Dispute over Discovery’s latest loyalty incentive

PF IOL 23Jan Discovery iol Colin Daniel

Financial services company Discovery has again sparked a debate over its innovative products, this time over the retirement-saving and pension products it introduced at the end of last year.

Discovery, which started as a medical scheme provider, now operates in the short- and long-term insurance markets and offers a range of investment products.

Its innovations were often opposed initially, but then they became accepted as the industry standard. For example, Discovery was fiercely criticised when it turned disability life assurance on its head by introducing benefits based on your level of physical or medical impairment, rather than whether or not you could do your own or a similar job. Now, most of the major life assurers offer cover for impairment.

The latest product range to cause controversy was introduced by Discovery Invest. Its pre-retirement product has an investment “boost” (loyalty bonus) that is paid when you retire, and its investment-linked living annuity enables you to boost your retirement income.

The pre-retirement investment boost depends on how long you remain invested and whether you use Discovery Invest’s collective investment scheme funds as the underlying investments. The boost on the living annuity depends on, among other things, your Vitality status (see “How the product works”, below).

Planners’ criticism

Top independent financial planners Janet Hugo, of Sterling Private Clients, and Wouter Fourie, of Ascor Independent Wealth Managers and the most recent winner of the Financial Planner of the Year award, say the new products are complex and potentially misleading. Hugo and Fourie hold the Certified Financial Planner accreditation and are executive members of the South African Independent Financial Advisors Association,

They say they are particularly concerned that people saving for retirement and pensioners are being encouraged to switch from their existing products to the Discovery Invest products without being made fully aware of the consequences. This is strongly disputed by Discovery Invest, which says its level of disclosure is better than that of most companies.

Fourie says Discovery’s offering sounds incredibly good and is backed by a good marketing strategy, but he cautions that you should compare all the costs with those of your existing or similar products before you decide to invest.

“If you compare apples with apples, you may be better off without the boost,” he says.

Discovery needs to disclose and explain in plain language that, depending on the size of the investment, its annual administration fee may be higher than that of other offerings, and this, together with the high fees on its collective investment scheme funds, is why Discovery can afford to boost the investment upfront, Fourie says.

Clients’ investment returns will be reduced by the extra fees over the long run. Investments with lower cost structures may out-perform Discovery’s offering over time, even after the upfront boost has been taken into account, he says.

Again, this is disputed by Discovery Invest, which says that Fourie and Hugo’s calculations are incorrect and that the costs are disclosed in full.

Fee structure

Craig Sher, the head of product development at Discovery Invest, says the boosts are funded from Discovery Invest’s standard fee structure, including an administration fee and an asset management fee.

“There are no additional fees or hidden charges. What we have found is that, as clients get healthier and live longer because of the Vitality wellness link, Discovery Invest makes more money from the standard fees earned over the longer life expectancy. It is this additional revenue from a longer life expectancy that is used to fund the boosts. The model we use is a ‘shared value’ one. We encourage clients to get healthier and invest for longer periods, and we use the surplus created to give them extra value.”

Hugo and Fourie are critical of the fact that you receive the full benefit of the boost only if you invest for a minimum of 10 years. If you die before then, or if you get divorced and the settlement includes a share of your retirement savings, you will lose the benefit.

Sher says if you are forced to retire because of ill health or disability, you will still receive a portion of the boost.

Hugo says: “We all know that 10 years is a long, long time – longer than Discovery Invest has been in business – so I have my doubts about how many people will actually stay the life of the product to receive the benefit of the investment product.

“What investors need to understand is that they run the risk that ‘life happens’ and they won’t get their bonus boost, plus investment performance, at the end of the 10 years. Discovery doesn’t put its hands in its pockets on day one of your investment and give you a bonus,” she says.

Sher says that, because you cannot mature an RA before the age of 55, it is unlikely that clients will withdraw early, but in cases where they have to, “they won’t be any worse off than with any other typical RA”.

The level of disclosure significantly exceeds the industry’s norms and standards. For example, in the case of the RA and preservation products, the date of vesting (when the payment will be made) is shown on the quotation and on the application form and is explained in the policy schedule and the Discovery Invest “fact file”, he says.

“The boost is shown upfront and tracked every day from inception to the date on which it vests, and every day in between. This is so that investors are aware at every point exactly what their boost will be at retirement. We see this as stronger disclosure than other products that offer a bonus at some time in the future, where the client is completely unaware of the quantum and whether it is worth waiting for,” he says.

Hugo and Fourie say the costs have also been affected by the recent introduction of a flat fee of 0.55 percent, instead of a scaled fee, for using Discovery Invest’s platform, which has resulted in clients who invest large amounts subsidising those who invest smaller amounts.

But Sher says the flat fee has resulted in lower administration costs for almost every client, including those who have not signed up for the loyalty bonus.

He says Discovery Invest provides investors with the industry’s standard illustration of costs, the reduction in yield, which shows the effect of costs with and without the boost, so that investors can see what the costs will be in the best- and worst-case scenarios.

He says the costs are lower when the boost is included, but the costs remain competitive without it.

“The industry standard does not require us to show the value at retirement without the boost, but we have opted to do so despite this.”

Healthy living

With the post-retirement product, Sher says the boost encourages pensioners to remain healthy and to be responsible when choosing a drawdown rate, with the result that they will live longer and their pension will last longer. This, in turn, will increase the size of Discovery Invest’s asset base and the period during which those assets will be under its control. “This allows us to earn additional asset management fees, which enables us to share the persistency surplus with our clients in the form of immediate income boosts,” he says.

