In search of the modern investments’ Holy Grail, better known as the calculation of causal event charges, we came across an interesting new perspective on the matter.
A broker that I spoke to mentioned that he requested to speak to the actuary responsible for drawing up the guidelines, only to be told that the gentleman had actually died a few years ago.
A case of “The creator is gone, but the malady lingers?”
Lisa Griffith, an Associate Director at BDO Wealth Advisers, wrote an article in SA Insurance Times in January 2016:
When switching, the issue of those pesky un-recouped charges – called ‘causal event charges’ – arises. Causal events charges, also referred to as penalties, are charges that the RA provider is permitted to levy every time an event takes place, she explains. The initial retirement annuity provider is entitled to deduct these charges prior to transfer. Logically, one would expect these charges to decrease over time. However, we have noticed that in a number of cases, after initially declining annually, these penalties steadily increased – quite substantially.
One disgruntled investor decided to challenge the status quo and determine the substance of his penalties. “The response from the company was astonishing,” says Griffith. “It referred to the imposition of an ‘Actuarial Reduction Factor’ – which didn’t particularly relate to the policy, but, according to them, needed to be viewed holistically within the business practices of the insurer.”
The principal of this view is that:
- The ‘pool’ of investments must be financially viable.
- When one investor exits the ‘pool’, the costs to the remaining policyholders will increase.
- Hence the “Actuarial Reduction Factor” levied on those who withdraw from the fund, in order to not place the burden of the extra costs (due to the shrinking pool) on the remaining investors.
- The company further stated that the ‘reduction in fund value is not a penalty but rather the recoupment of future income derived from its existing business.’
Not receiving the answers, he was seeking, the investor then lodged a complaint with the Pension Fund Adjudicator.
The Adjudicator ruled in favour of the Insurer on the basis that causal event charges must be computed using generally accepted actuarial principles and that the penalty was less than 30% of the fund (legislative). An independent actuary confirmed that the un-recouped costs had reduced to zero, but that the Actuarial Reduction Factor had increased in monetary terms.
“This was an upsetting turn of events for the complainant and indeed, all consumers.” The Tribunal did, however, express their misgivings on the company’s claim that it was not in a position to determine, at any stage of the policy, what the financial impact of early cancelation would be.
This was seen as being inconsistent with the Treating Customers Fairly (TCF) approach – a regulatory proviso that is designed to ensure that specific and fair outcomes are delivered to financial services consumers – and the Tribunal has referred this matter to the Financial Services Board. We hope for a better outcome from them.
The closest one will probably get to an admission that all is not kosher is contained in this sentence:
“…the ‘reduction in fund value is not a penalty but rather the recoupment of future income derived from its existing business.’”
In other words, it is not so much about the other members of the fund, it is about income losses the insurer will suffer if it no longer has those funds under management to earn investment returns on.
Treating Customers Fairly
At the Insurance Regulatory Seminar in November last year, the FSB was at pains to point out that it had been sending out a consistent message regarding the necessity for an incremental implementation of TCF. The industry was advised to move from talking about TCF outcomes to proactive management of market conduct risks.
Outcome six of TCF states: “Customers do not face unreasonable post-sale barriers imposed by firms to change product, switch providers, submit a claim or make a complaint.”
Retail Distribution Review
Proposal QQ: Conflicted remuneration on retirement annuity transfers to be addressed
Specific conduct standards will be set to mitigate the risk of poor customer outcomes where an adviser recommends the transfer of accumulated benefits from one retirement annuity fund to another. Standards will include strengthened disclosure requirements to ensure that the cumulative impact of any early termination charges deductible from the transferred value, together with that of advice fees and product charges on the investment value post transfer, are clearly communicated. Consideration will also be given to placing specific obligations on both the transferring and the receiving funds and / or product suppliers concerned, to take steps to satisfy themselves that the transfer is in the fund member’s interests – particularly in instances of transfers from underwritten RAs (where up-front commission costs will already have been incurred).
As referred to in Proposal PP, early termination values on legacy contractual savings products will also be reduced to reasonable levels within the next few years so as to address excessive penalties on the transfer of retirement annuity savings.
This will be used in combination with other measures to help ensure that early termination values on legacy contractual savings products are reduced to reasonable levels within the next few years, and that such products deliver fair outcomes for both new and existing customers.
The “conflicted remuneration” referred to here is a drop in the ocean, compared to the causal event penalties inflicted on clients.
As for “…placing specific obligations on both the transferring and the receiving funds and / or product suppliers concerned, to take steps to satisfy themselves that the transfer is in the fund member’s interests” is concerned, I am afraid this smacks of naivety, given what we have been discussing over the last week.
A review of the calculation of causal event penalties is long overdue.
In fact, one has to question the justification for its continued existence, if equal sharing of the risk between the various parties is to be achieved.
Click here to review Part I of this article, and here for Part II.
