March 31, 2010
By Bruce Cameron and Laura du Preez
A decade ago, consumers were at the mercy of unscrupulous scamsters offering dodgy investment schemes and financial services providers with a take-it-or-leave-it attitude. Since then, a plethora of legislation and a new approach to doing business have made the financial services arena a lot more consumer-friendly. We toast 10 of the most important developments since 1999.
This edition marks the 10th anniversary of Personal Finance magazine. Over the past 10 years, a number of important milestones in the financial services arena have given consumers a lot more peace of mind and have improved the financial position of many of our readers. This article has a dual purpose: to celebrate our first 10 years and to remind you of some of the beneficial changes and extra protection you now enjoy.
But a word of warning: this extra protection does not mean that you can rest on your laurels. There are still people out there who will try to take advantage of you and who will willingly break the law when doing so. However, your hand has been strengthened considerably over the past 10 years, both by legislation and by a consumer revolution that has forced the providers of financial services and products to offer you better choices.
1. FAIS Act
Until 2002, one of the most serious regulatory voids in the financial services industry concerned the advice and marketing of financial products. Time and again, innocent and gullible investors were conned out of their money by smooth-talking product providers and salespeople who left a trail of misery in their wake.
This misery was not limited to scams such as Masterbond, following which about 14 elderly people who had lost everything committed suicide. The formal industry also inflicted its share of suffering on consumers by selling products that were based almost entirely on the commissions and other incentives the industry could pay its aggressive product-floggers, rather than on what was in your best interests.
The scams and unacceptable practices led to a public outcry. One of the results of the Masterbond debacle was the appointment of the Nel Commission of Inquiry, which identified many of the shortcomings in the legislation designed to protect consumers of financial products.
The result was the drafting of the Financial Advisory and Intermediary Services (FAIS) Act, which was signed into law in November 2002.
In a nutshell, the FAIS Act requires financial services providers (FSPs) to give you appropriate, honest and fair advice that is in your best interests. And they must do so with due skill, care and diligence.
The Act has not been fully implemented yet; the qualification prerequisites for people who sell you financial services products under the "fit and proper" requirements still have to be ratcheted up.
The "fit and proper" requirements, which are the key part of FAIS Act, were published in the Government Gazette in September 2003. The requirements stipulate the conditions a company or person must meet in order to be licensed to sell you financial products or give you financial advice.
The requirements provide for licences for different categories of FSPs and sub-categories of financial products. For example, a person who sells and gives advice only on short-term insurance has a different licence from a person licensed to sell investment products. However, all FSPs have to meet standards of integrity and honesty.
The other key aspect of the implementation of the FAIS Act was the appointment in July 2003 of Charles Pillai as the first Ombud for Financial Services Providers. The ombud has the power to deal with all complaints that fall under the FAIS Act, excluding those about investment performance where there are no guarantees, or where there is no presumption of misrepresentation, negligence or maladministration. Importantly, the ombud is able to order compensation where he feels a consumer has been prejudiced financially.
In serious cases, the Financial Services Board (FSB) can withdraw the licence of an offending adviser.
In March 2004, thousands of financial intermediaries who did not have the minimum prerequisite qualifications sat for the Insurance Sector and Training Authority assessments to determine whether they had sufficient knowledge to obtain a licence to practise under the FAIS Act.
The appalling state of the industry was revealed when the examining authorities had to reduce the initial planned pass mark of 75 percent to 50 percent. And even then, 20 percent of those who wrote the assessments failed.
Three members of the staff of Personal Finance wrote the assessments, even though they were under no obligation to do so. All three obtained distinctions. One staff member obtained the top mark in the country and was the only candidate to score more than 90 percent in the most difficult section, Long Term Insurance Sub-category C.
Since 2004, the FSB has imposed ever-higher qualification hurdles to improve the level of advice you receive. In October last year, the "fit and proper" standards were amended to require FSPs, from 2010, to write regulatory examinations and comply with continuous professional development requirements to improve the standard of advice.
Since October 2004, the FAIS Act has required the licensing of all financial advisers. There are currently 14 818 licensed FSPs, with about 130 000 representatives operating under their licences. A total of 1 683 licence applications have been rejected and a further 160 have been withdrawn.
October 2004 marked the date from which the Office of the Ombud for Financial Services Providers could hear complaints, which are limited to any advice given or any product sold from this date.
In July 2005, the ombud issued his first ruling, which was against Nedbank and its insurance brokers for contravening the FAIS Act by insisting that a home loan client insure her property with the bank’s associated insurance company.
