Earlier this year, following the problems created by the virtual collapse of Fedsure and the sharp decline in investment markets, I wrote a number of columns highlighting the risks that you need to take into account when you invest in a "with profit" life assurance product.
"With profit" policies are sold to individuals and to retirement fund members.
Most "with profit" policies in South Africa guarantee your capital and some growth (normally not more than 4.5 percent a year) and smooth the investment returns, holding back some of the profits in good years to pay out in the years when markets are down or flat. The profits are paid out as bonuses.
Historically, most "with profit" policies have paid out vesting bonuses, which cannot be taken back once they have been paid by the life assurance company, and non-vesting bonuses, which can be taken away under extreme circumstances.
When markets drop sharply, as they did late last year and earlier this year, it may well happen that the life assurer's liabilities (what it has to pay out in vesting bonuses and guarantees on capital) exceed its assets.
This means that, in most cases (if non-vesting bonuses are not removed), your bonuses in future years will decline while reserves are rebuilt. The longer the investment markets stay down, the longer it will take for your bonuses to improve.
This creates a problem for new investors because they will in effect be subsidising existing policyholders.
Many investors have become wary of "with profit" products because of this and because they do not understand the underlying investments or how the bonuses are calculated. This is a result of the fact that very few life assurance companies provide policyholders with this information.
The life assurance companies have taken various measures to deal with these issues. These include:
- Closing existing portfolios to new funds and creating new portfolios; and
- Structuring products differently. A policy could, for example, be designed with fully vesting bonuses.
But this is not enough. Life assurers could do more to assure investors that there is no dark bag of tricks.
Fedsure abused investors' funds quite bluntly in numerous ways. Then the company's virtual collapse and dismemberment resulted in losses of R600 million being incurred by pension funds that had invested in "with profit" policies.
One way of reassuring investors is for life assurers to provide proper explanations of the consequences of the different "with profit" structures.
Metropolitan Life
Last week I had a meeting with two senior executives at Metropolitan employee benefits, John Melville and David Nicol, to discuss how Metropolitan Life is handling its "with profit" business, among other things.
The company is doing some good things to meet the needs of investors with policies of this sort.
The most significant is the appointment of a governance committee of four members, two of whom are from inside the company. The other two are independent members - Mickey Lowther, an independent actuary, and James Downie, an investment specialist - both of whom stand head and shoulders above many others in terms of ethics and expertise.
The function of the committee is threefold:
- To ensure that the business is properly and ethically managed. This includes preventing policyholder funds from being abused in pursuit of strategic investments - the kind of ones made by Fedsure. This mandate includes ensuring policyholder and shareholder funds are kept separate;
- To ensure that bonus declarations are made in line with Metropolitan's stated philosophy. For example, bonus reserves are not permitted to exceed 10 percent of the portfolio's assets for significant periods. The benefits of strong returns must be passed on to policyholders. The committee must also guard against a repeat of a Fedsure folly, that of declaring unaffordable bonuses, to the detriment of future bonuses, in a vain attempt to keep market share; and
- To monitor long-term performance objectives.
This is good news for investors and is an example that should be followed by all life assurance companies offering these products.
Melville says, quite rightly, that there is a lot of confusion about "with profit" products, particularly the consequences of the newer versions that do not have non-vesting bonuses.
The main consequence of having vesting bonuses, he says, is that the underlying investment structure has to change in order for the life assurance company to meet its guarantees. A fully vesting policy will therefore have a different asset class mix than a policy with non-vesting bonuses.
A fully vesting product will have more investments in interest-bearing products, such as bonds and money market funds, which are more stable, and fewer investments in more volatile equities. However, since equities have provided superior returns over the long term, you will most likely have to forgo this greater growth potential if you opt for the greater security of irreversible bonuses.
Metropolitan (and in fairness many other life companies) is also providing some idea of the underlying assets, so you can see, at a glance, whether you have another Fedsure, which at one stage ploughed almost 50 percent of its assets into just three companies, including the now-bankrupt Saambou.
To me, the issue is not whether or not you should invest in a "with profit" investment. The main issue is that you understand what it is you are investing in.
"With profit" policies are a solid banker for any investment strategy, and it is a good thing that life assurance companies are now taking measures that will provide more useful information and give comfort to those people who want the security of guarantees. It will also prevent these products from being so easily exploited by cowboys, as in the case of Fedsure.
For the record
Last week an advertisement published in Personal Finance made reference to certain "omissions" from an article we published on September 13 about KwaZulu-Natal Medical Aid Scheme.
According to the advertisement placed by the scheme's administrator, Private Health Administrators, the report had put the administration company in a negative light.
The report was based on the contents of an application to the Durban High Court by the Registrar for Medical Schemes, who wanted the scheme placed under provisional curatorship before the scheme's trustees were able to respond. The provisional order was granted and the trustees were given 30 days to prove why order should not be made final.
For this reason, our report did not include comment from any of the parties named in the report, including Private Health Administrators. Outside comment is not usually sought, or granted, on matters that are still before a court.