As with Discovery’s other integrated products, the more you use other, but often unassociated, products, such as Vitality, the better the deal you receive.

Some financial advisers have repeatedly warned that you are in danger of forfeiting the benefits of integration if you become dissatisfied with one Discovery product and switch to another product provider.

Sher says product integration is designed “only as an upside to clients. If they lose their integration benefits, they should be no worse than the market. At the outset, the products are designed to be best-of-breed without integration.”

With Discovery’s integrated products, it is “crucial to Discovery that clients are acutely aware at every step how to maximise value for themselves, as this also maximises value for us through better consumer behaviour”, he says.

HOW THE PRODUCT WORKS

The loyalty-bonus products that Discovery Invest, the investment arm of financial services company Discovery, launched in September 2015 are for people who are saving for retirement and retirees who buy an investment-linked living annuity.

Savings product

The Discovery Retirement Upfront Investment Integrator provides a notional boost of up to 15 percent to a lump-sum invested in a pre-retirement savings product, provided that the underlying investments are Discovery Invest collective investment scheme (CIS) funds and the investment is maintained to retirement. The minimum investment term is 10 years.

The incentive uses Discovery Invest’s Core and Classic pre-retirement products, which are for people who invest a lump sum in a retirement annuity (RA) or who transfer a benefit from an occupational pension or provident fund to a preservation fund. The incentive does not apply to recurring contributions.

The initial boost grows at the same rate (after fees) as the returns earned by the portfolio.

To earn and retain the maximum boost, the underlying investments must be in Discovery Invest CIS funds.

The initial notional boost will reduce if you:

* Switch all or part of your savings out of Discovery Invest CIS funds into CIS funds offered by other CIS managers on the Discovery Invest investment platform. Switching into Discovery CIS funds from the funds of non-Discovery managers will not increase the initial boost. The initial boost can be increased only if you increase the investment term.

* Make withdrawals from the investment portfolio (for example, because of transfers to another product, death or a settlement in terms of a divorce order) before your pre-selected retirement date.

* Change your retirement date. You are allowed to change your retirement date, as long as it is not within 10 years of the retirement date you selected. The new retirement date must be at least 10 years later than the date of the retirement date you chose initially. The notional boost will be recalculated in line with the new term to retirement.

The return you receive on the initial notional boost will match the return on your capital investment. This return will depend on the funds you choose and how well those funds perform.

You will not be paid the initial boost or the return on the boost if you do not stay invested for the predetermined period. The longer the term, the larger the loyalty bonus. Discovery says this is to encourage you to start saving for retirement as soon as possible, and to keep saving, to improve your chances of retiring financially secure.

The initial notional boosts for each investment term are as follows:

* 10 to 15 years – 7.5 percent

* 15 to 20 years – 10 percent

* 20 to 25 years – 12.5 percent

* More than 25 years – 15 percent

An example: Joe is 35 years old and plans to retire at age 65. He has R500 000 to invest in an RA. He is 30 years from retirement and therefore qualifies for a Retirement Upfront Investment Integrator boost of 15 percent, or R75 000, but his underlying investments must be in Discovery Invest CIS funds.

Assuming an investment growth rate of eight percent a year after fees, the initial boost of R75 000 will grow to R754 699 over 30 years. At retirement, Joe will receive his initial capital and the investment returns, a total of R5 031 328, plus the boost of R754 699, or a total of R5 786 027.

Pension product

The Discovery Retirement Income Investment Integrator is an investment-linked living annuity. Therefore, you must select the underlying investments and how much of your capital – between 2.5 and 17.5 percent – you want to withdraw as a pension each year. You take the risk that your pension income will last until you die.

To receive the full benefits of this product, you must belong to Discovery Health’s wellness programme, Vitality.

The level of your pension top-up depends on your Vitality status, which ranges from Diamond (top) to Blue (bottom), the rate at which you draw down a pension and the underlying investment products.

If you meet all the criteria, you can boost your pension by up to 50 percent for 10 years from the date of retirement.

Discovery says the Retirement Income Investment Integrator rewards pensioners for leading a healthy lifestyle and making sound financial decisions.

The enhanced income payments are made directly into your bank account as part of your pension after the deduction of tax.

You will receive the maximum income bonus of 50 percent if the underlying investments are in Discovery CIS funds, your Vitality status is Diamond, and your pension drawdown is less than 3.25 percent for 10 years.

The additional income will be reduced if:

* Your pension drawdown is more than 3.25 percent initially or at any time during the 10 years. If you draw down more than 10 percent, you will not receive an income boost.

* Your Vitality status is lower than Diamond. For example, if your drawdown is less than 3.25 percent and your Vitality status is Diamond, you will receive the maximum income boost of 50 percent. The boost will fall to 45 percent if your status is Gold, to 40 percent if it is Silver, to 35 percent if Bronze and to 30 percent if Blue.

* You are not a member of Vitality. If you draw down less than 3.25 percent, your maximum boost will be 20 percent.

* You limit investing in Discovery Invest’s CIS funds in favour of funds offered by other CIS managers on the Discovery investment platform.

* You switch from Discovery to non-Discovery funds during the first 10 years in retirement.

Craig Sher, the head of product development at Discovery Invest, says pensioners have more control over their Vitality status early in retirement, and this why the loyalty bonus pays out over the first 10 years.

He says pensioners are warned that they should use the additional income wisely.

Sher says pensioners can smooth their income by reducing their drawdown rate in the first 10 years of retirement to earn the loyalty boost and then increasing the drawdown rate once the bonus ends.

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