What the Act requires
The seven main requirements of the FAIS Act are:
1. Information about your adviser. Within 30 days of your appointing an adviser, he or she must provide you with full details about him- or herself. Importantly, your adviser must tell you which financial services he or she is licensed to provide and which products he or she is allowed to sell. Your adviser must tell you whether he or she has professional indemnity or fidelity insurance, in case you want to sue your adviser.
The information you must be given includes the details of your adviser’s registration under the FAIS Act. In terms of the Act, any person or organisation that provides you with financial services is called an FSP, while anyone who acts on behalf of an FSP is called an FSP representative.
An FSP must provide you with his or her licence number. An FSP representative must provide you with confirmation, certified by the FSP, that a service contract or other mandate to represent the FSP exists and that the FSP accepts responsibility for the activities the representative performs in terms of the mandate.
You can check with the FSB whether your adviser is licensed by going to www.fsb.co.za and then clicking on the "FAIS" link.
2. Your financial status. Before he or she gives you any advice, your adviser must obtain from you as much information about your financial situation, your experience with financial products and your financial objectives as is necessary for him or her to provide you with appropriate advice. This information includes your assets and debts, your income and expenses, your obligations to your dependants, your life and disability assurance, and your financial goals, such as the education of your children or a financially secure retirement.
3. A suitability analysis (financial needs analysis). Based on the information obtained from you, your adviser must analyse your financial situation before identifying the financial products that are appropriate to your risk profile and financial needs.
If you do not provide your adviser with sufficient information, he or she cannot conduct a proper analysis. If he or she is unable to carry out a proper analysis for any reason, your adviser must ensure that you "clearly understand" that a full analysis was not done, and, as a result, there may be limitations on the appropriateness of the advice you have been given.
4. Factually correct and understandable advice. To enable you to make an informed decision about any transaction, all the advice and information your adviser gives you must be factually correct, adequate, timeous, comprehensive, appropriate and provided in plain language that is not misleading.
When your adviser gives you advice about a pro-duct, he or she must inform you of all the benefits, risks, costs, consequences and implications of buying that product, as well as your responsibilities. You must also be provided with details of your cooling-off rights, which give you an opportunity to change your mind when buying a financial product.
Your adviser is not allowed to ask you to sign any written or printed form or document unless all the required details have been completed.
You must also be properly informed about the consequences of replacing a financial product. A major problem in the financial services industry is the way many unscrupulous advisers advise people unnecessarily to replace one product with another to generate a new round of commissions for themselves.
5. Product providers. When you buy a financial product, your adviser must, within 30 days, provide you, in writing, with full details of the product provider and his or her relationship with the provider. Among other things, this is to ensure that the adviser does not "push" the product of a favoured provider.
6. Payment. Your adviser must disclose the details of all earnings, including any potential earnings, he or she receives directly or indirectly for giving you advice or selling you a financial product that might lead to a conflict of interest.
7. Record of advice. Your adviser must keep a record of all the advice he or she gives you; all the information and material on which the advice was based; the financial products that were considered; the products that he or she recommended; and an explanation of why the products that were selected are likely to satisfy your needs and objectives. You must be provided with a copy of the record of advice.
2. Statement of intent
In December 2005, then Finance Minister Trevor Manuel announced that life assurance companies had agreed to pay back about R3 billion to holders of retirement annuities (RAs) and other life assurance products on whom confiscatory surrender penalties had been levied when they stopped or reduced their premiums. This payback was announced in what is known as the statement of intent signed by the life industry and Manuel.
In effect, under pressure from Manuel, the life industry agreed to the pay-back as an admission-of-guilt fine for the many years they had been ripping off policyholders, making you pay the penalty for often inappropriate products that had been widely mis-sold by perversely incentivised product-floggers.
The life assurance companies based their penalties on undisclosed loans, on which they charged you an undisclosed rate of interest, to cover all their costs and presumed profit for the life of the policy, including the upfront commissions paid to their product-floggers. This loan was paid off gradually over the life of the policy.
However, if you altered your premiums or withdrew your money before the contractual maturity date of the policy, the life companies would deduct the outstanding amount of the loan from your accumulated savings. The deduction could result in your losing all your savings in the first few years of the product and substantial amounts in later years.
The life companies did not take into account any changes in your personal circumstances, such as acute illness or the loss of your job, that resulted in you stopping or reducing your premiums, or cashing in your investment.
The FSB estimated that in 2003 life assurance policyholders lost R1.84 billion by allowing their policies to lapse (where they received nothing in return) and unquantifiable billions more by surrendering their policies early.
