A blame-game is starting with complaints about overpaid financial advisers and expensive product options. Readers have provided numerous examples of high-cost investment products sold by advisers working for large insurance firms.

Clients are angry about high fees and poor performance, as well as being forced to pay surrender penalties when they try to switch out of these expensive products.

While the market was booming, fees were largely ignored, because returns were sufficient for above-inflation performance to be achieved even after fees had been paid.

After the credit crisis in 2008, market returns became more volatile, and between 2016 and 2019, performance was decidedly lacklustre. Fund managers have warned that we should get used to lower market returns.

If the cost of your investment is 3% per year, but you are getting 15% per year in returns, a net return of 12% is tolerable.

But when average returns fall to between 8% and 10%, that 3% fee now consumes a third of your return, dropping it to 5%-7% per year. So it’s not surprising that investors feel they are better off cashing in and paying off debt.

We spoke to three life insurance companies, namely Liberty, Old Mutual and Momentum, to explain the statements from their unhappy customers.

There are several layers of costs and these are distributed differently between different service providers and products, but there are at least three sets of fees: advice fee, platform/product fee and the fund fee.

The cost of advice

Insurers have a complex charging mechanism which differs depending on the company and the product, so this is just an illustration.

The adviser is renumerated on the basis of a commission, which is a percentage of each contribution. The maximum allowed is 5% (5.75% with VAT) per premium. The adviser/customer can elect for 50% of this to be paid upfront and the balance in as-and-when premiums.

In an example provided by Old Mutual, if the adviser sells a 20-year retirement annuity with a R1 000 monthly contribution, the adviser receives R3 551 upfront and R25 for each premium collected.

The administrator pays the adviser this amount upfront, and the aount is then recouped each month from the investment for the first five years (in most cases). After five years, the upfront commission is fully paid and only the R25 per month as-and-when commission is deducted as the adviser’s fee.

This is why the “effective annual cost” (EAC) generally drops after this period. The EAC is a way for an investor to understand the impact that fees have over the period of the investment.

It becomes more complicated when escalations are added in. Each year that the client increases their contribution, the adviser receives a portion of the commission on the increase paid upfront. So, even after five years, a surrender value can be applied if you cancel your premium before the term of the investment is over.

Henk Appelo, Liberty Investment product developer, says it is about how a customer chooses to pay for advice.

“If you would like to get professional help you can choose to pay either out of your pocket or from the investment. The commission paid to the adviser upfront is payment for the work to set it up but also to help review the investment regularly.”

Appelo says few independent fee-based advisers would open a retirement annuity for a client for R500 a month as it would take years to cover the cost of their time. By paying 50% of the commission upfront, the adviser is paid for their time but has the incentive to continue to service the client to receive the ongoing as-and-when fee.

However, for larger investments, commission can be lucrative. This was especially true when it came to ‘older-generation’ products where the full commission was paid upfront, and the company charged interest to the investor for funding this commission.

Prior to 2008, Toby took out a Momentum retirement annuity with a 10% annual escalation. His adviser received full upfront commission plus a booster from Toby’s 10% annual escalation.

Over the period Toby has paid the adviser R95 000 commission and R59 000 in interest to Momentum. Momentum has recouped R123 000 through deductions, however, an amount of R32 000 is still to be deducted as the investment has several years to go to maturity.

The question Toby is asking is whether the advice he received from an adviser he had not spoken to for several years was worth R95 000, or R11 000 a year plus the interest charged.

Werner du Plessis, product specialist at Momentum argues that Toby was better off being able to invest the full contributions and paying off the advice fee over time even if he was charged 10% interest.

Fund choice matters

While the debate focuses on commission, it is not the biggest cost to the investor.

Another reader, Snyman, told us that the effective annual cost (EAC) to date on his Liberty Retirement Annuity Builder is 4.1% per annum. Even over the full 20-year period, his EAC would be a massive 3.9% per annum. Yet advice only made up 0.4% of that total cost. There was an administration cost of 1.8% and fund fees of 1.5%.

Depending on the product structure, administration costs can include product and service fees and are also recouped over a period, affecting the surrender value if you make the investment paid up or transfer to another provider.

In all the cases we looked at where the total EAC was above 2.5%, it was the choice of the underlying fund that drove up the costs.

Many of these investors had selected to have a guaranteed fund. Guaranteed funds are expensive and often unnecessary for longer-term investments.

Elaine complained about her fees in an Old Mutual Max Investment she was using as an education fund. Since 2013 she had paid an average of 5% per annum which included an asset management fee of 1.85% for the guaranteed smooth bonus fund. Considering that the fund had only delivered a return of 5.3% over the last five years, Elaine is understandably very unhappy with her outcomes. Elaine could have selected the Old Mutual Equity Tracker with costs as low as 0.35%. In Snyman’s case, he could move to the Liberty Balanced Equity Tracker fund and reduce his investment fund costs significantly to 0.75%.

