May 15, 2010
 By Bruce Cameron
Recently, both Judge Brian Galgut, the Ombudsman for Long-term Insurance, and Jonathan Dixon, the Financial Services Board's deputy executive in charge of insurance, expressed concern about life assurance savings products that are aimed at the low-income market.
Galgut is especially concerned about the high costs, which are likely to result in negative returns, particularly when the premiums are low and the investment term is a minimum of five years.
Dixon is concerned that people on low incomes often do not have a sustainable income flow and, because they often experience periods of unemployment, are exposed to the penalties that life assurance companies impose on people who do not maintain their premium payments.
He is also concerned that low-income earners are exposed to tax liabilities that they would otherwise not incur if they use, for example, a far more flexible and cheaper unit trust investment.
These are very real concerns and they probably apply to the products of most life assurance companies.
Then along came a report by the FinMark Trust, which found that low-income earners are actually more acutely aware of the need to save than any other segment of the employed population, but their savings goals are short term.
This confirmed earlier FinMark research, done in 2008, that found that lower-income earners "do not save for the long term, because they do not see it as a priority, cannot easily afford to forgo current consumption and prefer to prioritise tangible long-term objectives, like piecemeal housing development and the education of their children ... and they find available products expensive, inflexible and unwieldy".
Unsuitable
Based on this, life assurance savings vehicles simply seem unsuitable for the low-income market.
The main problems are minimum savings period of five years; penalties levied by life companies if premium payments are not maintained; high costs, particularly if premiums are low and the investment period is less than 10 years; product complexity; and tax disadvantages.
In fact, many of these life assurance savings products measure up so badly against the best interests of the target market that they could be regarded as a cynical attempt to exploit the poor, particularly if misleading marketing tactics are used.
Life companies should concentrate on providing good risk assurance products, such as funeral assurance, to the lower-income market and on intervening more strongly in the credit risk market, where furniture retailers in particular sell totally over-priced, exploitative and inappropriate risk assurance products to people who buy goods on credit.
All the main life companies have unit trust divisions. They should put their resources into marketing a unit trust savings product, with greater flexibility and lower costs, instead of the inferior life products.
Lower-income earners with short-term saving horizons will be better off in interest-earning products.
They should consider products such as Capitec Bank's savings accounts, which offer high interest rates on lower savings amounts, or RSA Retail Bonds, which can be bought at the Post Office or Pick n Pay or at www.rsaretailbonds.gov.za. The bonds have maturity periods of two, three or five years and there are inflation-linked bonds.
How Old Mutual's savings product fares under scrutiny
Old Mutual is actively promoting its low-income savings product on the internet, so it seems a good example to pick on to see how it compares with the remarks made by Galgut and Dixon.
It can be assumed that most life assurance savings products aimed at low-income earners would reflect much the same picture as the Old Mutual product to a lesser or greater degree. It also needs to be recorded that Old Mutual fully answered all Personal Finance's questions on the issue but had a list of excuses of why it could not provide comparative figures with its unit trust products.
This is what Personal Finance found:
A five-step online application process requires you to provide a lot of information, from your identity details to your employee number.
You have to progress through all five pages before you reach the terms and conditions, which do not tell you very much.
Old Mutual's marketing material provides the absolute minimum of information, as well as a fair dollop of misleading information, ranging from the tax implications to the costs. Here are some examples, with Old Mutual's response to my concerns about the lack of proper disclosure:
* Old Mutual states in its promotional material that: "Assuming the current tax regime continues, whatever the size of your payout, it's tax-free." In another internet teaser it bluntly states that the product is "tax-exempt". This is totally misleading.
The truth is that income tax is paid on your behalf by the life companies at a rate of 30 percent a year on all interest, net rental and foreign dividend investment returns earned in the portfolio, and CGT is paid at rate of 7.5 percent a year on all the portfolio's capital gains.
This means that anyone on a marginal tax rate of below 30 percent is paying tax they would otherwise not have paid. On top of this, the tax exemptions on interest and foreign dividends, as well as the exemptions on capital gains, do not apply.
Remember, people who are younger than 65 do not pay tax on income below R54 200 a year and they enjoy an exemption of R21 000 a year on interest earnings.
So the likelihood of their paying tax on any other type of low-contribution savings product (for example, a unit trust) is about nil.
The consequence for lower-income earners is needless lower returns.
Asked why it misleads investors on the tax issue, Old Mutual's response is: "This can certainly be expressed more explicitly, but we were focusing on the fact that the customer would not have to pay tax on the proceeds received from the policy, which is correct. We are working to improve the wording of the marketing material."
Old Mutual says that "further" disclosures are contained in an information pack sent to policyholders after they have applied for the product, after which the policyholder can cancel the policy if he or she does not like the terms and conditions.
My comment: why not treat customers fairly and tell the truth upfront about the negative tax implications?
* No mention is made in the terms and conditions contained in the online application and promotional material of the penalties that may be incurred as a result of what are called causal events, such as non-payment of premiums in the first five years.
Old Mutual's response is that the penalties are made explicit in the policy pack sent to policyholders after they have submitted their application, and if they do not like it they have 30 days to cancel the policy.
Why doesn't Old Mutual treat customers fairly by disclosing everything upfront? Or is deceit a major marketing tactic?
* No mention is made of the costs. Old Mutual's response is that the costs are disclosed in the policy pack. And by the way, Old Mutual retains the right to increase the costs and it does so annuallly with all rand-based costs increasing in line with inflation.
In response to Personal Finance's questions, Old Mutual says the charges are 11.5 percent and R9.50 of every premium. In addition, there is an asset-based charge of 1.75 percent, which covers investment and asset management expenses and includes the capital (protection) charge of 0.25 percent. The rand-based charges can be increased broadly in line with inflation.
Costs and returns
Galgut says it is not easy to understand a list of rand and percentage costs. Not even the reduction in yield (RiY) figures provided help very much. The RiY is the percentage by which costs will, on average, reduce your annual returns (See Table A).
Galgut says for policies with larger premiums (R500 plus) and longer maturity periods (10 years plus), the average RiY is about 3.5 percent, which is "still considerably higher than that of some other developed markets", where the average is about two percent in some cases.
The RiY is even worse on the Old Mutual product than the average quoted by Galgut: it is 3.6 percent, even at an escalating premium of R1 000 a month over an investment term of 15 years.
The acid test, however, is to see whether or not investors actually receive any value for their money. Personal Finance asked Old Mutual to reconstruct the returns using the current costs but based on the historical performance of Old Mutual's smoothed bonus portfolio up to December 31 last year.
The figures in the table assume that the rand charges escalate annually at six percent to keep level with inflation. The premiums are assumed to increase at the inflation rates that were experienced over the periods in question. The total charges are given as the sum of all premium charges (percentage and rand-based) and all asset management, investment and capital charges.
If the premiums were not escalated, the rand-based costs as a percentage of the premiums would increase yearly, resulting in poor or negative returns.
Old Mutual says it also considered the returns over 10-year periods to the end of 2008, 2007, 2006, 2005 and 2004, and the returns for the 10 years ended December 2009 (selected by Personal Finance) in Table B were the worst when compared with inflation.
So you could expect to receive positive returns as long as you kept paying your premiums on time for the entire contract period.
The inflation (CPI) column reflects what you would need to get back (your capital and investment returns) just to come out square (the break-even point).
So while you receive real (after-inflation) returns over all the periods and on all premium amounts, they can hardly be described as good. If the costs had been lower and the returns had not been not subject to any taxes, the policyholders would have been far better off.
  
 
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