The statement of intent set the maximum surrender penalties that life assurance companies can charge at 30 percent on an RA policy and 40 percent on an endowment policy where a policyholder reduced or did not maintain his or her payments, or cashed in a policy prior to the maturity date.
The maximum penalty has now been reduced to 15 percent on any RA or endowment policy sold after January 1, 2009.
Manuel’s intervention followed public anger that had been growing for years over the abuses in the retirement industry. Matters came to a head when:
Independent actuary Rob Rusconi revealed that retirement products sold by South Africa’s life assurance companies were among the most expensive in the world; and
Determinations from the then Pension Funds Adjudicator, Vuyani Ngalwana, set aside the confiscatory penalties. In March 2005, Ngalwana issued his first ruling against an RA fund that imposed a surrender penalty that was not provided for in the rules of the fund. Liberty Life had confiscated about R32 000, in the form of a surrender penalty, from Carlos de Souza after De Souza stopped paying his premiums when he was unemployed. This ruling was the first of 82 similar rulings.
The life assurance industry successfully challenged Ngalwana’s determinations in the High Court, but, as a result of Manuel’s intervention, it was a pyrrhic victory. The life assurance industry won a battle, but it lost the war.
Another spin-off of Manuel’s intervention has been the phasing out of the perverse commission structures on which the life assurance industry based its widespread mis-selling. Traditional life assurance commissions were calculated as the size of the premium multiplied by the number years of the contract multiplied by a percentage. Seventy-five percent of the commission was paid out in the first year of the contract and the balance in the second year.
The consequences of this was that unscrupulous product-floggers – with the life companies turning a blind eye – would encourage you to cancel your existing policy (thereby incurring penalties) and replace it. This would happen some time after the two years in which the commission was paid, so that salespeople could generate a new round of commissions.
Regulations that took effect from January 1, 2009 introduced a new commission structure that limits the commission that may be paid upfront to 50 percent, with the balance paid over five years.
Policyholders can also cancel the ongoing commission payment or change the adviser to whom the ongoing commission is paid. The intention is to force financial advisers to give you better ongoing service.
3. Retirement reform
Retirement reform has been on the government’s agenda since 1994. However, certain developments gave added impetus to the government’s resolve to reform the country’s retirement-funding system. They included Rusconi’s research, Ngalwana’s controversial rulings, excessive charges and unacceptable practices, such as the bulking of the bank accounts of retirement funds by retirement fund administrators to make secret profits.
Retirement reform is not a single event but a dual-stream programme, with urgently required reforms being implemented on an ad hoc basis while a total overhaul of the Pension Funds Act and the social security system is under way.
Significant stepping stones in the reform process have been:
The 2002 report of the Taylor committee of inquiry into a comprehensive system of social security following a growing campaign for the introduction of a basic income grant to address the needs of the estimated 22 million people who live in poverty.
The 1996 interim report of the Katz commission on tax restructuring, which led to the government introducing a tax on retirement funds, during the build-up (contribution) phase, at a rate of 17 percent on all interest, net rental and foreign dividend income. The rate was increased to 25 percent in 1998.
The tax had a significant impact on retirement savings, and, as a result of pressure, the government gradually reduced the tax to nine percent before scrapping it in 2007.
Simultaneously, the government has simplified the taxation of lump sums taken at retirement and as early withdrawals from retirement funds.
The requirement, since 1998, that 50 percent of boards of trustees are elected by fund members.
The opening of foreign investment to retirement funds. Funds are now allowed to invest up to 20 percent of their assets offshore.
The removal of differences based on race in the payment of the Social Old Age Grant (SOAG); the equalisation, to 60, of the age at which both men and women can receive the SOAG; increasing the grant year after year; and making it easier for people to access the SOAG by relaxing the means test on wealth and income.
The introduction of the "clean-break principle" at divorce. This gives non-member former spouses immediate access to any court-endorsed division of a fund member’s retirement savings, either in cash or by transferring the money to a new fund.
The establishment of beneficiary funds, subject to the provisions of the Pension Funds Act, to protect the death benefits due to widows and orphans. This measure was introduced after Fidentia plundered R2 billion in benefits due to widows and orphans that were held on their behalf in the Living Hands Umbrella Trust.
The lifting of the requirement that you must mature a retirement annuity (RA) and purchase a pension with at least two-thirds of the amount before the age of 70. Now you can decide at what age, after age 55, you wish to take a pension from an RA.
The right of RA fund members to transfer their retirement savings from one product provider to another. This flexibility was introduced to increase competition between product providers, thereby reducing their historically excessive costs.
The limiting of surrender penalties and changing the commission structures to prevent the mis-selling of life assurance RAs.
