vesting bonuses. Normally, non-vesting bonuses are about half of the full declared bonus. However, in times of extreme market volatility, life assurance companies tend to favour non-vesting bonuses.
The effect of a non-vesting bonus is to reduce your capital guarantee over time. A vesting bonus is added to any guarantees you have on your initial capital while non-vesting bonuses can be removed under extreme market conditions. This seldom happens. It happened with the implosion of financial services company Fedsure . This measure could be expected if the bonus reserve account drops to more than 15 percent negative for more than a few months. Life assurance companies are increasingly making products available that do not have non-vesting bonuses. The current breakdown on bonuses is:
Metropolitan
* Taxed: two percent vesting, four percent non-vesting (zero for both for 2008).
* Untaxed: two percent vesting, three percent non-vesting (zero for both for 2008).
Old Mutual (Flexi Smoothed Bonus Fund)
* Taxed: three percent vesting, three percent non-vesting (two and three for 2008).
* Untaxed: 4.2 percent vesting, three percent non-vesting (3.2 and three percent for 2008).
Sanlam
* Taxed: 2.75 percent vesting, 4.5 percent non-vesting (two and 3.25 percent for 2008).
* Untaxed: 2.75 percent vesting, six percent non-vesting (two and 4.75 percent for 2008)
3. Interim bonuses
These bonuses are applied between annual bonus declarations. For example, if your policy matures in June, you will receive the interim bonus for the period from the previous bonus declaration date to the maturity date.
The interim bonus can be adjusted at any time, depending on the underlying value of the portfolio. If the bonus reserve account is in trouble, the interim rate will quickly drop to zero.
The assurers' current interim bonus rates are:
Metropolitan
* Taxed: four percent (two percent in March 2009).
* Untaxed: three percent (two percent in March 2009).
Old Mutual
* Taxed: five percent (five percent in March 2009).
* Untaxed: 6.2 percent (6.2 percent in March 2009).
Sanlam
* Taxed: 7.25 percent (3.5 percent in March 2009, but increased to six percent in September 2009).
* Untaxed: 8.75 percent (five percent in March 2009, but increased to 7.5 percent in September 2009).
4. Market value adjusters (MVAs)
An MVA is normally applied to investors who want to disinvest before the maturity date. (MVAs are not applied to maturing investments.) As a rough rule of thumb, an MVA is likely to be equal to the difference between the portfolio value and the actual, lower value of the underlying assets.
An MVA is used to stop astute investors taking advantage when they know or suspect that the guaranteed value of their investment is greater than their share of the underlying value of the portfolio. This is known as anti-selection.
In crude terms, it works like this: Say your guaranteed value is R100, but the underlying assets are worth only R80. If you cash in your investment and then buy exactly the same assets elsewhere, you are receiving an effective discount of 20 percent, or you are making a return of 20 percent.
Life assurance companies apply MVAs to stop policyholders taking advantage when they know or suspect that the guaranteed value of their investment is greater than their share of the underlying value of the portfolio, to the detriment of remaining investors in the portfolio.
Metropolitan. There are currently no MVAs being applied to any of the retail product lines.
Old Mutual. There are currently no MVAs on any of Old Mutual's retail smoothed funds. This time last year, there was an MVA of five percent on all retail smoothed products.
Sanlam. Currently no MVAs. The MVA for the Stable Bonus Fund at the end of February 2009 was eight percent.
5. Closed portfolios
One of the problems for people who make new investments in a smoothed/stable bonus fund when there is a negative situation in the investment portfolio is that they lose money immediately on entering the fund.
In simple terms, say the actual value of the portfolio is 10 percent below the guaranteed value and you invest a lump sum of R10 000. The value of your investment will immediately drop to R9 000. However, if you had invested in a market-linked portfolio, your R10 000 would buy R10 000 in value. (I am excluding costs in the example.)
When a portfolio is in positive territory at maturity, you do not receive a top-up for the difference. So when life companies' existing products go solidly negative and they perceive that the negative position may last a while, they open new products. This ensures you start off with proper value.
Currently, the position is:
Metropolitan. No line of business was closed to new business in 2009, nor was any new bonus series opened in 2009 as a result of the market turmoil. Metropolitan monitored the situation closely throughout the year, but funding levels never dropped to such an extent for any sustained period to warrant such a step.
Old Mutual. None of Old Mutual's retail smoothed bonus funds was closed to new business in 2009, because its "smoothing accounts have not been at the levels where we feel this is necessary", Andrew Ruddle, Old Mutual investment product manager, says.
Sanlam. The Stable Bonus Fund, which was closed to one-off payments this time last year, has been opened again for all payments.
  
 
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