Essentially, an endowment is a life insurance policy, as defined in the Insurance Act. An endowment policy can be used as an instrument to create wealth tax-efficiently. That is however if you are a potential investor with a marginal tax rate greater than 30% and a minimum investment time horizon of 5 years.
Access to one’s capital within an endowment is limited in the first five year period, and taxable growth (interest, net rental income and foreign dividends) is taxed at 30% within the plan to then provide you with a tax-free maturity value. The main concern for the Office of the FAIS Ombud is that in most instances the recommendation of an endowment policy was not appropriate to the client’s needs and circumstances and ought not to have been recommended.
The misleading component of endowment policies stems from the way these policies are sold. These policies are in fact sold as investment solutions and savings products, utilising the term investment as opposed to policy, without any emphasis on the fact that they are, as stated above, life assurance policies. It may appear to be a fine technical issue, but it has significant implications since this description results in the avoidance of how these life assurance products are structured and the various layers of costs involved, because the discussion then focuses on the investment horizon and illustrative returns.
Whilst these products have a place within the financial planning environment, they are not always suitable recommendations to the average client who is looking to invest funds for wealth creation or to save for a specific objective. The categorisation of these products as life assurance policies means that, in addition to surrender fees and penalties, there are additional consequences to the restriction period applicable to, for instance, an endowment policy. In accordance with prevailing legislation the minimum restriction period applicable to an endowment policy is five years.
During this five-year restriction period the insurance company may not allow an investor to either fully surrender the policy or to borrow the full investment value. Furthermore, in the event of the investor increasing the monthly or annual contributions by more than 20% of the previous year’s contributions, a new five-year restriction period will be applied. This means that a 5-year term endowment policy could effectively become an 8- or 9-year term policy by one merely increasing one’s premium more than what is allowed.
These restrictions involved in investing in an endowment policy especially with regards to the liquidity and penalties are not adequately disclosed to potential clients to allow them to make an informed decision as to the policies’ suitability to their needs and circumstances.
N v M
The complainant had initially applied for an educational investment with the respondent in respect of her daughter. The investment subsequently matured during 2019, when the complainant’s daughter was still in Grade 11. As a result, the complainant asked the respondent for the funds to be reinvested in a manner that would allow the funds to be accessed when her daughter matriculated during 2021.
In addition, the complainant had instructed the respondent to initiate a debit order to make further contributions towards the investment. The complainant claims to have explicitly explained not only when the funds would be required but also the reason for the investment, which was the furthering of her daughter’s education. Later in 2019 the complainant made a withdrawal from the investment and in 2020 she attempted to make a further withdrawal, however, she was informed that she could not because of the previous withdrawal during 2019, which the complainant understood.
During 2022 when the complainant’s daughter was making plans to register at a tertiary institution, the complainant was advised of restrictions, that the investment was now in a restricted period and that she is unable to access any of the funds until 2024. The complainant was not satisfied with the feedback provided as she claims this was not disclosed to her at the inception, and that the investment did not cater for her needs as expressed to the respondent’s representative.
On conducting the preliminary assessment of the complaint received from the complainant, this Office noted that the investment referred to by the complainant was in fact not an ‘investment,’ but an endowment policy. It was apparent from the documentation provided that the endowment policy had not been provided to the complainant as a policy, which would then have seen the respondent’s representative make the required disclosures in respect of the restrictions applicable to the policy.
Instead, the respondent’s representative provided this to the complainant as an investment, without any disclosure of the material terms and conditions of the policy. In addition, this Office was also concerned that the advice provided to the complainant during 2019, when the complainant had sought to reinvest the proceeds of the original investment with specific instructions as to when the proceeds will be required.
This Office was therefore concerned that there would not appear to have been compliance with section 7(1)(c) (vii) and 8(1) (a-c) of the General Code and this was put to the respondent in addition to this Office’s concerns with the way the policy was sold to the complainant. Upon receiving this Office’s correspondence, the respondent advised that it would be resolving the matter with the complainant.
The respondent confirmed that the complainant was indeed provided with an endowment policy for a term of 10 (ten) years, with an initial monthly premium of R690 and a lumpsum investment of R83 909,01. In view of the cash withdrawal of R20 000 made by the complainant on 14 February 2020, the respondent offered a settlement value of R82 334,55 which represented the full surrender value as of 14 February 2020 (less the R20 000 already paid) as well as all premiums paid by the complainant after 14 February 2020. This was accepted by the complainant.
Settlement value: R83 909
LESSONS LEARNED:
Financial Services Provides (‘FSP’) will use terms like investment plan, investment builder, savings plan, growth plan etc., when recommending an endowment policy. Always ensure that your financial advisor explains exactly what it is that you are applying for and that you understand the material terms of the product being recommended and that you are satisfied that it meets your investment needs.
When your FSP recommends an investment solution with a term of 5 years, you are more than likely being recommended an endowment policy. Make sure your FSP then explains the material terms of an endowment policy and why the recommendation thereof suites your specific needs.
When an FSP tells you that an endowment policy provides you with a tax free lump sum at maturity, i.e. after 5 years, it is because the growth of the portfolio has been taxed within the endowment at a rate that can be as much as 30% depending on the composition of the portfolio.
