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Will the new rules for financial advice make a difference?

From 1 July 2013, investment managers and platforms will be banned from paying commissions on new business to financial advisers. In my opinion, this is a positive step and should have happened years ago. However, the industry’s tardiness in addressing such ‘conflicted commissions’ has resulted in additional regulations which apply to any advice fees that are deducted from clients’ accounts, not only the commissions.

Financial advisers will be required to send clients an annual fee disclosure statement, and every two years clients will have to sign an agreement to allow those fees to continue to be deducted. The catalyst for these measures was the implosion of Storm Financial, but there have been a number of similar collapses which resulted in heavy losses for investors. High commissions and conflicted advice were adjudged to be the main culprits, but percentage-based advice fees which were deducted from a client’s investment also came under attack. The Government view is that advisers should charge a ‘fee for service’ via an invoice, just like other professional service providers such as accountants and lawyers.

Another unexpected legislative change was that insurance commission in super will be banned, but not if the insurance is arranged outside super.

The major objectives of the legislation – unbiased advice with clearly identified charges that are agreed in advance – are commendable, but do they address the original problem, are they fair and will they work? It is possible that the legislation ignores some ‘inconvenient truths’ which have not been addressed or even satisfactorily debated.

Inconvenient truth 1

There is a fundamental difference between commissions and percentage-based service fees. Commissions are hidden payments to advisers (usually via their dealer groups or licensees) by fund managers or platforms which the client cannot access, even if they sack the adviser. Asset-based service fees are mutually agreed, transparent fees paid to the adviser by the client from their account balance.

Inconvenient truth 2

The legislation encourages ‘fee for service’ invoicing, which doesn’t suit many clients in need of financial advice such as working families with a mortgage to pay, kids to educate, elderly parents to look after, and student children living at home. These people invariably have a cash flow problem already. Given a choice between paying an annual invoice and having the money deducted from their super account, they invariably choose the latter.

Inconvenient truth 3

Australian investors have lost lots of money where criminal or fraudulent activities by advisers, or bad product design by manufacturers, are involved. Commissions were often a symptom but not the underlying cause. Provident Capital and Banksia have recently gone into receivership, and clients will lose a serious amount of money. Their mortgage income products did not pay commission and were sold directly to the general public.

Inconvenient truth 4

Licensees and dealer groups are responsible for the training of their employees and representatives and have absolute responsibility for their actions and advice. In turn, these organisations are regulated by ASIC which is supposed to make sure the licensees are operating properly and identify any misdemeanours. If this system is not working, it will not be fixed by banning commissions and better fee disclosure.

Inconvenient truth 5

Insurance commission for advisers in super is usually a relatively small amount of money deducted on an annual basis from a client’s account. Insurance outside super is usually a relatively large upfront commission payment with a relatively small amount paid annually. The former will be banned, the latter will not. Ask yourself whether this measure will see Australians receive advice that is in their best interests.

It is extremely difficult to charge fairly for insurance advice. There is a lot of work involved in setting up an insurance policy, possibly not much while it’s in force but a huge amount if a claim needs to be made. Insurance providers work on the premise that everyone pays a relatively small amount of money in order to cover the payouts given to those unfortunate few. Consequently, it seems logical for a financial adviser to use the same principle – receiving small monthly commissions from everyone in order to subsidise the high cost of assisting with a claim. It’s not perfect, and there is a high degree of cross subsidisation, but surely this is better than charging a grieving spouse hundreds of dollars at the worst possible time.

Inconvenient truth 6

The average financial adviser does not make much money. The cost of running an independent financial planning practice is rarely less than $250,000 per annum. Expenses include office rental, support staff, professional indemnity insurance, compliance costs, research, licensee fees, IT, accounting, auditing, and on it goes. The majority of these costs have to be paid monthly. Statistics from the Corporate Super Specialists Alliance reveal that the average superannuation balance is around $20,000 and the average commission is 0.44% per annum. After GST and company tax, this adds up to $56 a year for the average client.

Inconvenient truth 7

The ‘opt in’ provisions require a client to move from an arrangement which the client can stop at any time to one where they are committing to paying advice fees in advance. Many clients will choose not to pay, and go without the advice they need. How can this be a beneficial change?

 

I agree that commissions are bad and should be banned. I agree that many financial planners focus primarily on selling product, and this is also bad. However, I fear that the new legislation will drive many small-to-medium financial planning practices out of business. Our profession has the potential to do an enormous amount of good. Australians need a thriving, well diversified financial planning industry in order to receive good advice about cash flow, debts, investments, super, insurance, estate planning and tax. Let’s not throw the baby out with the bathwater.

 

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