The Mechanics of Global Pensions/Investments Frauds

Annuities in Retirement (SASI paper)

This paper won an award for research excellence from the South African Savings Institute (SASI) (2003) – adjudicated by ex Reserve Bank Governor Chris Stals, Professor Biekpe (London & Stellenbosch Universities)

The paper has been removed from SASI’s website after SA’s Standard Bank took over control of the SASI since it is embarrassing to Standard Bank as well as to all Financial Services Industry players.

The data in this paper verifies itself. Apologies for difficulties with presentation of excel spreadsheets.

__________

South African Savings Institute

Research Excellence Awards Competition

Entry by

Chris Addington Pr.Eng.

Category 4 – SA Financial Institutes

The South African Financial Institutional Industry is one that is in urgent needs of reformation. It has for decades been instrumental in many fraudulent practices of increasing complexity & deceptiveness.

Soon after graduating as an Electrical Engineer the writer was approached by various salesmen from various Financial Institutions with the view of selling Institutional “products”. Questions asked produced unsatisfactory answers – this caused the writer to begin delving into the investment arena – the results were shocking.

Two distinctly separate issues are submitted.

1. Annuities in Retirement & 2. With Profit (Smoothed Bonus) funds

But it should be noted that these are merely two of the many fraudulent & deceptive issues within the Financial Institutional Industry.

Annuities in Retirement.

In December 2002 the writer appeared on SAfm (Dennis Beckett as a stand in host) – alternative viewpoints were presented (as best as possible with many interjections). Later that month an Old Mutual General Manager contacted the writer to request a meeting. This occurred in February 2003. OM requested a joint project to address one particular issue – Annuities in Retirement – the attached research is a preliminary project report.

Unfortunately, despite numerous requests, the information from OM was not very satisfactory. It also transpired that the gargantuan Goliath of OM was expecting the input from a miniscule David to be on a freebie basis. Consequently the writer has not been able to progress the research further for lack of funding – some 130 plus hours have not been paid by OM.

Nonetheless the data provided was sufficient to allow proof of the inadequacies of Institutional Annuities.

What do the results show?

This is best answered by looking at a practical situation.

Assume 2 people approach OM – both are wanting to retire – the first person is a 55 year old female, non-smoker, in excellent health and has R100K, she asks for a monthly annuity income quote. The second person is a 65 year old male, a chain smoker, in disastrous health, he also has R100K and requests a quote for a monthly annuity income.

On the surface one would expect that the 55 year old female would require a considerably longer income stream because of anticipated longevity compared to the 65 year old unhealthy male – hence the female would receive a lower monthly annuity income than the male. Quotes from OM support this.

But this is wrong – both should receive identical monthly incomes per unit of money paid for the annuity stream.

This outcome is contrary to quotes from OM (& other institutions are really no different).

The question is why do Institutions not pay out the full annuity that every individual is entitled to? The answer to that question lies in the deceptive, fraudulent, nature of Financial Institutional “products”.

This research project report, despite the limited data from OM, shows conclusively that consumers are being defrauded in their retirement incomes.

This is a significant result and shows clearly that the Financial Institutional Industry needs urgent reformation

With Profit (Smoothed Bonus) funds

The essays are self explanatory – and also support the need for urgent reformation in the Financial Institutional Industry.

Monday July 28, 2003

I confirm that the entire contents of this submission are my own original works (except where clearly identified as outsourced data) and that I agree to the Rules & Conditions of the Competition.

Chris Addington Pr.Eng.

CDADD Consulting Services

South Africa

+27 83 962 7098,

Institutional Annuities versus Government Long Bonds

A Project with Old Mutual to investigate these Financial Instruments

For Retirement Purposes

Tuesday June 17, 2003

Background:

In December 2002 I was on one of the weekday SAfm morning chat programmes with Denis Beckett. I was putting across my views that the Financial Services Industry was in dire straits with historical’s of collusion between the Institutions & government. Their objective being to manipulate legislation aimed at protecting the turf of the Institutions, and acting detrimentally to the consumer.

I also pointed out a number of serious pitfalls with regard to particular products (so-called) and to beware the “financial advisers” that promoted their businesses in the radio & press media under the guise of giving an advice service to listeners & readers.

About a week after this I had a call from Mr Dave Hudson (DH), a senior General Manager at Old Mutual (OM). He said that he had listened to a recording of the programme - We had a general chat - He said he would like to meet and discuss matters further in the New Year and to embark on a process to establish more detail as to what kinds of problems existed with Institutional Products. I was in agreement but on the condition that any matters pertaining to the “subject matter” was open & transparent, i.e. I could record & circulate the points of discussion/research; and that the focus would be on consumers best interests - DH was agreeable to this.

Later in December I came across a circumstance in which two married pensioners had been put into annuities with OM. What the pensioners related to me did not make sense. I then contacted OM Customer Services and discussed the matter with them. The information I was given also did not make sense. In January I had further telecons with OM then developed a letter setting out the circumstances (January 2, 2003). The responses were unsatisfactory. I had also made contact again with DH to arrange our meeting and suggested that this particular issue would be one of our agenda items.

I met with DH on Thursday February 27, 2003 @ 10h00 for a 3 & ½ hour discussion - on general issues initially then later focusing on Annuities & GLB’s. The letter of February 27, 2003 summarises the key points regarding this topic. We agreed that we should investigate the issue of Annuities versus GLB’S as a first project. I pointed out to DH that this issue was just one of many pitfalls that existed with Institutional “products” and that it would be beneficial for OM to have an independent & global assessment of its business.

A write-up I did (Annuities in Retirement) was sent to OM in March, despite this explanation OM maintained their view that Annuities are favourable to clients; or alternatively stated that there are little differences. Consequently more substance was required to counter their opinion. Much later OM sent me an Excel spreadsheet setting out a comparative model as well as, later, some quotes for annuities. In the interim I delved further into GLB’s, and later visiting the Bond Exchange of South Africa (BESA), their website, and discussing the topic with brokers.

In a telecon with DH on June 6, 2003 he raised his concern that retirees could face difficulties with Living Annuities if they were not sufficiently educated as to the type & nature of this product. I voiced my broader concern that all institutional annuities are detrimental and that it was important for alternative approaches to “retirement planning” be developed. It was agreed that we should steer this project towards a “recommendation” to government for this very purpose.

However, before we can move in this direction we first need to reach understanding of the underlying issue that Annuities are detrimental to consumers and that GLB’s are considerably to their advantage in comparison. From a recent email from OM’s setting out arguments it is clear that OM & myself are “missing each other” in arguments. We need to close this gap – hence this preliminary project report.

This project report compiles the various points raised regarding this issue to date

The conclusion I draw thus far is that Institutional Annuities are detrimental to consumers & that GLB’s are considerably better in comparison. Are GLB’s, however, the best option – that is a point to be addressed later along with developing recommendations for alternative “retirement planning” proposals.

I reiterate my initial statements, that this issue of Annuities is just one of many pitfalls in the Financial Institutional Industry. Consumer:- Beware!

But also, Financial Institution:- Beware!

In delving into a number of pitfalls, this report addressing just one of them, has made me realise that there is urgent need for the Financial industry to be cleaned up and re-engineered to ensure that fair rules are structured. This will have a serious impact upon the mammoths of the industry, and could lead to their demise as market forces move investor funds to new & dynamic organisations that gear themselves to “fair play”. Be warned.

[PS. As agreed with OM this material is available for general circulation & information as it is important for society to understand how the Financial Institutions have deceived them. However as OM are paying for my consulting time, I feel that it is fair that they have at least a two week window to review this report, prepare a reply (to which I will add my counter-reply) and all will be compiled for general circulation.]

Chris Addington Pr.Eng.

CDADD Consulting Services

083-962-7098

The Root of the Problem (one of many)

Financial Institutions have undertaken extensive research over the decades to perfect the “sales” approach that salesmen use to sell Institutional products. The research itself has also been used to modify then existing, and to develop new, “products” – according to the perceived needs that the consumer is asking for, or is led to believe that they need. It has become a sophisticated system within Institutions; so much so that one becomes caught up in the perceived “emotional” issues that drive the development of “products” – to the exclusion of “rational” thought coming into play to question the original deductions from the research.

In the process of carrying out this project, and prior, I had confidential discussions with a number of people in OM and also independent “financial advisers”. It became clear that people in the Financial Services Industry have become brainwashed by the emotional issues to the exclusion of rational fact. The arguments from these people were extremely convincing, so-much-so that I found myself being drawn in, and then having to reach out & grab hold of the rational anchors to bring myself back to ground.

At various points it became necessary to mull over particular issues to rethink the rational to check & verify that it was soundly based. This could take a number of days away from the project to let matters settle in the mind and for the rationals to come through.

An example of this comes out of this project:- An adviser would explain that one has to take into account the age of a person, their health, sex, if life cover was required, whether an initial guarantee was required, to determine the level of annuity income they would receive for a given capital into the annuity. Then the source of the funds had to be considered, voluntary or compulsory annuity.
- On the surface it all seemed very sensible stuff that the adviser was talking – but then reach out & grab hold of the rational anchors, then the advisers arguments crumble into emotional nonsense. And it is this emotional deception that the reader needs to continually be on the look-out for.