The longer you hold, the lower the cost

The effective annual cost decreases the longer you hold the investment. In most cases the first five years show an extremely high EAC – in some cases as much as 9.5% per annum. This is the effect of the upfront commission being deducted.

For example, according to Momentum, the effective annual cost of advice on a R1 000 retirement annuity escalating at 10% per annum, would be 2.45% over the first five years but only 0.59% over the full 20-year period, as the effect of the upfront costs is diluted over time.

This is also affected by the value of the fund relative to the fees. As the fund value increases, so the fees as a percentage decrease.

Marius Pretorius, head of marketing retail sales at Old Mutual, explains that Elaine’s EAC drops from 5% to 2.6% if she keeps the investment for the full agreed 12 years.

This structure, however, negatively impacts short-term or low-value premium products.

Lesang’s employer opened an investment of R300 a month into Momentum’s Investo platform escalating at 10% per annum. After nine years of investing a total of R46 700, the fund had returned R12 000 of which R5 347 went to fees, leaving Lesang with only a growth of R5 316 – a return of less than 2% per annum.

Werner du Plessis, product specialist at Momentum, explains that on a low-contribution investment, the flat admin fee of R15 per month has a significant impact. As the contribution was R300, the R15 represented a 5% fee.

In the first five years her effective annual cost would have been 9.5% if she terminated at that time. As these products penalise small investors, Momentum has introduced new products where the admin fee is phased in over time.

This reduces the costs in year five to 7.37%, however the total EAC over the nine-year period would still be 4.4%. Her investment would need to deliver 9% just to keep up with inflation.

In conclusion

The fee debate is a complex one. Positive changes have been made since 2008, including the limitation of upfront commission and the removal of interest charges on new-generation products, but if investors are to meet their retirement outcomes, costs must come down further.

• Over time advice fees earned on insurance-backed products are not out of line with independent advisers, they are just structured differently. More options should be available, such as paying a per-hour fee, or the first few premiums going to pay for advice. Product houses are now reflecting the rand value of the fees earned by the adviser. This is an important step ‒ customers should know the rand cost of the advice and be empowered to negotiate. Would Toby have been prepared to pay the adviser R95 000?
• The cost of the underlying investment and platform matters. Advisers need to pay more attention to providing cost-effective solutions and encouraging existing clients to switch to these. However, this also assumes that product providers do not have targets for their tied agents in terms of selling specific products.
• If investors are unhappy with their investment, they need to look at the effective annual cost to maturity and the underlying performance of the fund. In some cases, the performance of the investments were well below the market, leading to poor outcomes. Simply switching to a tracker fund within the platform could be a cost-effective solution without paying surrender penalties.
• Advisers need to be honest with investors who are looking to invest over a short timeframe. Given the costs of products and advice, for most people who want to invest R500 per month for five years or less, a high-interest bank account (such as African Bank’s TFSA, paying 6% p.a) may be the best option. Alternatively, investors should look at investing in low-cost index-tracking products via cheap platforms such as Satrix or EasyEquities, without using the services of an adviser.

Upfront or ongoing?

Commission paid for policy-backed investments are not necessarily higher than for investment-backed products sold by independent advisers.

Policy-backed investments pay a commission of 5% on the upfront monthly premium and no trailer fee. Investment-linked products tend to pay annual trailer fees of between 0.25% to 1% of the value of the investment and can include an upfront fee of up to 3%.

In figures provided by Liberty, over 25 years, based on a R500 monthly contribution increasing by 10% per annum, a 5% commission per contribution would come to R16 730 of which R9 888 is paid upfront. In comparison, a 0.5% fee on the annual value of the investment (assuming a growth rate of 6% per annum) would be similar at R16 760. If the adviser also took the upfront 3% allowed, that would bring the total fee to R34 917.

Advice fees or commission?

For an independent financial adviser investing a client into a unit trust retirement annuity, there are several ways to bill.

The adviser may charge an upfront fee to cover the cost of the advice either as an hourly rate or a percentage of the investment amount. If the adviser charged a fee based on the contribution, this could be as high as 3% upfront and an annual trail fee of 0.25% to 1% on the value of the fund, depending on what is agreed with the customer.

Independent financial planner Gregg Sneddon says a client can opt to pay an upfront planning fee at a rate of R1 800 an hour. “It usually would not take more than an hour to set up an RA, but does not include financial planning. There would be no initial or ongoing advice fees – just platform and fund fees.”

Sneddon says they use passive investments to keep costs low. For a R500 monthly contribution, the total investment cost is around 1% a year. Keep in mind that this does not include ongoing advice. If you wish to get further advice you would pay R1 800 for an hour.

If the adviser charged an upfront commission of 3% plus a 0.5% annual fee, that would be R200 in the first year. By year 10 you would pay R984 and in year 20 R3 564. One does need to take into consideration that in 20 years’ time the per hour fee would be higher.

This article first appeared in City Press.