Last year the Association for Savings and Investment South Africa (Asisa) introduced the Effective Annual Cost (EAC) standard. This was a significant move to help investors make direct comparisons of the costs of different financial products.
The idea was to make sure that there was a standardised measure used across the industry so that comparisons were genuinely done on an “apples with apples” basis. All costs would have to be disclosed in certain brackets and expressed as a percentage of assets invested.
Historically, different products had not only shown costs in different ways, but many had layered costs in ways that were very difficult for investors to understand. Setting a standard to ensure that investors were truly aware of what they would be paying and could compare this across different providers was therefore a big step.
However, the truth is that it hasn’t delivered the neat solution that many might have been hoping for. I have discovered this over the last few weeks as I have tried to gauge the true costs of different retirement annuity (RA) products.
It began with an analysis of low cost RA providers and what they would charge on a lump sum investment. This proved to be fairly straightforward and the EACs allowed for a simple comparison.
Essentially, these products were all fairly similar in structure. Each of them offered an investment into an underlying fund through an RA platform, and in the absence of any advice fee that was all that needed to be considered.
When I wanted to extend the same analysis to include life insurers, however, things grew a little more complicated.
The immediate problem was that it was not so easy to get EACs out of some of the insurers. It seems that a number of them are still coming to terms with the concept.
Given the industry’s reputation, my immediate concern was that they were reluctant to show the true costs or that they were trying to hide something. But recent conversations with product providers have left me with the impression that there is a genuine desire to reform, reduce costs and be more transparent.
In fact, Old Mutual provided figures showing that a lump sum invested into the South African Retirement Annuity Fund through their XtraMAX solution could cost as little as 0.3% over five years, before advice fees.
The problem, therefore, is something else. And it may start with the fact that in many of these products there is a lot more going on inside them, making an EAC measure a little less effective than it may seem at face value.
Innovation in the RA industry has been such that many providers have come out with products that offer guarantees, for example, or bonuses for remaining invested. These will come at a cost, but how do you quantify their value?
Many of them also offer ‘premium holidays’ if some financial difficulty prevents you from making monthly payments for a period of time. However, these are not standardised. Momentum’s Investo RA allows investors to skip four months over their investment period without penalty, while Sanlam’s Cumulus Echo allows 12 months. How do you assign value to one or the other?
Some RAs may also continue to pay your monthly contributions for the duration of the policy if you become disabled. Again, there is a value attached to that that is very difficult to quantify and certainly can’t be captured by just looking at an EAC.
I don’t want to suggest that the EAC is a failed concept. Far from it. It is a necessary improvement. But it doesn’t tell you everything.
Certainly what it does do is highlight the costs to investors of terminating their RA policies early. Figures calculated by Sanlam show that products from some providers would cost as much as 34% of the invested amount if they were cancelled after the first 12 months.
These costs do reduce significantly over the life of the product, and in some cases even become competitive if the RA runs to a full term over 25 years or more. However, they are a reminder that the flexibility and simplicity of unit trust-linked RAs have become appealing for good reason.
The challenge for investors and financial advisers is to assess the pros and cons that come with the range of options now available. The EAC is part of that analysis, but it can’t be all of it.