It was this kind of emotional deception that had to be overcome to achieve the objective of this project.

It required more intensive delving to extract the proofs for OM

Legislation has been developed over the decades to protect the turf of the Financial Institutions. Complex rules have been put into place under the guise of protecting consumers from their own folly of potentially spending their hard earned retirement funds. In truth the complex rules are simply legalised means for Institutions to take more cuts of the consumers retirement pie.

In the early 60’s and onwards, an employee moving from one co. to another would lose much of their retirement funds. Employer contributions would be deducted & only a nominal return would be accrued to the employees contribution, there would be hidden exit charges. In placing the funds into another retirement vehicle further, initial, charges would be incurred. In other ors “gaps” were created in which Institutions could take a further slice from a consumers retirement pie. The legislation was well engineered to make piles of money for the institutions, and to diminish the consumers.

In a similar way:- the rules were engineered for the time when a person retired – e.g. an RA would be required to be used to buy a compulsory annuity i.e. a lock-in to a Financial Institution. Initially the lock-in was to the particular institution that the RA was run through; but later this was relaxed – but the underlying lock-in remains to date.

But stepping back from these engineered & complex, but defective, annuity rules of Institutions and using some rational thought one can clearly see the extent of the deception. This project report continues from the earlier write-up “Annuities in Retirement”, which was rejected by OM, and sets out the proofs that were researched. Much of the research was time consuming delving into various data sources, tools, etc. and having to change the presentation format to be able to see the relationships in a correct light.

It is also important to remember that a pensioner is planning his retirement; i.e. we are not looking at a critical scenario in which decisions need to be made on the spot. A retiree would have thought the issues through a few years prior so the argument that bonds pay out, say twice per annum, is not a significant issue – the pensioner can plan his income needs in 6 monthly cycles and ensure that his cash needs are sufficient from each 6 monthly coupon payment.

There is a global awareness that retirement funds have historically been a pot for institutions to enrich themselves, but the awareness has not been converted into understanding. And it is understanding, of this one particular issue, that this project report focuses on – to dispel the historical deceptions.

Bond Exchange of South Africa

www.besa.za.com

Bond Exchange of South Africa (BESA) have a comprehensive website which gives one access to a Bond Calculator which can be downloaded. It also has a full mathematical treatment Bond Pricing Formula used for the Bond Calculator.

This Bond Calculator is designed for wholesalers (traders), not consumers (retailers) BESA are developing a Retail version – so one has to understand the way it is working to convert back to a practical comparative to Annuity quotes. This is a little tedious, but not difficult, once the process has been established.

It was necessary for me to get a clear understanding, from a users perspective, of the Bond Calculator to do this.

I therefore visited BESA on Thursday June5, 2003 and spoke to Alan Jones and Mark Rafaelli to get a clearer understanding, and to clarify some particular points/uncertainties that had cropped up in discussions with DH & other OM’s. They were most helpful.

BESA Calculator

Recall: This calculator is designed for wholesalers (traders) not retailers (consumers)

Inputs: Settlement Date (mm/dd/yy); Bond (select); Nominal (the amount of Nominal value of Bond); Yield (the “price”, effective interest rate, you bid on the open market in %)

Outputs: We are interested in the “All In Price” – note, if we are investing R100K then we need to work back to determine the amount of Nominal that we will be getting for that initial investment

Quotes given by OM, and others were for June 6, 2003 – we will use this date for the calculator

Settlement Date	Bond	Nominal	Yield
6/06/03	R153	100,000	9.1%
All In Price	But we have R100K cash: 100000/123768= 80796 Nominal Coupon = 13%; 80796 x .13 = R10503 per annum Or R875.29 per month(I have ignored the interest accrual in bank)
123768

Comparing to quotes from OM of June 6, 2003

The highest monthly annuity is for a 65 year old taking a voluntary annuity with no guarantee period and no capital repayment to the estate on death of the pensioner = R934.01

The comparative position would be for Capital Repaid at term, therefore deduct quoted Life Cover premium of R248.74 gives annuity income of R685.27.

This Institution annuity of R685.27 is considerably less (875.29 – 685.27 = 190.02) than the GLB monthly payment

Clearly the GLB paying out R875.29 per month with capital being repaid at term is the better option.

It also becomes clear now that factors such as, age, voluntary/compulsory, sex etc. do not have any effect with the GLB, but it does (wrongly) reduce the income via an institutional annuity.

We now need to consider the circumstance where the pensioner needs to switch from one bond to another. Does this materially affect his income?

Assume:-

R150 Bond on March 1, 1995, R100K cash.
Switches to from R150 on October 10, 2001 and into R157 on October 15, 2001

BUY R150 on March 1, 1995

Settlement Date	Bond	Nominal	Yield
3/01/95	R150	100,000	16.7
All In Price	But we have R100K cash: 100000/77549=128950 Nominal Coupon = 12%; 128950 x .12 = R15474 per annum Or R1289 per month
77549

SELL R150 on October 10, 2001

Settlement Date	Bond	Nominal	Yield
10/10/01	R150	128950	10.15
All In Price	All In Price = Cash Payout = R137,237
137237	All In Price = Cash Payout = R137,237

BUY R157 on October 15, 2001

Settlement Date	Bond	Nominal	Yield
10/15/01	R157	100,000	10.7
All In Price	But we have R137237 cash: 137237/121128 = 113299 Nominal Coupon = 13.5%; 113299 x .135 = 15295 per annum Or R1274 per month
121128

Initial monthly income as R1289 with the R150; with the R157 it is similar at R1274.

Also note, that the pensioner can play the interest-rate cycles to make additional capital gain – but extreme caution must be exercised.

Government Long Bonds

Graph comparisons

The source of the graphs are from SFWExecXP from Share Direct, the underlying data is downloaded daily from the JSE via Progressive Data Services.

The first series of graphs show a selection of GLB’s and their close “price” and “relative strength” relative to the R150

The second series shows the relative strength of the R150 against other GLB’s

The price is the prevailing interest rate which is determined through market forces, and these forces are influenced by the prevailing prime rate.

The relative strength (RS) is the daily data of the selected bond divided by the daily data of another selected bond, yielding a relative strength ratio between the two bonds.

What the RS is telling us is whether the numerator bond or the denominator bond is stronger or weaker at any particular point. Studying the graphs we see that there is an indication that new bonds have a weakness relative to a longer established bond.

The R150, which is in it’s 4^th quarter life cycle, expiry on February 28, 2005, is showing wide RS oscillations compared to other established GLB’s. These could be used to an investors advantage.

The key points coming out from these graphs is:-

That established bonds have a correlation around unity for their relative strengths. This means that if one was to sell out of one bond that is nearing its 4^th quarter to buy into a younger bond in its late 1^st, or early 2^nd quarter, then the impact upon the coupon income flow would not be materially different. Trading costs have been ignored.
- What flows from this is that a pensioner “riding” GLB’s for his pension requirements is not hampered by the argument that a GLB may reach its redemption date before the pensioner becomes deceased. It is immaterial as long as a little bit of wisdom is used in making the switch from one GLB to another.
That market forces cause discrepancies between the prevailing interest rates of each particular bond, therefore the use of a little wisdom can possibly offset the trading costs, and could even generate a small profit = increase in annuity income.
The interest rates move in cycles so a pensioner could use a portion of his bonds to generate some capital gain by playing these cycles. Extreme caution to be exercised though, and only with a small portion.

Annuities versus Government Long Bonds

Graphs of selected GLB’s showing Close graph and elative Strength graph

Close = Close Price = effective interest rate of the bond

RS = Relative Strength = a graph of the Ratio between the particular GLB divided by another GLB (RS/Rxxx) e.g. the R194 is divided by the R150 to produce the “ratio” graph. It shows the relative strength of the one bond versus the other.

Note the correlation to unity for established bonds (R150, R177, R184 etc.) to the weaker correlation with newly established bonds (R194, R186)

Chris Addington Pr.Eng., CDADD Consulting Services, 083-962-7098

Graphs from SFWExecXP by Share Direct.

GLB’s – Issue & Redemption Dates, and Coupon Rates

GLB	Issue Date	Redemption Date	Coupon Rate
R150	May 2, 1989	February 28, 2005	12.0%
R153	June 22, 1989	August 31, 2010	13.0%
R157	January 18, 1991	September 15, 2015	13.5%
R177	April 15, 1994	May 15, 2007	9.5%
R184	March 3, 1996	December 21, 2006	12.5%
R186
R194

Annuities versus Government Long Bonds

Graphs of R150 GLB with Relative Strength against other GLB’s

Each graph is of the R150, but the RS is taken against different GLB’s

NOTE the different time scales on the lower two graphs, this because the RS denominator bonds are newly issued.

Note: Government Long Bond’s are exactly that - long – it raises the question why the ratio between an established bond and a newly issued bond should have such a large discrepancy e.g. R150 versus R186 (bottom left graph)

Institutional Annuities versus Government Long Bonds

Preliminary Conclusions

A comparison of Institutional Annuities to GLB’s clearly show that the latter are providing significantly higher benefits.

In the alternative the Institutions are raising extraneous issues to reduce the annuity income, and wrongly so.

