Breaking some bread with a number of more mature investment advisors and financial journalists the other day, the subject of fee transparency and disclosure within the financial services industry came up.
As a consequence, I thought it best – especially for the benefit of a younger crop of investors and advisors – to take a trip down memory lane to the eighties and nineties when the world of financial advice was dominated by the large insurance behemoths, with Old Mutual, Sanlam and Liberty absolutely ruling the roost.
That was before the days of the Allan Grays, the Coronations and the Investecs and the massive surge in popularity of unit trusts.
Those were also the days when the immense advertising power of the Green, Blue and Grey – as these companies were described – could cause a shaking journalist to be brought before a newspaper editor, recently wined and dined by the PR manager of one of these firms, and hauled over the coals for writing “too much” about unit trusts, as happened to me.
They were the days of the ‘polis- smouse’ when any investment advice was wrapped up into a policy of some kind.
This is how it worked: someone with say R100 per month to invest, either into an endowment or retirement annuity (if there was a tax benefit to be had), would be be steered into a long-term insurance contract, the longer the term of contract the better … better for the advisor and the assurance company concerned, not for the poor investor, that is.
The reason was simple: the cost structure of the policy, which included the advisor’s commission plus the profit of the life assurance company, was determined by a simple formula: a factor (maximum of 85%) of the amount of premium times years of contract up to a certain level. Some of the actuaries of the insurance companies who still remember this could perhaps comment under this article as to how this was done.
The cost of the insurance policy (commission and profit) was ‘loaned’ to every particular policy and every subsequent premium into the policy was first used to repay this loan, plus the interest. Only
after several years would the policy start to acquire a value of any sort.
So any investment contract taken out with a life insurance company in SA started with a deficit equal to the loan on this policy.
The trick in the insurance industry was to extend the term of the policy to its maximum, up to a maximum of 28 years, to generate the maximum cost and commission. This was never stated in any policy document even given to a client, but contained in a master policy document which could be obtained on request. Even then you’d need to be a qualified actuary or serious number cruncher to even remotely understand how it all worked. But you could be sure of one thing: you were being royally screwed by the insurance industry.
Boetie gaan border toe
In fact, I have my own experience with two such 20-year endowments I took out on my first day in the army. I stood in a queue to get my boots, helmet and gun and lo and behold, at the last table in the row was a man representing one of the colours referred to above.
Such was his power of persuasion that I took out a savings policy for which the monthly premium of R22 was more than my army stipend at the time. I had to borrow money from my mother to make the payments, but I did after all, make her my beneficiary. As the advisor said to me: “You are going to fight on the border, boetie, and you might not come back and then who is going to look after your mother?” Sniff, sniff…where do I sign?
Such was my first-time experience with the mighty assurance industry in South Africa. Its marketing and distribution power was unrivalled probably anywhere in the world.
About seven years later, when I needed some cash, I did a quick back-of-an-envelope calculation- and thought, with a bit of growth I could cash in about R2 000. But that was not to be, as the letter I got back, posted from somewhere in the Cape, said: Sorry, this was a 30-year endowment and you still actually owe us money in terms of the loan agreement.
I had no cash in my pocket but was immensely wisened by this experience.
Journey with no end
And thus began a journey which still has no end in sight.
It also reminded of me of the quotation in the book ‘The Sovereign Individual’ by William Rees-Mogg, former editor of The Times which reads: “Those who are ignorant will never know that they are being abused.” Truer words have never been written and that for me summed up the whole investment advice industry in SA as it was in the eighties and nineties.
For a while I used my public plartform as a journalist to try to expose these malpractices being foisted on the investing public. It was also a small baton that I handed over to Bruce Cameron who ran a much greater and durable race than I could ever try to.
So apart from these long-dated endowment and retirement annuity policies (the longer the better) there were also other toxic investment products which were very popular, such as the back-to-back product (a lump sum investment used to purchase a term annuity which gets reinvested into another ten-year endowment policy), the tax-bucket investments (lump sum investment from
which a loan of 90% is taken each year which is then reinvested into another ten-year endowment and so on).
And then you have products such as the ‘revisionary bonus’ portfolio which no one really understood. I once attended a luncheon at a large insurance company where, after this topic came up, I witnessed the actuary and CEO of the said company have a full-blown disagreement about how this product actually works.
All these products, to my view, were created to ensure maximum profits and commissions for all concerned and with the least regard for the individual investor.
Benefits all the same
And then there was the other beauty of the insurance industry: the benefit illustration agreement (BIA). This was simply the crudest cartel-like type of behaviour in any industry in any part of the world.
What this meant was that for any investment product, for illustration purposes, the expected returns over time as well as cost structures were identical. It mattered not where you went to in the assurance industry, they all had (a) the same illustrated performances and (b) the same cost structures, which today we know were both bollocks.
Thankfully, around the turn of the century this practice was seen for what it was and stopped, but only after immense pressure from the media and the public who were wisening up very rapidly.
Many of the historical behaviours and market conduct of the large insurance companies would today land those directors of companies in jail, so bad and toxic they were.
When I discuss these products and other practices (5% upfront commissions on lump-sum investments; new fees on any change in the portfolio; exit penalties etc.) with the youngsters in the practice, they are absolutely gobsmacked that this was allowed to happen.
In a certain sense the insurance industry created such a groundswell of rejection of its practices and products, that it opened the doors for the unit trust industry to explode. Its offer is significantly better in terms of greater transparency in costs, fees and performance.
Happen it did, but thankfully we have a much more transparent and better-regulated industry than a generation before. Much of it is due to the immense power of the internet which has, for want of a better description, democratised the knowledge and workings of investment products.
SA investors today have total transparency on fees, costs and rebates. All to the better.
Written by Magnus Heystek