I guess now that both IFSA and the FPA have run the Government’s line on commissions, we need to look at the ramifications for the industry.
I personally don’t have as much against commissions that many have, provided we have appropriate disclosure and perhaps some limits on the amounts of up-front and trail commissions that can be provided without a client warning clearly set out on the PDS. For smaller clients, even those not serviced every year (if that is what is agreed with the client up front) a modest up front and trail approach can be appropriate.
A planner friend set up a great business several years ago, focussing on a niche market for employees leaving a defined benefit plan. Typically, the best advice was to rollover a small lump sum, and continue with a deferred defined benefit pension. In return for this (in my opinion) appropriate advice, the firm received a modest advice fee and a small rollover (typically, say, $20,000).
The firm received trails of 0.25 per cent on these rollovers (on average $50 a year) and clients didn’t receive a full review each year. The client was aware of this and accepted this arrangement.
I have heard senior FPA employees publicly criticise these types of arrangements which, in my mind, are entirely appropriate.
Given that this niche strategy worked well for the client and helped the adviser build a respectable business, this is to me “normal” business. Planning is not a homogenous business, it is a range of services with different value propositions that suit different clients.
THE KEY ISSUE
But the key issue here is that there is really no turning back – once you say commissions must be able to be separated from super products then you really have to apply it to ALL products and services that planners use, and arguably both from an up-front and trail perspective.
It is very hard to imagine the Government applying this to superannuation only, as most of the abuses of the system were outside the super regime in any case.
And for this reason I am a bit surprised that the big life companies have come out in favour of the more purist “fee” approach.
The other crucial issue is whether the planning client should receive 100 per cent compensation in terms of an equivalent reduction in product fees or a cash payment equivalent to the commission if they choose to “switch off”.
It’s a bit hard to argue against this in that if a payment is made to a dealer group bank account then surely that could be substituted for the client’s bank account number (or to grant the clients additional units or benefits to the same value).
Incidentally, more than seven years ago a few fund managers did change their existing retail products, and gave clients a new option to turn off the trails (in return for extra units each month).
And whilst this functionality was only used by a few planners (and a couple of clients directly), this at least demonstrates that the technology has always been there to achieve this in terms of investment products.
Moreover, if new clients are able to turn off trail commissions on new sales only then the consumer lobby will (naturally) argue this should be the case also for existing clients, and for up front commissions as well.
FEE OBSESSION
If, as described above, this fee obsession passes to all products, then life insurance clients will probably in the next few years be able to also turn off commissions. The ex-commission price of life insurance (ex-advice) will fall dramatically.
Call me old fashioned (and many do!) that whilst this looks good from a consumer point of view, this approach may not help raise the overall level of insurance amongst Australians, as it can be argued that life insurance needs to be sold, not simply purchased.
I personally know that the life specialist who (thankfully) forced me to review all my life and income protection insurances a few year ago gets ongoing commissions from two life companies. I knew that was part of the deal and I wasn’t charged any up-front fees and he did a great job on the insurance needs analysis, selection of policies, client education (I learnt a lot about the best way to structure my insurance), and he did have to chase me eight times to get me to complete my medical information.
Let’s think about other commission-type payments (excluding soft dollar to make this simple)
– Up front and trail commission on investment products, including master trusts
– Up front and trail commission on superannuation products, including master trusts
– Life Insurance contracts
– General Insurance
– Mortgages
– Share brokerage type commissions received by planners (typically up front, transactional only)
Whilst super does have some compulsory element, surely the purist argument that product sales and commissions must be ultimately be separated should apply to all of these “commissions”?
POWER TO THE PEOPLE?
Let’s now imagine that the Government forces the industry’s hand (seems like it doesn’t need much forcing) and this is applied across the board. The numbers are staggering just from the annual reports.
For example National Wealth Management Holdings Limited (part of the NAB/MLC Group) paid $445m in commissions on life insurance and life investment commissions in 2008, and AMP lists a “commission expense” of $557m in its accounts.
Just these two life insurance based firms add up to more than $1billion in commissions, so the industry numbers are large without even extending this analysis beyond the big life companies to, say, non-life investment and super products.
OK, so now assume that clients are given the right to switch off commissions in the future (which I have stated above I don’t agree with) and let’s assume that each client has, on average, 10 commission-based products. This means that each client would receive 10 letters from their product providers giving them the Government-endorsed message that they now have the right to turn off the commission.
And what would be the BEST advice to give these people? Simply turn it off and re-negotiate with your adviser – nothing to lose, perhaps something to gain and in the future you will more directly control the payment for the services that you receive. And if the client doesn’t respond, should the commission continue or stop? Will the Government adopt an opt-in or opt-out approach?
ORPHAN CLIENT AND LEGACY ISSUES
From a product revenue point of view, a payment that ceases to be paid to an external adviser (with a resultant lowering in the client’s fees) is revenue neutral to the provider (more correctly slightly revenue positive as the payment transaction does not have to be made).
This is not the case for clients where the commission was being received by the product provider, particular for old legacy products.
CHANGE THE GAME, “INTERNALISE” OR BADGE THE PRODUCT
The industry response will be clear. For the major services that a planner uses, simply badge a product that is effectively “owned” by the licensee and perhaps the adviser. The product would have no commission as such but the effect would be much the same. Naturally the conflict would need to be disclosed. Only complete separation of product providers and planners would totally stop this approach. Soft-dollar regulations become more important – and hopefully we won’t see product commission being replaced by more soft-dollar.
QUID PRO QUO
If the industry plays the game, do they deserve something in return? Perhaps the quid pro quo is clear tax deductibility of advice fees and an advice rebate for low-income clients in return for the ability for clients to totally “switch off” commissions.
Whilst commissions could still be built in the industry would also agree a maximum limit of in-built commissions of say 3 per cent up front and 0.6 per cent ongoing for investment products to stop some product manufacturers promoting big commission products to planners.
It was interesting that Professor Robert Shiller from Yale University advocated this approach in the talk he gave at Perennial’s INVEST’09 conference – his logic was that the root cause of the GFC was a lack of appreciation of risk at even the consumer level (who gobbled up the sub-prime loans) and the Government should encourage advice and financial literacy.
WINNERS AND LOSERS
Winners :
Manufacturers of good products that stand up ex-commission
Planners with excellent value propositions and delivery mechanisms
Providers of flexible back office systems to facilitate this process
Planners independent of product providers
Losers
Discount investment product brokers
High-commission players who refuse to change
Product providers with big legacy books not being serviced
Life product providers
Planners owned by product providers
THE BOTTOM LINE
Not all commissions are evil. Financial planning is a value-add service that, like other services, needs to be paid for. Selling someone life insurance to protect their family is a sometimes unappreciated service that needs to be paid for.
Giving superannuation investors the right to switch off trails and the continued bashing of commissions may be politically correct but whether it really solves the puzzle of how to help the average person budget, save, invest, borrow and insure is the real issue.
Let’s agree to a sensible timetable to go give the total “switching” power to clients, but work hard to gain some important concessions on the way to ensure planning in the future is not only available to the wealthy with a big cheque book.
Brian Thomas is head of retail funds management for Perennial Investment Partners