Institutional Annuities considerably disadvantage retirees than GLB’s,

simply because Government liabilities are met by the country.
Institutional annuity income is less than GLB income
Institutional annuities are riskier because
- the Institution cannot provide the same level of security as can the government.
- There is no Risk premium to the Institutional annuity
- reduced benefits = increased pensioner risk.
Institutions have created a set of deceptive emotional issues to justify the reduction of annuity income to the pensioners.
Institutions reduce (wrongly) annuity incomes to cover issues such as:
- Sex
- Health
- Capital repaid/not repaid – life cover
- Voluntary/compulsory
- Single/joint survivor
Institutional annuities are inflexible and lock-in pensioners
Legislation governing Institutional annuities seriously disadvantages pensioners
GLB’s offer pensioners full flexibility

The Institutional deceptions have become over time an increasing & downward spiralling destructive reiterative process.

What is required now is for OM to comment on the aforegoing and for us to reach agreement; then to develop a framework for a sound & secure annuity structure which can be used as the basis for a proposal to Government..

Chris Addington Pr.Eng.

083-962-7098

Institutional Annuities versus Government Long Bonds

ANNEXURES

Annuity quotations as at 06 June 2003

Assumptions
Lump Sum Investment:			R100 000.00		Cost of Life Cover		Buy life cover of R100000
Tax:			0%		Recurring Premium Life Policy:		FlexiLife Maximum Cover
Guaranteed Period:			0 and 10 years		Investment Portfolio:		Smoothed Bonus
(c&t = certain and thereafter for life)					Income:		Maximum
Annuity:			monthly in arrear		Guaranteed period:		0

MALE
A.N.B.	Capital Not Repaid				With Life Cover**
	Voluntary Annuity		Compulsory Annuity		Premium	Net Voluntary Ann	Net Compulsory Ann
	0 c&t	10 c&t	0 c&t	10 c&t	for life cover	0 c&t	0 c&t
55	801.77	788.08	816.49	800.55	136.52	665.25	679.97
60	858.94	831.36	877.77	845.99	180.00	678.94	697.77
65	934.01	881.83	957.66	898.56	248.74	685.27	708.92
** Note that OM sells a "Capital Preservation Option" as a package. This is not what is quoted above.
Instead we have used the simpler approach here ...buying an annuity and life cover separately and showing
the explicit cost of each above and then netting the premiums off to give the net position to the annuitant.
FEMALE
A.N.B.	Capital Not Repaid				With Life Cover
	Voluntary Annuity		Compulsory Annuity		Premium	Net Voluntary Ann	Net Compulsory Ann
	0 c&t	10 c&t	0 c&t	10 c&t	for life cover	0 c&t	0 c&t
55	751.39	745.20	761.54	754.71	131.50	619.89	630.04
60	784.18	773.98	796.99	785.40	135.76	648.42	661.23
65	829.86	811.07	846.58	825.00	180.00	649.86	666.58

Chris, the ss I sent you was aimed to approximate the annuity for a 60 yr old.
As an example, using interest of 9% my ss had
	a cost of "buying" the cover on death as R150 - which is somewhere between the R135 (female)
	and R180 (male) shown above for a 60 year old.
	Annuities of R853 and R703pm (vs. R877 [d25] and R697 [h25]actual)

Quote from PLJ Financial Services- June 4, 2003

	June 4, 2003
Bond Code	Issuer	Coupon Rate	Maturity	Interest Payable 1	Interest Payable 2	Books closed 1	Books closed 2	ISIN Code	Coupon Indicator	MTM	YC Differential
R150	REPUBLIC OF SA	12.000	28-Feb-05	28-Feb	31-Aug	31-Jan	31-Jul	ZAG000010521	f	9.870
R194	REPUBLIC OF SA	10.000	28-Feb-08	28-Feb	31-Aug	31-Jan	31-Jul	ZAG000017997	f	9.210
R153	REPUBLIC OF SA	13.000	31-Aug-10	28-Feb	31-Aug	31-Jan	31-Jul	ZAG000010539	f	9.250
R157	REPUBLIC OF SA	13.500	15-Sep-15	15-Mar	15-Sep	15-Feb	15-Aug	ZAG000010547	f	9.260
R186	REPUBLIC OF SA	10.500	21-Dec-26	21-Jun	21-Dec	21-May	21-Nov	ZAG000016320	f	8.760
R177	REPUBLIC OF SA	9.500	15-May-07	15-May	15-Nov	15-Apr	15-Oct	ZAG000010661	f	9.430



Bond Code		YC Intersection	All in price	Clean Price	Accrued Interest	Duration	Modified Duration	Delta	Rand per Basis Point	Convexity
R150		10.343	106.47926	103.25734	3.22192	1.574	1.500	-1.597	R 159.67	3.11
R194		9.324	105.61176	102.92683	2.68493	3.804	3.637	-3.841	R 384.08	16.95
R153		9.312	122.88858	119.39817	3.49041	4.973	4.753	-5.841	R 584.09	30.69
R157		9.201	133.72182	130.65196	3.06986	6.883	6.578	-8.797	R 879.66	63.50
R186		9.085	116.80092	117.23243	-0.43151	10.070	9.648	-11.268	R 1,126.85	149.97
R177		9.342	100.78249	100.20989	0.57260	3.361	3.209	-3.234	R 323.44	12.88

Annuity quotes – Independent Broker – June 3, 2003

3-Jun-03	CAPITAL REPAID					CAPITAL NOT REPAID
	Male			Female		Male		Female
	Income	Taxable Portion		Income	Taxable Portion	Income	Taxable Portion	Income	Taxable Portion
55	677.75	371.20		664.84	402.31	852.56	484.96	815.30	502.80
60	673.44	316.69		669.83	360.21	921.60	475.18	878.56	506.84
65	668.71	244.50		663.78	299.40	1,004.99	449.43	962.46	507.89


Notes
1	There is no difference between smoker and non smoker
2	I have quoted on single life, voluntary purchase, life annuities, level income
3	CAPITAL REPAID		understood to mean; capital is paid out to beneficiaries, estate, or cessionaries on death of the annuitant
4	CAPITAL NOT REPAID		understood to mean; capital is exchanged for income at a predetermined rate for the life of the annuitant.
			There is no residual capital
5	In determining the absolute benefit of the annuity, the taxable portion vs. the gross income needs to be taken into account
6	Once the contract is established, all risk rests with the life office

Yield	Purchase	Eff i
0	208100	5.8
1	122097	9.8
2	120235	10.0
3	118413	10.1
4	116628	10.3
5	114800	10.5
6	113169	10.6
7	111493	10.8
8	109851	10.9
9	108242	11.1
10	106667	11.2
11	105123	11.4
12	103610	11.6
13	102127	11.8
14	100674	11.9
15	99250	12.1
16	97854	12.3
17	96485	12.4
18	95143	12.6
19	93826	12.8
20	92536	13.0
21	91270	13.1
22	90028	13.3
23	88810	13.5
24	87616	13.7
25
26
27
28
29
30	80903

R150 GLB – Interest rate effect

Yield Purchase Price Effective i

Annuities in Retirement

The “tip of the iceberg” of the many scams within Financial Institutions

The points canvassed herein highlight the need for extreme caution when dealing with Financial Institutions.

It also highlights the need for employers to deliver service to their employees; especially if employers expect service in return – quid pro quo.

Employers need to become pro-active and develop alternative & sound plans to cater for employees Retirement Planning – Group Schemes account for some 10% to 15% of employee salary cost to company – a significant portion to justify pro-activeness.

Financial Institutions in South Africa have, for decades, colluded with governments to develop legislation that essentially protects their business “turf”; but very much to the detriment of the consumer/investor. Although SA has had a structural change to a Constitutional state the collusion continues – the latest Financial Advisory & Intermediary Services Act, The Financial Intelligence Centre Act are examples of draconian legislation that offers no real benefit to consumers but entrenches fraudulent & unconstitutional practices by the Financial Institutions.

The explanations herein covers just one example of the many & substantial pitfalls of utilising Financial Institutions.

Throughout the entire time frame of “retirement planning” there are many other pitfalls, but this explanation focuses solely on the annuity aspect – i.e. when upon reaching retirement age the RA, Group Pension, Preserver Fund is converted to an annuity. It also applies to voluntary annuity purchases.

The following is an extract from a recent letter to the writer from a particular Financial Institution and explains, briefly, the different types of annuities.

A life annuity with no guarantees:

One often finds that investors simply have the need to generate maximum income from the investment without the need to preserve the investment capital. This annuity type is fully dependent upon the life expectancy of the annuitant and will, assuming the same annuity interest rate, result in a higher annuity when compared to an annuity offering underlying guarantees.

A life annuity with guarantees:

Joint life annuities:

Annuitants also have the option of making an annuity payable until the death of for instance two separate people on whose lives the annuity has been affected.

The level of the annuity will therefore be dependent upon the type of annuity selected as well as the annuity interest rate prevailing at the time the specific option is exercised. The important issue to bear in mind is that the annuitant must select an annuity (at least with the two thirds portion of the retirement capital) – no other investment options are available.

It is important to note the last part of the final sentence - no other investment options are available – the reason for this is that legislation has been purposefully engineered to achieve this result, which result is desired by financial institutions.

