Life assurance capital-guaranteed, smoothed- or stable-bonus products, which, for decades, have provided millions of pensioners and retirement fund members with what they regarded as a safe haven for their savings, are facing a significant revision.
National Treasury has twice signalled that it has major concerns about the products in their current form.
Treasury’s first warning shot was when it excluded smoothed-bonus products from being included in tax-free savings accounts. The second came with draft regulations which, if implemented, will require retirement fund trustees to provide members with default options. The regulations exclude smoothed-bonus products in their current form from being offered either as a default investment strategy for members saving for retirement or as a vehicle to provide a pension.
Life assurers use smoothed-bonus portfolios in long-term savings products and as underlying portfolios in with-profit annuities (pensions).
The main selling point of these products is that you can have your cake and eat it, too. This is because you can invest in equities – which, historically, have provided higher average returns over the medium to long term than other asset classes – while at the same time mitigating volatility risk, particularly when your savings mature.
Smoothed-bonus products substantially reduce the volatility risk to your savings by:
* Guaranteeing all or part of your capital; and
* Smoothing the investment returns, by holding back some of the returns (in a so-called bonus stabilisation reserve) when markets are performing well, so that they can be paid out when markets are down.
Treasury is of the view that the cost of smoothed-bonus products, either as pre-retirement investments or as pension products, may exceed their benefits, and that members of retirement funds may be better off using other products.
In an explanatory memorandum accompanying the draft regulations, Treasury notes its concerns about the structure and costs of smoothed-bonus products and invites the industry to give feedback. Its main concerns are:
* High charges for poorly defined capital guarantees. If there is a major market crash, the bonus stabilisation reserve can turn negative, which can result in zero returns for policyholders until the reserve is positive.
However, zero returns are normally declared only when the reserve drops to about minus 10 percent in any year, while returns over about 15 percent are likely to be retained in the reserve to be distributed in future years.
Recovery from severe market conditions can take a few years, particularly if markets fall dramatically and stay down. Even once markets recover, returns and pension increases may not immediately reflect the more positive conditions, because the good returns are used to rebuild the bonus stabilisation reserve.
* Market value adjusters (MVAs). A life assurance company applies MVAs when a portfolio’s bonus stabilisation reserve is negative and a policyholder wants to withdraw his or her money before the maturity date. Instead of receiving the policy’s declared value (the value you see on your statement) and the accrued bonuses, you are paid a lower amount, which reflects the market value of the underlying portfolio.
* The application of confiscatory penalties when policyholders stop and/or reduce their contributions. Treasury is also concerned about products that include loyalty (or terminal) bonuses, which are paid only if you remain invested for the full term of a contract.
* With-profit annuities in which pension increases are entirely at the discretion of the life assurance company and there are structural conflicts of interest between pensioners and shareholders (who have to make good on the pension guarantees). Treasury says that, in the past, shareholders have not acted in the interests of pensioners and their actions have not been transparent.
The two biggest providers of smoothed-bonus products and with-profit annuities, Old Mutual and Sanlam, say they are not sure of the future of the products.
Braam Naude, the head of income and guaranteed solutions at Old Mutual, says that even if the products are not allowed as default investment and annuity options for retirement fund members, they can still be sold to people who want to opt out of the default options.
Lizelle Nel, the head of regulatory co-ordination and advanced analytics at Sanlam, says Sanlam does not want to comment on the implications, “as we are at this stage uncertain about the direction the legislation will be taking.
“We believe that smoothed-bonus [products] might still be sold, but we are uncertain whether they will be allowed to be sold as part of the default strategy. In our view, the current regulations are not 100-percent clear on this.”
Nel says that more engagement with Treasury is required and more detail is required, particularly with regard to the default annuities.
Naude says the proposed regulations do not specifically exclude smoothed-bonus portfolios as default investments.
“The requirement that the default investment portfolio should be appropriate for members, and, in particular, their preferences for balancing risk and returns, in our view supports the consideration of smoothed-bonus funds as a possible default investment portfolio. However, some aspects of the proposed default regulations (for example, if MVAs are not allowed for voluntary bulk disinvestments) may effectively limit the extent to which investment returns can be smoothed.”
Some changes may have to be made to smoothed-bonus funds before they can be used as a default investment portfolio for occupational retirement funds and RA funds, Naude says.
He says with-profit annuities will not meet the requirements of the proposed default regulations, and therefore retirement funds will not be allowed to offer them as a default pension from a life assurer. However, they can still be offered to members of funds who select in writing to opt out of the default option.