Performance: what should you reasonably expect?

ost people, when they make an investment, have an expectation of what they will receive at the end of the investment period. This can be fairly easy – for example, if you put your money in a bank term deposit for, say, 12 months at a fixed interest rate of five percent, you know exactly what you will receive at the end of the term.

Put your money in a unit trust fund, you look at the historical performance of the fund and you hope it will at least be equalled over the long term, and your reasonable expectations will be met.

But put your money in a life assurance endowment policy that is not market-linked, and you have very little idea of what you will receive when it matures.

In a retirement fund, trustees aim at meeting the reasonable expectations of members, normally a percentage of final salary after 40 years of membership.

Apart from fixed-term, fixed-rate deposits, there are some life assurance investments with limited guarantees of performance, but mostly you are dependent on the very vague term “reasonable expectations”.

The problem is in defining reasonable expectations.

Take reader GJ, a 66- year- old pensioner from Knysna. He took out two life assurance endowment policies in 1979, both of which had a premium of R50 a month, which he dutifully paid for 34 years. One policy was issued by Sanlam and the other by now- defunct Southern Life, which was taken over by Momentum.

When the policies matured, he received R275 480 from Sanlam, and from Momentum he received R1 067 675 – almost four times as much.

So which amount represents a reasonable expectation, and why such a big difference?

And importantly, if GJ had only the Sanlam policy, without the benefit of a comparison, would he have felt his reasonable expectations had been met by Sanlam?

Most people do not have the ben-

Mefit of a comparison such as this when their life assurance investments mature – be they retirement annuities or endowment policies.

Life assurance investments cannot be compared in the transparent manner that the performance of collective investment schemes (unit trusts and exchange traded funds) can be compared.

For example, if you look at the collective investment performance tables for periods ended March 31, 2013 in the multi-asset, flexible funds category ( go to our website, www.persfin.co.za and select “Unit Trusts” under the Personal Finance menu, then select “Quarterly Unit Trust Results”), you will see that in first place over 10 years is the Coronation Absolute Fund (A), with an average annual return of 18.61 percent, against the bottomplaced Marriott High Income Funds of Funds (14th position) with an average annual return of 10.61 percent. The average inflation rate over the period was 5.2 percent.

You cannot get the same comparisons on life assurance balanced funds (the life assurance equivalent of a flexible fund).

And in the case of GJ’s policies, he would not even have known over the period whether his expectations would be met.

Both policies were what are called reversionary bonus policies, which are no longer sold. The returns you received were based on what the life assurance companies received in returns on investing your savings.

However, in these policies, the full investment return received by the life company is not added to your annual value. Part of the return is added annually to your savings in the form of what is called a reversionary bonus, and the balance is paid at maturity as a terminal bonus.

Over the full 34 years, Sanlam provided GJ with an average annual return of 12.5 percent against an average annual return of 18.2 percent provided by Momentum (Southern Life). The average inflation rate over the period was 9.96 percent.

I would suggest a reasonable expectation should be based on the average annual return you expect to receive above inflation – the real return – at the inception of an investment.

GJ received a real return of 2.54 percent from Sanlam. In my view the minimum average annual real return you should reasonably expect from such an investment is three percent.

YARDSTICK

GJ obviously felt his reasonable expectations were not met, because his yardstick was the performance of his Momentum (Southern Life) product. As this was money he planned to live off in retirement, he demanded an explanation from Sanlam and an improved maturity value.

Sanlam provided GJ with a variety of complex actuarial mumbojumbo excuses for its performance.

The Momentum policy had a minimum sum assured (maturity value) of R32 373. The minimum sum assured on the Sanlam policy was R23 113.

Sanlam actuary Carel Wandrag argues: “Due to the workings of a reversionary bonus product, this difference in the sum assured at the start date has a direct impact on the eventual retirement benefits – the retirement benefit on the Momentum policy will be higher in exactly the proportion as the sum assured for the same bonus rates – that is, 40 percent.

“The likely explanation of the difference in the sums assured would be different actuarial bases at that in time, but it is impossible to verify without access to the Southern Life reversionary bonus basis of 1979.”

Professor JG van der Walt, Sanlam’s internal arbitrator, told GJ that, in terms of the Longterm Insurance Act, life assurance companies “must execute all policies in terms of an objective set of actuarial rules, specifications and formulae.

“Furthermore, in order to manage discretionary participation business, long- term insurers must use their discretion in managing investments and allocating bonuses.”

GJ could not understand the relative Sanlam under- performance from the explanations he received.

So I asked Momentum and Sanlam if they could explain why Momentum had so thoroughly outperformed Sanlam, even beating the 13.8-percent average annual return of the FTSE/JSE All Share Index.

It appears now that the most significant reason is that GJ received a windfall in the early stages of his investment as a consequence of the listing of Southern Life on the JSE in 1984.

Freek Kruger, head of Momentum’s retail insurance product management (existing products), says the policy was part of a group of policies that was ring-fenced into a segregated portfolio when Southern Life listed.

A condition of the listing was that this group of policyholders would share in profits/losses that might occur from this block of business. When Southern Life merged with Momentum, this arrangement was continued in terms of the administration of this portfolio.

Says Kruger: “This portfolio has performed exceptionally well and we are comfortable that the bonuses declared for this policy reflect the returns achieved for the particular pool of policies.”

He says returns depend on a variety of factors, such as:

The charging structure (costs);

The underlying asset performance (the portfolio was a balanced investment portfolio, investing across asset classes); and

The nature, type and extent of profits in which the policy shares.

So the reasons are complex and demonstrate the difficulty in defining a reasonable expectation.

In my view, GJ’s benchmark of a reasonable expectation for Sanlam should have been a minimum annual average real return of three percent – not the Momentum performance. This was not met.

You should always select an investment that will provide a reasonable expectation, over the medium to long term, of a return above inflation.

Next week, I will deal with factors you should take into account when deciding on a reasonable expectation for returns on your investment.