To get a clear understanding of the problem it is necessary that annuities are compared to Government Long Bonds (GLB)

A GLB is initially established by Government who seek to raise funds; they promise to pay back the capital at the redemption date, but in the interim and every six months pay out interest according to the coupon (or interest) rate that government offers. (For example the R150 was issued on 2^nd May 1989 with a coupon rate of 12% and a redemption (capital payback) date of 28^th February 2005.)

GLB’s can be part-traded through stock brokers

The effective interest rate is determined by prevailing interest rates, and because of the inverse relationship between interest rates & value (yield):– as interest rates increase above the coupon rate the yield decreases, and as interest rate decreases below the coupon rate the yield increases. Therefore in high interest periods the purchase price per one Rand value of bond is less than one Rand; vice versa when interest rates are below coupon rate, the purchase price per one Rand of bond is more than one Rand.

GLB’s are issued from time-to-time so retirees can plan to switch from one GLB to another as circumstances deem appropriate.

Comparing prevailing Effective Interest Rates for GLB’s with corresponding prevailing quoted rates for Institutional Annuities shows that they are essentially of the same order. (Don’t accept this argument on face value - check it out - get current rates from a broker)

However a substantial difference exists in the way they operate.

A Government Long Bond is an “annuity” in which the annuitant (or their estate) receives back their rightful redemption capital on death.
An Institutional Annuity is an annuity in which the Institution unlawfully, immorally, withholds the annuitants rightful redemption capital (death cover) on death.

The difference can be summed up as follows – collusive legislation created the circumstance in which the consumer is blocked from utilising GLB’s which would provide a virtually identical “annuity” income stream to that of an Institutional Annuity, which thus allows the institutions to retain (steal) the capital upon death of the annuitant.

Argument raised by Institutions is that it creates a collective pool to ensure security of the annuity – but - it is immoral to expect one client to fund the risk of another client

All of the annuity types have the problem that the full annuity entitlement is not received and/or capital is not paid out to the estate of the annuitant upon death (which would not be the case with a GLB)

Arguments raised by Institutions concerning tax planning in retirement are generally invalid. The bulk of investors are low to medium income earners whose taxable position at retirement would likely result in low tax thresholds – therefore arguments pertaining to tax planning are superfluous (a similar argument possibly applies to the higher income earners as well) .

Arguments regarding guarantees are invalid – the GLB is about the highest guarantee on offer. If SA collapses it means that institutions collapsed beforehand.

Arguments regarding joint life are also invalid – A GLB does not differentiate between annuitants, it simply continues providing the interest plus capital upon redemption regardless of who dies first, or when.

A brief explanation of another similar issue.

A retiree was paid out in 1995 the 1/3^rd cash of an RA – then induced by a “financial adviser” to top up to give R40K and to enter into a “structured” plan – vis:-

1/3^rd of the R40K was used to fund a monthly stream into an endowment with R40K life cover over 10 years

2/3rds of R40K was used to purchase a 10 year annuity paying (then around 16.1% effective) = R434 per month

BUT both run for 10 years max – but drop away if retiree dies within the 10 years. Only pay out on death is R40K death cover from the endowment.

If surviving the full 10 years retiree receives R434 pm + growth on endowment (which can be less than R40K)

Compare this to a GLB which in 1995, using R150 GLB, would have yielded around an effective 16.1% on the FULL value of R40K = R537 per month PLUS the capital was guaranteed in February 2005, regardless of whether retiree survived to that date or not.

The aforegoing sets out clearly just one of many fraudulent issues with Financial Institutional “products”.

But when one speaks to any person within these Financial Institutions they are all extremely nice people - so much so that it is hard to imagine such huge scams occurring – but clearly these scams do occur – the overwhelming evidence proves this.

And all of this is aided & abetted by the Financial Services Board, whose puppet-strings are pulled by the Financial Institutions (read the FA&IS Act).

Who then are these immensely powerful people within these Financial Institutions who intellectualise & manipulate these deviant schemes to defraud society as a whole. They are not faceless & nameless people. They have faces and they have names! Who are these people????????

Then there are the people within government with whom these powerful Institutional intellectuals collude to develop such disgraceful legislation. Who are these people??????

In conclusion

Employers need to rethink the service they provide to employees if they expect employees to deliver service to them.

Employers need to become pro-active and develop alternative & sound retirement planning for their employees.

Reiterate:- The focus herein has solely been on one aspect of annuities, the many other pitfalls pertaining to RA’s, Group Schemes, Preservers etc. have not been addressed.

Chris Addington Pr.Eng.

South Africa

+27 83 962 7098

Chris Addington Pr. Eng.

PO Box 724, Lanseria, 1748 - Tel: (012) 205-1461(H & F) Cell: 083-962-7098

email:

NOTE: CORRESPONDENCES IN REVERSE CHRONOLOGICAL ORDER

Thursday February 27, 2003

OLD MUTUAL

Attention CEO Roddy Sparks

Dave Hudson

Eileen Steeman

Mr Spreeuwenberg

And globally

RE:– Reply to Mr Spreeuwenberg’s letter of 17 Feb 2003 pertaining to Client 1 & Client 2 & follow up to meeting with Dave Hudson.

Please note that I am now circulating these issues globally, as they are of importance to society as a whole, and, for client protection, have edited correspondence to reflect name change to Client 1 (C1) = no. 5598287, 9540565 & 9540564; & Client 2 (C2) = 4670667

Briefly: As a result of broadcast of my viewpoints on SAfm radio in December 2002, Dennis Beckett chairing programme (see also attached complaint to Broadcasting Commission who refuse to enforce the Code of Conduct), I was contacted by Dave Hudson of Old Mutual who requested a meeting with myself in early 2003. Issues concerning Old Mutual (OM) annuities pertaining to C1 & C2 cropped up later in Dec 2002. As a consequence of correspondences (attached) which set out the issues I had a meeting today with Dave Hudson (DH).

After my discussions with DH the view that I have of OM is that there are many staff in the organisation that are truly honourable & with the best motives. However the same applied to Barings - but yet a rogue, Nick Leason, was uncovered – how many were not?

A similar viewpoint exists with OM & other Institutions, as the facts in the attached correspondences show that these issues could not exist unless rogue, immoral, persons were/are within OM, & other Institutions..

Nor could disgraceful legislation such as the “Financial Advisory & Intermediary Services Act” be enacted in Dec 2002 unless the Institutional Investment industry & the Financial Services Board & Government had rogue, immoral persons colluding to put such disgraceful legislation into place.

These issues are merely two examples of the many disgraceful situations within the Institutional Investment industry.

The reply, by Mr Spreeuwenberg, to the issues I raised concerning C1 & C2 are very far from satisfactory for the following reasons. (Note:- The arguments apply to ALL institutions not simply OM.) (Note: The background, as set out in my letter, leading up to the purchase of annuities has minor errors but this does not materially impact upon the complaint re the annuities)

Argument is raised that legislation restricted options for C1 & C2 – but my argument is that the legislation was purposefully engineered by Institutions colluding with the then government to protect the “turf” of the institutions.
Consequently “advice” was purposefully restricted by collusive legislation.
the comparison to Government Long Bonds (GLB’s) is very much of relevance
Annuity rates are quoted as monthly receipts per R100K of funds invested. Examination of these annuity rates show that they are essentially the prevailing rates of Government Long Bonds
A GLB pays out interest every six months until the bond reaches “term” at which point the capital is repaid/redeemed.
An annuity by OM is essentially the same but OM do not pay out the lump sum upon “term” (death) of the annuitant – OM keep these funds, which rightfully belong to the annuitant.
there was nothing to prevent OM (& other institutions) from circumventing legislation and to hold GLB’s and to morally pay out the capital upon death to the annuitants estate. OM chose to keep the capital.
Therefore:-
1. A Government Long Bond is an “annuity” in which the annuitant (their estate) receives back their rightful redemption capital on death.
2. An Institutional Annuity is an annuity in which the Institution unlawfully, immorally, withholds the annuitants rightful redemption capital on death.
the argument of the dual endowment & annuity by OM are invalid –
1. legislation forces an RA to be converted to an annuity
2. consequently taking out an endowment is a “churning” issue
3. the endowment which is funded by 1/3^rd of the capital recovers (hopefully) the initial full capital after 10 years, but the annuity funded by 2/3^rd only produces 2/3^rd’s of the monthly annuity income that a GLB would. Therefore C1 has a shortfall of 1/3^rd of the equivalent monthly income that a GLB would yield.
It is immoral to expect one client to fund the risk of another client which the current OM (& other Institutional) annuity scheme does.
The capital within a GLB is in effect a “death cover”
All of the annuity types have the problem that the full annuity entitlement is not received and/or capital is not paid out to the estate of the annuitant upon death (which would not be the case with a GLB)
Mr Spreeuwenberg’s arguments pertaining to the different types of annuities are invalid simply because all the “types” are less beneficial than a GLB.
OM & other institutions need to explain why annuities are not geared to the “best interests” of the annuitant.
The bulk of investors are low to medium income earners whose taxable position at retirement would likely result in low tax thresholds – therefore arguments pertaining to tax planning are superfluous. (a similar argument possibly applies to the higher income earners as well)
In discussions with DH
1. it is imperative that OM, as well as all corporates, focus on “Moral Leadership instilling Moral Governance” (= Corporate Governance in corporate sector). Corporates cannot use excuse that Government is immoral – it’s up to corporates to set example.
2. It is necessary that OM have an independent assessment of its business; internal assessments are meaningless. (An assessment of 4 man weeks (40 to 50 hrs per week) of fact find, plus 1 man week for finalising report & proposals, would yield substantial benefit for OM)
3. DH advised that OM had done an extensive, global, survey to establish best practice. In a follow up telecon I asked him to look into research carried out by a Gary Boal of Boal & Co. (http://www.boal.co.uk/articles/Investment%20Bonds.htm). The viewpoints of the OM researchers on Boal’s work would be of interest to me. (Note: The results of this article are defective – WHY?)