The reform process is being driven by the government’s Inter-Departmental Task Team on Social Security and Retirement Reform, which reports to an inter-ministerial committee.
The appointment of the committees followed the release in December 2004 of a National Treasury discussion paper on retirement reform. The appointment of the committees changed the reform process from looking just at overhauling the contributory retirement-funding and pension system to widening the social security net – and it could stretch as far as creating national health insurance.
The main thrust of the narrower retirement reform process is to ensure that all people of retirement age have access to a liveable and sustainable income until death. The government also wants to ensure that the maximum number of people who can afford to save for their retirement do so and that retirement savings are preserved for retirement.
To achieve these objectives, the current reform recommendations include:
A national social security fund (NSSF), which will aim at providing a basic pension equal to about five times that of the SOAG (currently R1 010 a month) or at least 40 percent of final salary. Contributions to the NSSF will be compulsory for all employed South Africans who earn above a prescribed minimum amount.
A second, voluntary level of retirement savings, which may be tax-incentivised up to predetermined rand amounts.
The merging of pension and provident funds to ensure that the bulk of all retirement savings is used to purchase a pension for life.
The mandatory preservation of savings until retirement, with withdrawal permitted only in a crisis, such as medium- to long-term unemployment.
The establishment of a single risk assurance vehicle to provide a minimum level of income for anyone who is disabled prior to retirement age or for their dependants in the event of a breadwinner’s death.
The creation of this vehicle could entail the merger of the Unemployment Insurance Fund, various compensation funds – including the Workman’s Compensation Fund, the Guardian’s Fund and the Road Accident Fund – and the South African Social Security Agency.
The introduction of measures to halt the ongoing exploitation of retirement funds by private sector service providers and to improve the standard of fund administration.
A stricter basis for approving the registration of retirement funds. Among other things, this measure aims to limit the total number of retirement funds to make them more cost-effective.
The bringing of all retirement funds, including government-sponsored funds, under a single regulatory framework.
Restrictions on individual investment choice, as well as on the underlying investments made by asset managers, to reduce investment risk.
4. Retirement fund surplus distribution
In the 1980s and 1990s there was a major move by employers from defined benefit retirement funds to defined contribution funds.
Initially, the move was driven by the trade union movement, whose members wanted to control their money, while the unions saw the control of retirement funds as a foundation stone to improving their muscle in the dying days of apartheid.
Employers resisted the move at first, but they quickly realised that the shift to defined contribution funds could be to their advantage, because, unlike the case with defined benefit funds, they would no longer have to carry the risk of ensuring that their employees were provided with a predetermined pension for life. This risk could be transferred to their employees (the fund members).
And some smarter employers realised that their funds had large surpluses, which they eyed as a useful fillip for their balance sheets.
A surplus of a defined benefit fund is the difference between the assets and the assumed liabilities of the fund. The liabilities are the moneys that would be payable to members who left the fund before retirement and the pensions that would have to be paid for life to members who retire from the fund. If the assets exceed the liabilities, the fund is in surplus.
Surpluses arose as a result of a number of factors:
Over-cautious valuations of funds, with actuaries under-estimating the value of assets and/or over-estimating the cost of future liabilities.
Better-than-anticipated investment returns.
Excess contributions by fund members and/or employers.
Poor or no increases for pensioners. Many funds had a policy of increasing pension benefits by a percentage of inflation, without taking into account actual investment returns. This increased the asset holdings of many funds, while gradually impoverishing the pensioners.
Poor withdrawal benefits. Many funds paid members only their actual contributions plus nominal interest if they left the fund before retirement. Employer contributions and the real investment returns were retained in the fund.
Even when departing members were paid their actuarial values, the calculations of actuarial value were not the same as the market value.
An actuarial value is the calculation of the assets held in a fund to pay a future pension of a member. The actuarial value is seldom the actual market value of the contributions made plus investment returns.
When people join a retirement fund at a young age, the value of their contributions will exceed the actuarial value. The reason is that very few members are expected to remain as members until retirement. Actuarial values are calculated on a curve that moves sharply upwards the closer a member is to retirement.
At worst, where members transferred from defined benefit to defined contribution funds, they received only their own contributions (not their employer’s share) plus nominal interest. At best, they received their actuarial value and not the market value of the assets. This, in turn, created larger surpluses in those defined benefit funds that remained in existence.
Employers could not simply remove the surplus money from the retirement funds. But there were ways, both legal (at the time) and illegal, in which they could get their hands on the surpluses. Many such methods were conceived by retirement fund administrators that were serving the best interests of the employers rather than fulfilling their fiduciary duty to the funds and their members. The methods ranged from closing down funds to removing money from funds fraudulently.
