We have published a fair amount recently about the fiasco surrounding the charging of commissions/fees in the medical schemes and life assurance industries.
One of the reasons for highlighting this issue is to underline that you need to know what you are paying in commissions/fees - or rather, what financial services companies are charging you on behalf of the people they use to sell you products and services.
There is nothing wrong with charging for services, but the following must be taken into account:
* The commissions or fees should be reasonable. If they are excessive, they will undermine the potential to receive a proper return on an investment or force contri-butions to medical schemes even higher;
* Commissions should be in return for proper services actually provided;
* They should be fully disclosed in an understandable manner; and
* They should be legal.
The main reason why commissions should be properly disclosed is that high commissions could be an incentive for products to be sold on the basis of the commissions paid rather than what is in your interest.
The issue of commissions is not limited to life assurers or medical schemes. It seems commissions are also becoming unreasonable in the group retirement fund industry.
And the pension funds of small companies with defined contribution pension or provident funds are particularly affected by unreasonably high commissions.
I recently met with Cape Town-based Derek Smorenburg, the managing director of TCS pension administration services. TCS is one of the larger administrators of smaller pension funds in South Africa.
Smorenburg says the commissions being paid in the group retirement fund industry are horrendous and should be investigated by the Financial Services Board (FSB). To make matters worse, these commissions are not voluntarily disclosed to fund members - and, it seems, very seldom to employers who sponsor the funds.
This does not mean that you, a fund member, or an employer-sponsor cannot obtain the information. Both members and employers are entitled to ask the trustees of their fund for full details (preferably in writing) of costs and commissions/fees. You can complain to either the FSB or the Adjudicator for Pension Funds if you do not receive the information.
Apparently, the current commission scales being paid by most life assurance companies for retirement fund business are:
* 7.5 percent for the first R126 500 annual premium income;
* Five percent of the next R92 000;
* Three percent of the next R253 000;
* Two percent of the next R908 500; and
* One percent for any further amounts.
Then to rub in salt in the wound, the financial adviser is paid an additional amount up to R5 000 for introducing members to the fund. Commissions of this nature are quite reasonable in a defined benefit fund, where a great deal of work is required by the financial adviser.
But they are not reasonable in the case of defined contribution funds, which make up the majority of funds in South Africa today.
In most cases, it seems the adviser does very little for this money. Often, the advice provided by the assurance company comes from specialist employee benefit consultants, working mainly for the life assurance companies. They do all the work for the financial adviser who gets paid the commission for minimal effort.
When you add administration and investment costs, you end up with a very unhealthy scenario for what for many people is their single biggest investment.
Smorenburg says these commissions are paid irrespective of whether the original introducer provides any follow-up services.
He says the issue is compounded by the fact that only about five percent of financial advisers selling group retirement products are properly qualified to do so.
It is all very well to criticise, but Smorenburg also has solutions.
Firstly, he says it is wrong for administration fees to be based on a percentage of contributions. Smorenburg charges on a flat fee basis, according to the number of members in a fund. Secondly, he pays financial advisers 30 percent of the administration fee his company charges members. This fee is about 30 percent of the legislated commission scales.
Thirdly, he only allows financial advisers who have proper skills to act on behalf of his company and he expects them to service the client. Together with Sanlam, he has gone one step further by compiling a training course to ensure that advisers are proficient and able to add real value for clients. Of the 150 financial advisers who have applied for the training course, 26 have already passed with flying colours.
Fourthly, he provides an internet service to financial advisers and fund members to give them access to the information they require.
But Smorenburg says that not many financial advisers convey his views to small companies with retirement funds, because the advisers will have to be better skilled, put in a bit more work and will be paid less.
The other problems in the industry he identifies are:
* Many life assurers are closing their administration services because they are uneconomical to operate, or they are raising costs to unaffordable levels;
* An ever-increasing number of group retirement funds, especially those of small companies are no longer healthy and the costs of commissions, increased administration fees and increasing group risk cover costs as a result of the HIV/Aids epidemic, are impacting negatively;
* There is no incentive for financial advisers to seek out competitive death and disability assurance rates or income protection schemes, because their commissions are based on a percentage of the premiums paid; and
* Instead of putting employer groups into cost-effective retirement funds, many financial advisers sell individual retirement annuities because they are paid upfront commissions for doing so.
One of the side-effects of this is that when a fund member leaves a company's employ and cannot continue to pay the premiums, the retirement annuity policy either lapses - with the member receiving nothing back - or it loses considerable value.
It is in the interests of fund members to get an array of quotes for a retirement fund and group-risk assurance and find out the costs, including commissions, involved. The more you pay out in costs, the less (and it can be substantial over the long term) you will receive as a pension when you retire.
CLIENTS SHOULD PAY BROKERS DIRECTLY
Commissions paid to financial advisers and brokers should be banned, Anthony Asher, the head of the actuarial department at Wits University of the Witwatersrand, has said.
Addressing the annual conference of the Institute of Retirement Funds, Asher said clients should pay fees directly to financial advisers.
He said there is a conflict of interest between giving "advice" and receiving payment from a third party on whose behalf one is selling a product.
"You cannot be giving advice in the best interests of the client if you are acting on behalf of a third party," he said.
Asher said the way in which commissions are paid and structured was clearly bedevilling the life assurance industry.
Thirty percent of policies have lapsed and financial advisers are selling life assurance products in the interest of the life companies rather than those of consumers.
A policy lapses when premiums are not paid.
When a policy lapses, you lose a lot of the money you have invested because all costs, including commissions, are deducted upfront.
The costs and commissions can absorb premiums for up to the first 18 months of the life of a life assurance contract.