The aforegoing is simply one example of the many wrongs that consumers are faced with from Institutions – Group Schemes are horrendous I contend.

In consequence OM, I contend, are obliged to provide a solution to this situation - on all annuities for both C1 & C2 – indeed for all its clients.

Yours Faithfully

Chris Addington Pr.Eng.

___________________________________________________

Mr. C Addington

CDADD Consulting Services

PO Box 724

Lanseria

1748

17 February 2003

Dear Mr. Addington

Retirement Annuities – Clients C1 & C2:

An electronic mail message from our Mrs. Eileen Steeman dated 13 February 2003 wherein it was confirmed that I would respond to your e-mail (dated 22 January 2003) during the course of this week, has reference. (Mrs. Steeman approached me for assistance during the course of last week and as your questions are of a somewhat “technical” nature, I offered to be of assistance.)

Before dealing with the different contracts I thought it well to first provide some general commentary as this is important to bear in mind when discussing the detail of the various policies, and to eventually tie this back to the questions in your letter. Please therefore bear with me if the following information sounds a bit superfluous, but I think it is necessary in order to provide a meaningful response to the issues raised.

Retirement annuities are essentially vehicles through which individuals can build up funds for pension purposes. The premiums are tax deductible subject to certain limits and a maximum of one third of the eventual retirement capital may be taken in cash, whilst the balance needs to be utilised to purchase an annuity. (The Pension Funds Act therefore governs retirement Annuities.) At the time these annuities vested the legislative framework governing what could and what could not be done with the proceeds was still very tight. Nowadays investors indeed have much more freedom in selecting the underlying asset compositions yielding the monthly income, but in 1995 selection was pretty much limited to a limited number of annuity types (more about this a bit later) and the company issuing the annuity. (I need to point this out as in this context the reference to a possible investment into long-term bonds (such as the R 150) remains of academic interest only.)

An annuity is essentially characterised by a return of the investment capital as well as an interest portion. As individual circumstances differ, the investor has a choice of various options e.g.

A life annuity with no guarantees:

A life annuity with guarantees:

The annuitant can select for the annuity to be paid for a minimum guaranteed period, and thereafter for life. Should the annuitant die during the guaranteed period the annuity will continue to be paid until the end of the guaranteed period. In both the case of C2, as well as C1 an annuity with a guaranteed term of 10 years and thereafter payable for life were purchased. (More about this under the individual policy discussions.)

Joint life annuities:

Annuitants also have the option of making an annuity payable until the death of for instance two separate people on whose lives the annuity has been affected.

Old Mutual provides different options as a standard part of the communication prior to the vesting date of the Retirement Annuities.

The above just as some background. The level of the annuity will therefore be dependent upon the type of annuity selected as well as the annuity interest rate prevailing at the time the specific option is exercised. The important issue to bear in mind is that the annuitant must select an annuity (at least with the two thirds portion of the retirement capital) – no other investment options are available.

I will comment further about these annuity types when commenting about the investment of R 40 000.00 and what the numbers mean.

At this stage it is however also important to highlight that the annuities purchased through the proceeds of a vesting Retirement Annuity (referred to as a Compulsory Purchased annuity) are fully taxable whilst annuities purchased otherwise (called Voluntary Purchased Annuities) enjoy certain tax benefits.

With the above as the backdrop I would like to turn to the individual policies and deal with your questions more pertinently:

Policies 5598287, 9540565 and 9540564 on the life of C1:

The policy originally vested on 01 February 1995 for an amount of R 54 364.21. From our papers it is clear that C1 elected for the maximum cash benefit (an amount of R 17 712.72) whilst the balance was invested into an annuity which is payable monthly (a monthly annuity of R 518.11) guaranteed for 10 years (up to and including 01 February 2005) and thereafter for life. I can obviously not comment on the selection of this particular annuity type (As opposed to annuities with a longer or shorter guaranteed term.)

At the same time an amount of R 40 000.00 was invested into a plan, commonly referred to as an Anchor Income Plan. The question you seem to be asking is that this appears to be rollover business for the purpose of commission.

This practice was actually quite common during the days this Retirement Annuity vested (i.e. To use the one third in cash portion to purchase an Anchor Income Plan.). Basically the plan is to generate an annuity that is only partially taxable. (In the case of a voluntary purchased annuity the capital content of the annuity instalments is tax exempt.) A portion of the annuity funds an endowment policy and the proceeds of the endowment policy can in turn be invested into instruments yielding a tax free income in the hands of the investor – obviously subject to the Income Tax Act prevailing at the time of the maturity.) In our case these investments occur via the Guaranteed Capital Fund.

Generally speaking these plans were therefore aimed at structuring income in the most tax efficient manner. (It is true that the intermediary earned commission through this structure, but I find it difficult to necessarily argue that this was the main objective. Other objectives also included to ensure a bit of liquidity with a portion of the retirement capital.)

Under this arrangement the investment term was usually 10 years. The annuities are, (what is referred to as) “Temporary life” annuities, payable monthly in arrear for a period of 10 years, but ceasing upon the prior death of the annuitant. The endowment policy (funded via an annuity) has an element of risk cover associated with it – in this instance R 40 000.00. Should the annuitant therefore not survive the investment period the original investment amount is protected. When comparing different annuity types it is important that this can not be dome in isolation of the entire plan.

The reason why a temporary life annuity was usually used in this structure is simply to generate a higher annuity with certain tax advantages during this period, whilst simultaneously protecting the original investment amount upon death. Income would then continue to be generated via a more tax efficient vehicle once the annuity ceases.

Assuming an underlying portfolio growth rate (at the time of the investment this assumption was 15% per annum) the policy would mature at the original investment amount and these proceeds can then be invested into a tax-friendly vehicle. (The method used by you in the specific letter therefore over-simplifies the comparison.)

The present estimated maturity value of the endowment policy (policy 9540565) is R 33 696.21 assuming an average portfolio growth rate of 10% per annum after accounting for management fees and tax. This is below the original investment amount of R 40 000.00, as growth rates were not maintained at a level of 15% within the lower inflation environment. (On the assumption of a 5% growth rate this figure is R 30 565.65.) The death benefit of this policy is however still R 40 000.00

I can simultaneously not really comment about the appropriateness (at the time) of this plan in C1’s particular circumstances, but felt that I needed to point out these elements, as it is not necessarily true that the construct was done for commission purposes.

I would like to respond to the specific issues raised in your letter

A1: As indicated in the above response I do not think one can argue that this is clearly a case of churning business. Churning is usually encountered in the context where policyholders are advised to surrender policies and replace these with so-called better investments. In this instance the policy reached the normal vesting date and the advice seems to have been consistent with advice generally given in those days.

A2: The two thirds vesting proceeds under the Retirement annuity was invested into a life annuity with a guaranteed term of 10 years. The investment of R 40 000.00 was done using a temporary life annuity.

A3: I trust that the detail provided addressed this issue sufficiently.

A4: This issue is unfortunately only of academic interest as the annuitant was compelled (through the Pension Funds Act) to purchase an annuity. Options were available to preserve the capital. (This is usually constructed through a life annuity with no guarantees, but effecting a policy on the life of the annuitant for an amount equal to the remaining vesting proceeds.)

These type of plans obviously yield a reduced income, as the premium of the life policy needs to be funded. I can unfortunately not comment as to why a plan preserving the full retirement capital was not chosen, but it appears from the correspondence as if a high emphasis was placed on generating income, with a reasonable guaranteed period.

B: The opening paragraphs under your heading marked (B) are confirmed.

B1: Your calculations indicate the nature of the different annuity types and cannot be used in this way to determine which option is the better option. I trust that my response addresses this issue sufficiently.

Policy 4670667 on the life of C2:

This policy vested on 01 February 1993 for an amount of R 49 230.42. In this instance a cash amount of R 15 541.46 was elected, whilst the balance was used to purchase a compulsory purchased annuity, payable monthly in arrear, guaranteed for a period of ten years and thereafter for life. (You mentioned in the letter that it is your understanding that this annuity is only payable for the 10-year period. This is indeed not correct, as the annuity will continue to be paid for life.)

I trust that the background and responses provided sufficiently addressed all your concerns. I naturally noticed from the correspondence that both C1 & C2 actually stay very close to Mutual park. I would naturally be prepared to pay them a visit should they wish to discuss any of these issues on a more personal level.

Should anything else be required please do not hesitate to contact me directly.