The main way to strip surpluses was devised by one Peter Ghavalas, who worked for a Nedbank subsidiary. This year, Ghavalas pleaded guilty to fraud charges for designing and assisting with surplus-stripping schemes. Two employers, Rowland Bailey, of Mitchell Cotts, and Jan Picard Junior, the chairman of the Picardi Group, have also pleaded guilty to criminal offences in plea bargains to avoid jail terms. Others, including a number of administrators, are still facing criminal charges for their part in the stripping and laundering of surpluses.
Legal methods of soaking up the surpluses included employers taking contribution holidays and executive pension top-up schemes.
Many surplus-stripping schemes were hatched when employers totally controlled retirement funds, because the requirement that members elect 50 percent of the boards of trustees was implemented only in 1998. When this change came about, the member-elected trustees of affected funds quickly realised they were being fleeced by their employers.
Fund members, in particular those who belonged to trade unions, started to agitate about the surpluses, and the newly elected African National Congress government took note. In a number of cases, court action was taken against employers to prevent the withdrawal of surpluses.
In 2001, Parliament approved amendments to the Pension Funds Act to allow for the more equitable distribution of surpluses, including giving former members and pensioners a claim to any surplus.
It was estimated at the time that retirement funds held about R80 billion in excess assets. This figure now seems to have been exaggerated.
To date, the Registrar of Pension Funds has considered 1 393 surplus-apportionment schemes involving a total of R18.9 billion, of which R17.1 billion has been approved for distribution. Some 18 000 funds have declared that they have no surplus to distribute. It was estimated that by the end of May this year some 500 funds had yet to submit surplus distribution proposals to the FSB.
Two key elements of the legislation on pension surpluses are:
Employers who "improperly" used surpluses must repay the money, even though the improper use may not have been illegal at the time; and
A pecking order must be applied to the distribution of any surplus.
A fund must investigate any possible improper use of a surplus by a participating employer going back to January 1, 1980. This is also the date from which any former member of a fund has a claim on a surplus.
The Pension Funds Act defines "impropriety" as the use of a surplus by an employer to pay for the costs of:
Providing improved benefits to selected groups of employees, such as executives;
Additional pensions to selected fund members (including pensioners) in lieu of the employer’s obligation to subsidise the medical scheme contributions of these members;
Pension buy-backs for selected members in excess of any amount paid into the fund by such members for such pensionable service; or
Any contribution holiday taken by an employer.
The first two claimants on any surplus are:
Pensioners who did not receive inflation-linked pension increases dating back to January 1, 1980. These pensioners’ benefits must be topped up to bring them in line with inflation to the present day. Any fund that cannot afford to give its pensioners inflation-related top-ups has to pay as much as it can afford from its investment returns.
Members of a retirement fund who since the cut-off date of January 1, 1980 have received a less-than-fair withdrawal benefit. These members are entitled to a top-up whether they were retrenched or dismissed, or resigned, and then, whether or not they transferred their money to another fund.
After the above two obligations have been met, the trustees of a fund must agree on how to divide any remaining surplus among all the stakeholders, including the employer. The FSB must approve any surplus-distribution scheme.
The portion of a surplus apportioned to an employer can be used for a number of things, including saving a company and jobs if the company is facing bankruptcy, or to prop up a medical scheme for employees of the company.
The distribution of surpluses has not been easy. There have been legal challenges to the legislation, the legislation has been amended, some employers and funds have tried all sorts of tricks to avoid making distributions to former members, and many former members have been unable to prove a claim.
The legislation places the onus of proof on former members to show that they were members of a particular fund. The kind of proof that could satisfy the trustees of the fund includes old IRP5 tax slips, benefit statements or even a payslip.
Very few former members have retained this type of information, and retirement funds and employers are not obliged to keep membership and employment records for longer than five years. This means many thousands of people will lose out on a claim, increasing the share received by other stakeholders, including those who can prove a claim to a surplus.
The surplus legislation gives the FSB the power to appoint tribunals to deal with a distribution if the Registrar of Pension Funds is not satisfied with a proposed distribution scheme or if a fund is tardy in meeting the requirements of the legislation to apportion a surplus.
So far, the FSB has appointed 151 tribunals. The surplus apportionment exercise is expected to be completed by mid-2010, with the exception of Bargaining Council funds, which came into the apportionment net only in January 2008.
For Part 2 of this three-part story see here.
This article was first published in Personal Finance magazine, 3rd Quarter 2009.See what’s in our latest issue
  
 
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