Yours sincerely

P SPREEUWENBERG

PRODUCT PROVIDER

FLEXI/CONVENTIONAL AND ANNUITY BUSINESS

Tel: 021 509 1225

Mobile: 082 4992458

Fax: 021 509 5055

E-mail: This email address is being protected from spambots. You need JavaScript enabled to view it.

Cc. Mrs. Eileen Steeman

_______________________________________

Wednesday January 22, 2003

OLD MUTUAL

Attention Eileen Steeman

Cc Roddy Sparks

Dear Eileen

RE: C1 & C2

I acknowledge receipt of faxes concerning C1’s policies – too numerous to list. However the issues & concerns that I raised with you have not been adequately addressed.

I would like to simplify the issues so that we can dispense with huge amounts of faxed paper.

Further point – I still await details on C2’s policy

The information I have gathered is as follows.

had 2 x Retirement annuities which were running up to 1995

In 1995 at the age of around 65 a consultant advised to do the following.

with one RA to take out an annuity (9540564) and a Flexi-dowment (9540565). Funded by RA payout plus a top-up of cash to give R40,000.00 total. This commenced in April 1995.

An amount of R25865.42 was paid into the annuity which would give R434.00 per month guaranteed for 10 years

An amount of R14299.46 was used to fund monthly premiums into the Flexi-dowment

CONCERNS:

A1 C1 was advised to take money out of one policy (RA) and to put it into another policy (Flexi-dowment) – this is immoral and is simply churning contracts for commissions. Your system should have picked up that one policy was being encashed and shortly thereafter another initiated.

A2 C1 was sold a 10 year annuity not a life annuity (more later on this).

A3 I was informed telephonically that it was guaranteed for 10 years, but see that the policy states it ceases on death of the life assured – therefore this is not “guaranteed. Please confirm.

A4 Long Bonds (e.g. R150) were giving a listed interest rate of 12%, in April 1995 this was an effective 16.56%, the redemption date is 28 Feb 2005, at which point government pay back the loan capital to investors. I therefore do not see how it was good advice to take out a 10 year annuity giving an effective 16.05% (see Excel spreadsheet) and no capital return at the end of the period.

With the other RA C1 was advised to take out an annuity for life (5598287)

An amount of R36651.49 was invested on 1/3/95 and pays out R518.11 per month, guaranteed for 10 years, thereafter pays out for life.

See policy endorsement letter dated 1/2/95 – item 1. – this gives details as of 1/2/95 that a full annuity would yield R751.90 per month for life. Alternatively a 1/3 encashment & 2/3 annuity would yield a lump sum of R17712.72 and a reduced annuity of R498.31.

A simple calculation shows that 1/3 = R17712.72, yields that 2/3 = 2 x 17712.72. Alternatively that the policy was worth 3 x 17712.72 as of 1/2/95 – or R53138.16. Clearly C1 took a lump sum & a reduced annuity. Your letter of 15/2/95 confirms that R54364.21 was the full consideration and that R17712.72 was taken in cash, with a reduced life annuity of R518.11 per month, but guaranteed for 10 years. Therefore 54364.21 – 17712.72 = R36651.49, and this would produce the 518.11 per month life payment

CONCERNS

B1 - It is clear that C1 (& C2) are not rolling in money, as would be self-evident to any “advisor”. Therefore regardless of where the monies came from to buy the various annuities it is clear C1 had 2 x RA’s and was advised to cash all and to take out another (the flexi-dowment). In addition to take out 2 x annuities – one for fixed 10 years the other for life.

Consider:-

9540564: the investment was 25865.42 yielding R434.00 per month for 10 years only. Or for each Rand invested it produces (R434.00/R25865.42) = 1.6779159 cents per month for every Rand invested
5598287: the investment wasR36651.49 invested on 1/3/95 yielding R518.11 for life (guaranteed for 10 years though). Or for each Rand invested it produces (R518.11/36651.49) = 1.4136123 cents per month for every Rand invested.
Both annuities were taken out at around the same time.
Clearly then there is a serious problem. Who in their right-mind would accept a limited 10 year annuity of 1.6779159 cents per month per Rand invested in stead of a life payment (and guaranteed for 10 years) of 1.4136123 cents per month per Rand invested. Clearly – no one would. So why has OM done this?.
The difference between 1.6779159 cents and 1.4136123 cents = 0.2643036 cents. This equates to (0.2643036/1.4136123) 18.69% premium on the life annuity (guaranteed for 10 years? Assumption that needs to be clarified). Simply stated:- the inference is that a person of 65 and in good health would trade a life annuity for an 18.7% premium to restrict it to only 10 years. No one in their right-mind would do such a thing - unless they were misled.
Further, a long bond (R150) would have given her the same effective rate and any decline in interest rate would have yielded a capital gain, plus capital paid back at redemption date.

B2 - When C1 cashed in the RA in February 1995 to start the 5598287 annuity C1 took a lump sum plus a reduced annuity. This lump sum was used towards the flexi-dowment. Again churning of funds in a policy to initiate another policy thus creating commission flows.

Therefore the main issues are that C1 was advised to enter into a churning arrangement, and secondly to take a 10 year annuity, instead of planning for life time security. Further, it appears that a bond would have given C1 a better return plus capital back at redemption.

A similar scenario exists with C2’s policy (4670667) which is also only a 10 year annuity, i.e. it is not a life annuity.

Gambling on annuities is only reasonable when the basics are met. In both their case’s it was not.

I would appreciate it if you would pass this to your insurers who provide the professional indemnity so that this matter can be resolved promptly either by OM or the insurers.

I would like to have a round table in your Jo’burg office with the appropriate senior person . You also have a David Hunt who contacted m after my comments on SAfm with Dennis Beckett in Dec 2002. He was wanting to have further discussions – it might be appropriate that he attend as well.

Please note: I have been through the issues fairly rapidly – it is quite possible that some calculation errors have come in, but I do not think that it changes the material issues regarding the matter substantially. Please provide your arguments and calculations prior to the round-table, thankyou

Yours Faithfully, Chris Addington Pr.Eng.

correct, except the "with life cover" we only did the maths for no gtee terme. So, for the 10 yr gtee, you need to take your R788 and R800 and subtract off R136 .

Rgds

Carl

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-----Original Message-----
From: Chris Addington Pr. Eng.
Sent: 12 June 2003 5:35 PM
To: Coutts-Trotter Carl
Subject: Re: telecon follow up

Hi Carl

we're missing each other.

Let me try it this way.

A. I am 55, I have R100K cash in hand, I purchase a Voluntary with 10 year guarantee (Capital not repaid) - I get R788.08 per month (from your quote of 6 June). I die exactly at the end of 10 years, my estate gets nothing. correct?

B. difference to A above is R100K comes from an RA = Compulsory annuity. Choose 10 year guarantee. This means that I get R800.55 per month. Die exactly at 10 years, estate gets nothing. correct?

C for the scenarios above if I choose "with life cover" then I get respectively R665.25 and R679.97 per month. When I die exactly 10 years later I get the capital (R100K) back. correct?

Correct so far - if not please insert corrections in the appropriate scenario's

kindregardschris

----- Original Message -----

From:Coutts-Trotter Carl

To:'Chris Addington Pr. Eng.' ; Botha Jeanette ; Hudson Dave ; Carter Roland

Sent: Thursday, June 12, 2003 12:59 PM

Subject: RE: telecon follow up

Hi Chris,

The "current value" you mention (R100) is not that same as the "bond capital".

The "value" is the Present Value of the future coupons + the present value f the redemption payment.

For arguments sake let's assume that you mean that the redemption payment is R100k. You want to know what the annuity payment would be if the client promised to pay us R100k in 12 yrs time (R157 matures in 2015 I think) and bought an annuity for a defined 7 year period (i.e. pmts end after 7 yrs). To calculate the payment I'd just put a present value on the redemption payment of R100k (i.e. how much is it worth today?) ... let's say that at current interest rates the R100k in 12 yrs time is equivalent to R33650k today (12yrs, 9.5% interest rate).

Then I'd just buy a 7 yr bondfor R33650 ... which gives a monthly payment of R498pm.

I'm not sure where you're going with this and I do not (as discussed) agree with you that annuities are "all bad" and that OM's practices are "wrong".

Hope this is what you're after.

Rgds

Carl

-----Original Message-----
From: Chris Addington Pr. Eng.
Sent: 10 June 2003 10:18 PM
To: Old Mutual (Jeanette Botha); Old Mutual (David Hudson); Coutts-Trotter Carl
Subject: Re: telecon follow up

Hi Carl

Thanx4that

I understand what you say on this point - but do you yet see why this is wrong of OM?

Perhaps if I restate another point.

Again assume I have a 5 to 7 year life expectancy. I have an R157 long bond which for ease of the argument has a current value of R100K, knowing that I'm going to peg off latest 7 years I want to maximise my monthly income, so I come to OM and say that I'll cede the bond capital to them in exchange for an additional monthly payment, i.e. I still receive the bond coupon as normal but would also get a monthly from OM for ceding the bond capital. What would OM quote on this?

Ignore technicalities as to whether OM currently has a mechanism to do this or not, I'm purely after the effective flat rate monthly payment that would be expected for those 7 years as from June 6, 2003.

regardschris

----- Original Message -----

From:Coutts-Trotter Carl

To:'Chris Addington Pr. Eng.'

Sent: Tuesday, June 10, 2003 6:11 PM

Subject: RE: telecon follow up

Hi Chris, (S please note - I didn't get the quotes for Capital Repaid (only received Not Repaid))

we have quoted you an annuity (R100k investment) and the cost of life cover for the R100k separately. So, the annuity payment less the life cover premium is the net annuity payment in the Capital Repaid case. We have called this the "net compulsory/voluntary".

Rgds

Carl

-----Original Message-----
From: Chris Addington Pr. Eng.
Sent: 10 June 2003 12:49 PM
To: Coutts-Trotter Carl; Botha Jeanette; Hudson Dave; Carter Roland
Cc: Arend Fairuz (ACTDIV)
Subject: Re: telecon follow up

Hi Carl

Thanx4that

I'm afraid I don't see your argument. Perhaps if you could explain the process briefly in deciding the "risk" of a person who is ill so that you can determine the rate at which the underlying capital is paid back during the clients expected remaining life span.

BUT please also view this from a bond perspective which is blind to all the parameters Institutions raise in argument re annuities (which still do not hold water).

Alternatively stated. Let us assume I was ill, life expectancy 5 to 7 years, and had to (could) choose between a bond or an annuity. If I chose the bond but also wanted to have the capital paid back over the expected life time I could then ask an institution to pay me this back by ceding the bond to the institution - what component of the compulsory would then be the pay back & what the income (annuity)? Or what is the annuity, and what the capital payback, components for the quotes given on Capital Not Repaid?

BUT - the quotes are already low just on a bond/annuity comparison without having to take a Capital Payback percentage off of them (R153 = 9.1% but capital repaid, Annuity M, 60, = 801.77 x 12/100000 = 9.62% but no capital epaid. ALSO NOTE the i is in turmoil so this time selectio would not have been a valid one, but it nonetheless shows that there is nothing to be gained by the annuity; only disadvantages: locked-in, fixed,)

Further point: state of health re compulsory - is immaterial with Capital Repaid

regardschris

PS please note - I didn't get the quotes for Capital Repaid (only received Not Repaid)

----- Original Message -----

From:Coutts-Trotter Carl

To:'Chris Addington Pr. Eng.' ; Botha Jeanette ; Hudson Dave ; Carter Roland

Cc:Arend Fairuz (ACTDIV)

Sent: Tuesday, June 10, 2003 12:05 PM

Subject: RE: telecon follow up

Chris

If you have to buy an annuity (as with the proceeds of your RA), you must buy it whether you are in good or bad health. If in poor health, the length of period we'll pay you is short/limitied. If you were in poor health you would logically also purchase a "capital back' or minnimum payment gtee.

If you have a choice wrt purchasing an annuity, you would not buy an annuity (without capital repayment or a min pmt period) if you were in bad health ... if you did, you'd get little value ... so, in general the voluntary pool is slightly more healthy than the compulsory pool.

Make sense?

This, to some extent comes back to the point you raised about it being "unfair" that clients do not get their capital back on death. If they know they're in poor health, it is certainly the prudent thing to do to buy some sort of gtee or capital back option. Good advice from the finacial planner is essential here.

Carl

-----Original Message-----
From: Chris Addington Pr. Eng.
Sent: 10 June 2003 11:17 AM
To: Coutts-Trotter Carl; Botha Jeanette; Hudson Dave; Carter Roland
Cc: Arend Fairuz (ACTDIV)
Subject: Re: telecon follow up

Hi Carl

Thanx4that

1st part understood & accepted

2nd part - I'm lost here - how can a "voluntary" or "compulsory" scheme be differentiated on this basis - how are mortality differences affected whether you've chosen one or other, do the consumers suffer different types of fatal shocks when they finally understand?

regardschris

----- Original Message -----

From:Coutts-Trotter Carl

To:'Chris Addington Pr. Eng.' ; Coutts-Trotter Carl ; Botha Jeanette ; Hudson Dave ; Carter Roland

Cc:Arend Fairuz (ACTDIV)

Sent: Tuesday, June 10, 2003 9:55 AM

Subject: RE: telecon follow up

Hi Chris

The quotes are correct.

We just put in that statement because our quotes package has all sorts of legal statements about how long quotes are valid for, about churning policies, etc. ... our note did not replicate all of that legalise and can therefore abviously not be regarded as an official offer to do business. Hence the statemernt.

Compulsory annuities are those bought with the payout from an RA (i.e. compulsory by law)... voluntary annuities are those bought voluntarily by the client with money from any source. There is a difference in rates because of the slight difference in mortality of the two pools of lives .... those who buy voluntary annuities are usually as a group slightly more healthy than the comparable compulsory annuity group ... hence the different annuity rate.

Carl

-----Original Message-----
From: Chris Addington Pr. Eng.
Sent: 09 June 2003 6:44 PM
To: Coutts-Trotter Carl; Botha Jeanette; Hudson Dave; Carter Roland
Cc: Arend Fairuz (ACTDIV)
Subject: Re: telecon follow up

thanxfairuz&carl

Please describe the differences betwen Compulsory & Voluntary - why the difference in quoted incomes?

Please note: "quotations are for info & not to be acted on" - I was wanting info that you are confirming as correct - please confirm

thanxchris

----- Original Message -----

From:Coutts-Trotter Carl

To:'Chris Addington Pr. Eng.' ; Botha Jeanette ; Hudson Dave ; Carter Roland

Cc:Arend Fairuz (ACTDIV)

Sent: Monday, June 09, 2003 2:38 PM

Subject: RE: telecon follow up

See ss.

Thanks to Fairuz for quoters.

Carl

-----Original Message-----
From: Chris Addington Pr. Eng.
Sent: 06 June 2003 1:45 PM
To: Old Mutual (Jeanette Botha); Old Mutual (David Hudson); Old Mutual (Carl Coutts-Trotter); Old Mutual (Carter Roland); Old Mutual (Eileen Steeman); Old Mutual (Pieter Spreeuwenberg); Old Mutual (Roddy Sparks)
Subject: telecon follow up

Hi Dave

(Jeanette - please make sure Dave addresses this when back in office on Thurs June 12 - thanx)

These are the points I picked up from our telecon - and agree that this should be included in the process of us assessing Annuities/Bonds.

I'm waiting for "quotes" from Arend Fairuz

Your key point about developing as a proposal to put to government is excellent - please have your "legals" contact me if they have specific requirements, it makes sense to have these built in upfront as well.

Points you raised that need to be considered.

Living Annuities - it's dangers of eating into capital

Fixed Annuities - its restrictions, and hence dangers of being inflation eroded.

To find an alternative,secure, sensible approach for retirement facilities. (thought:- flexibility with moving between cash & bonds would allow for capital gain without high risk of capital loss or income reduction - this, because Institutions are playing the markets with investor funds, they clearly act as a buffer).

Can you give me a brief overview of Living Annuities, key rules etc. - thanx

Any other points?

regardschris

ps we can look towards last week of June to get together - please advise what is convenient.

Chris Addington Pr.Eng.
CDADD Consulting Services.
PO Box 724, Lanseria, 1748, South Africa
+27-83-962-7098

With Profits policies – a scam

I have previously mentioned that the Global Investment arena is a rocky one with many pitfalls. One particular pitfall is the “With Profits” type of investment scheme. In my opinion these are simply fraudulent scams designed to deceive unwary and uninformed investors. “With Profits” type schemes are also sometimes known as “Smoothed Bonus”

How do these schemes work and why are they promoted by institutions.

The investment industry is one that is highly geared to commission earnings of consultants, their success is determined by the amount of business written and hence commission earned. To increase the volume of business written the investment industry has invested a lot of time and money into analysing human behaviour, and have determined that people buy on emotions. Not on rational considerations. This is crucial to understanding why many so called investment opportunities that are promoted are done in such a way so as to address the emotional aspects of each and every client.

Most inexperienced investors are mis-guided to investments that always report consistent, positive returns – yet we know that markets are inconsistent; a consistent low to moderate return is viewed (incorrectly) as being better than a more volatile high return. To satisfy the security emotion of a consistent low return the “With Profits” scheme was developed.

The approach is that investors are told that “With Profits” report nominal annual returns (currently around 9%) but that depending upon performance over the term of the contract any additional gains are paid out on maturity date (the With Profits portion). This all sounds very good but upon further investigation gaps appear which bring these schemes into line with standard investment opportunities thus any advantage disappears if the WP plan is run to maturity, but if encashed early leaves the investor in a sorrowful position. And further investigation reveals that non-transparent aspects make the scheme highly unfavourable.

The contractual conditions generally require that the investor run the plan to maturity, however should they wish to access the funds (in an emergency) they can do so but then penalties apply, and these are usually severe.

In certain instances a further emotional point that is used to generate a sale is that there are no annual management charges. Whilst this is true of the nominal (say) 9% return that is reported what is not stated is that the institution takes it’s annual management charge from the undeclared profits which are held back until maturity. The investor is not

informed of this, nor do they know what percentage charge is levied – i.e. non-transparency.

Further, in the event of general market turn-downs institutions apply what is known as an MVA (Market Value Adjustment). This is applied when an investor wanting to encash does so when the reserves have disappeared/diminished due to market down-turn. It essentially results in a reduced payment. Therefore although the institution continue to report the annual growth based upon a nominal 9% annualised, in the event of a down-turn and the reserves having disappeared the reported unit price is not adjusted. This misleads the investor into believing that their investment has a higher value than is actually the case.

A further penalty of early encashment is that the investor forgoes any reserve profits that have accumulated and which would rightly belong to the investor under normal investment plans.

Contrasting this with a normal investment plan – although volatility is transparent and seen by the investor through the reported periodic unit pricing, in the event of encashment the investor gets the full amount (9% plus the additional profits that might have accrued – but less any early encashment charge).

A secondary market has been created with these With Profits plans and are known as TEP’s (Traded Endowment Policies – With profits variety). Institutions have become aware that many people do not run their With Profits plans to maturity generally because the investor has run into a cash squeeze and needs to access funds from the WP plan. Previously the investor would approach the institution holding the funds for encashment and receive a very poor payout. Now other institutions have come into the market and bid up the encashment value, the objective being that these institutions use new investor funds to take over the policy. The new holder has the benefit of reserves (With Profits) payout at maturity plus any additional benefit from the life assured (usually the original investor) becoming deceased during the policy term.

Whilst this secondary market has improved the lot of the original investor the nett encashment value still falls far short of the inherent value which should really belong to that investor in the first instance.

However a cautionary note to new investors into TEP’s, one has no control over new funds entering into this secondary market therefore the investor is at the mercy of the institution and as to whether the fund and performance is diluted by over-subscription.

I have suspicions that the WP & TEP funds were purposefully designed in the knowledge that many investors do not run their investment plans to maturity, therefore these deceptive scams were devised to churn investor funds.

Recently two articles highlight the kind of reporting that exacerbates this deception.

The first: “The bones of the bonus” (published under www.moneymarketing.co.uk) by a Fellow of the Chartered Insurance Institute takes the view point that “need to know” principle is best. This can be restated as "we know what is best for you - so don't bother asking". Transparency and respect for an investors concerns were not, I contend, in the authors mind. Nothing more need be said about this article

The second: "With profits continue to shine despite bad press" (published in Investment Statistics?)- the trap here is that, as we have seen earlier, the true value of the investment is never revealed, one never knows the true position, or whether in fact it has sufficient funds to meet the unit price. Remember an MVA (Market Value Adjuster) is applied at the time of accessing funds, it is only then that one sees the correct position.

Another caution: is with a "Fund of Funds" approach - I strongly disagree with this unfocused shotgun approach - one can never be certain whether these funds contain "With Profits" or similar funds which with their false reporting would be bolstering the fund-of-fund wrapping. Nor is it easy, if at all possible, to unravel the level of "With Profits" type of funds.

If the absence of regulations allow for non-transparency with the "With Profits", then what is the position with fund-of-funds round-tripping and investing back into it's own funds? (An incestuous form of investment!)

Ultimately the problem lies, I contend, with the Financial Services Commissions/Boards in the various jurisdictions. Focus is more on policing consultants than ensuring that “products” (so called) are correctly engineered. Compare to the motor industry: Regulations focus upon the roadworthiness of a vehicle not on the qualifications/expertise of the car salesman. Many investment opportunities/”products” would not achieve a “roadworthy certificate” – this is why the global investment arena is a rocky one with many pitfalls.

Consequently an investor who is sold a With Profits plan is being deceived into a false sense of security.

In my opinion it is always better to know the truth - look to those institutions that are transparent and report full information; and as an investor take responsibility for your own future; adopt a focused investment approach, also accept indications of downturns as warning signals. And most importantly – don’t panic if you miss a signal.

One will never get it right one-hundred-percent of the time - but what is certain is that by having a disciplined well structured approach the positives far outweigh the negatives. It's a matter of playing a sensible strategy and utilising the right tactics.

Future comment - Demutualisation, another scam.

Chris Addington Pr.Eng.

CDADD Consulting Services, Broederstroom, NWP, South Africa

+27 83 962 7098,

With Profits policies & TEPS

In a previous write-up I discussed the problems of With Profits type of policies (With Profits are also known as Smoothed Bonus). My viewpoint is that these policies are fraudulent scams, as explained previously.

I also touched on, briefly, Traded Endowment Policy Funds (known as TEP funds).

Regardless of my arguments on With Profits & TEP’s my main reason for advising that these funds should be avoided is because of non-transparency within the funds. These arguments merely attempt to explain some of the problems, and dangers.

After further thought my viewpoint is that the two types of funds (With Profits & TEP’s) create a combined effect which must, I contend, cause the schemes to implode (or collapse). I do not countenance the use of either of these types of funds, so I admit that I do not follow them closely, but my understanding is that both With Profits & TEP funds are facing serious problems. So much so that a number of funds have been frozen and I anticipate that others will follow; the reasons for this, I contend, are as follows.

It is important to understand that With Profits are designed to deceive the investor by creating a warm-fuzzy feel of a steadily growing investment; and that nominal returns are posted during the life of the policy; and that (hopefully) and the end of the period that bonuses (the difference between actual performance and posted returns, but less costs) are paid out.

A serious problem comes in when markets take a severe dip, and reserves are consumed totally in trying to plug the gap (between posted values & actual values). In this scenario encashments result in MVA’s (Market Value Adjuster) being applied, i.e. payout is reduced. But nevertheless the remaining investors are still seeing the regular nominal return printed on their valuations (via unit pricing).

It is also important to note that Institutions rely upon early encashments to build up their reserves. In fact research has been done extensively on the early encashment issue and reliance is placed upon these statistics for the With Profits to work effectively. It is the retained growth (not paid out to the investors when cashing in early) that helps to build up the plugs for lean periods.

However another, and more serious problem, comes in: TEP’s. These have now been promoted for a number of years.

Briefly: TEP’s have come about because of the inherent reserves which would be payable if the policy was run to maturity. Consequently a secondary market has sprung up to buy up, and continue, the With Profits policies to maturity. And in turn the Institutions have developed TEP funds.

The nett effect of the secondary market of With Profits policies (TEP funds) is that the underlying With Profits funds are seeing encashments (direct to the issuing Institution) drying up. Consequently the surpluses (retained growths not paid out on early encashment) are no longer there to build up reserves, which in turn squeezes the funds ability to fill the gaps, which in turn means that the utilization of MVA’s increases. This in turn means that new investor funds are more likely to be used on pay outs to old investors cashing-in. But unit price reporting continues with its nominal steady (but false) growth (otherwise investors would no longer have that warm-fuzzy feel – again, a false one though). Which means that new investors are likely to lose heavily (but not seen because of non-transparency, and false unit price reporting)

Obviously at some point this must implode, and this is more likely to happen in deep market troughs, as we are experiencing now. (2000 to 2002).

My contention is that this is why some TEP funds have been frozen, but non-transparency of the funds make it impossible to verify.

A further point for consideration. What is the contractual position of the Institution (in the first instance of issuing a With Profits policy) in relation to the Investor when that investor cashes-in early?

Since transparency in With Profits funds is non-existent it is impossible to say. But my contention is that the Institution buys back via a fronting arrangement so that the Institutions shareholders can claim a portion of the reserves for themselves (via the fronting arrangement)

Consequently it raises the question: What portion of the retained growth actually accrues to the With Profits fund? Non-Transparency prevents us from seeing this. Deception?

The main thrust of this explanation is to caution you to be extremely wary. Some TEP funds have been and still are frozen, this is a serious concern for investors.

The reason for this warning of caution is solely that With Profits & TEP’s are non-transparent. The arguments herein, and previously, attempts to explain just some of the inherent problems with these funds. And that there is a real danger of implosion.

My viewpoint has always been to stay clear of these non-transparent schemes.

A further caution to South Africans. Many people state how well their local investments have performed and that they have “offshore exposure”. My contention is that most of this exposure is in TEP or With Profits funds. In addition there is (has been) a possibility of “round-tripping” of funds back into SA, via “internal” Asset Swap capability, which creates a pyramid.

The shrinking & rusting pot is not Gold!

If you would like to discus these issues, or any other, please do not hesitate to contact me.

Chris Addington Pr.Eng.

CDADD Consulting Services, Broederstroom, NWP, South Africa

+27 83 962 7098,

With Profit (Smoothed Bonus) funds

A Project with Old Mutual to investigate these Financial Instruments

BESA Calculator

All In Price

But we have R100K cash: 100000/123768= 80796 Nominal

Or R875.29 per month(I have ignored the interest accrual in bank)

BUY R150 on March 1, 1995

All In Price

But we have R100K cash: 100000/77549=128950 Nominal

SELL R150 on October 10, 2001

All In Price

BUY R157 on October 15, 2001

All In Price

But we have R137237 cash: 137237/121128 = 113299 Nominal

Or R1274 per month

Graph comparisons

PO Box 724, Lanseria, 1748 - Tel: (012) 205-1461(H & F) Cell: 083-962-7098

NOTE: CORRESPONDENCES IN REVERSE CHRONOLOGICAL ORDER

Yours Faithfully

P SPREEUWENBERG

had 2 x Retirement annuities which were running up to 1995

Yours Faithfully, Chris Addington Pr.Eng.

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