“Turn him to any cause of policy
The Gordian knot of it he will unloose
Familiar as his garter.”
(Shakespeare, Henry IV, Act 1, Scene 1)
The financial planning industry is in a state of revolution. Basic assumptions that have been accepted as “holy writ” since the modern industry’s genesis some thirty years ago are being vigorously questioned.
Unprecedented falls in the value of stockmarkets, combined with government- and media-driven inquisitions into collapses such as Storm Financial, Westpoint and managed investment schemes, have led to a crisis of confidence amongst planners. They are concerned about the industry’s future and their ability to retire from their businesses for the handsome prices that were available only twelve months ago.
Such is the demand for reform that key industry bodies, such as the Financial Planning Association of Australia (FPA), have been forced to propose a move away from commissions – a position that was heresy only twelve months ago. Some planners hope that when the market recovers, much of the negative talk and calls for reform will dissipate. They hope that life will return to “business as usual”. It won’t.
While the immediate catalyst for revolutionary reform has been the global financial crisis (GFC), the financial planning industry was built on crumbling foundations of conflict of interest, rather than on a solid platform of independent professional standards. Therefore, fundamental reforms were always going to happen sooner or later. The crisis simply made them happen sooner.
It is an unavoidable conclusion that the financial planning industry’s “corrupted” structure has created a transaction-based sales culture, which more often that not improperly influences the quality of financial planning advice. This is the core of the industry’s problem, both real and perceived. Regrettably, to put it another way, the problem is saying one thing and doing another – also known as hypocrisy.
The planners know it, the dealer groups know it, the fund managers know it, the regulators know it and most importantly of all, the clients know it. However, such is the entrenched nature of the vertically-integrated product distribution culture that it has taken a severe crisis to force reform on an industry that has no enthusiasm for it. Why the lack of enthusiasm, when it is so obviously needed?
The answer lies in an understanding of the recent history of the financial services industry and in the development of its basic power structures. Financial planning emerged as a separate discipline in Australia in the early 1980s. Its culture is deeply rooted in the sales-oriented life insurance industry. The 1980s were boom years for life insurance selling in Australia.
Throughout that decade an army of high-pressure sales agents, with little regard for their prospects’ circumstances, aggressively sold whole-of-life insurance policies to naïve victims who were seduced by promises of big tax deductions and capital-guaranteed returns. Their widespread success in this activity was rewarded with huge undisclosed commissions (up to 200 per cent in some cases).
In addition to lucrative commission structures, these were the days of low/no interest Agency Development Loans (ADLs), during which time tens of millions of dollars were literally thrown at “big producers” by otherwise conservative life insurance companies who were at war over market share. In most cases, their mutual status and their lack of accountability to shareholders made it possible to engage in practices that would now be viewed as an irresponsible, if not illegal, use of shareholders’ funds.
The “big producers” were courted on the basis of “whatever it takes” to sign them up to an agency agreement. Many accountants were offered ADLs because it was correctly assumed that the profession was well placed to convince clients to buy these awful policies of insurance. A minority of accountants couldn’t resist the temptation, selling out their independence in return for a pot of easy money that could be employed to buy a building or to pay off the working capital overdraft.
And some of the more colourful sales agents were reported to have ploughed their loans into fast cars and luxury yachts. Such was the strong sense of ego-driven competition surrounding who could win the biggest ADLs, that there were weekly stories in the financial media about who had extracted how much out of whom.
It was simple to qualify for an ADL: Sell lots of whole-of-life insurance (or even promise to do so), and you, too, could be the recipient of millions of dollars in loans, most of which were written with such inadequate security as to make the US sub-prime market look positively responsible. The best way to describe the life insurance industry in the 1980s was as being “in a state of frenzy”.
Market share was king, financial disciplines mattered little, and consumers mattered even less. And then the sales frenzy subsided. The 1987 stockmarket crash, followed closely by the “recession we had to have” in the early 1990s, ensured that sales of whole-of-life insurance policies ceased. The recession meant that cash-starved businesses and individuals, who should never have been sold these policies in the first place, could no longer afford to pay the hefty premiums ($100,000 per annum was common).
To make matters worse, many of the policies were funded through bank overdrafts on which agents were receiving trailing commissions. As a result, the clients suffered termination penalties (but still owed the bank), the agents suffered substantial commission write-backs (which curtailed their impressive lifestyles) and the insurance companies wondered how to recover the ADLs and their tarnished reputations.
At much the same time, compulsory superannuation came on line, providing for most people a minimum amount of life insurance cover and an excuse for not buying any more. The fall of the life insurance agent coincided with the rise of the financial planner. Not wishing to be tainted by the poor image of life insurance selling, many former insurance agents found new opportunities in the world of managed investment funds, and life insurance was pretty much ignored as the province of the old “white shoe brigade”(until the resurrection of life insurance selling by planners in 2009, driven by financial necessity).
This combination of factors has led to a situation in which many Australians are underinsured. Many people would prefer to assume that their superannuation fund will cover them adequately should the need arise; whereas in reality, most funds do not tailor insurance to members’ individual needs. They simply provide a minimum sum insured.
Throughout this time, the accounting profession simply looked on with a somewhat superior and elitist attitude. A number of unsuccessful attempts were made to engage the accounting bodies in serious strategic thinking about financial planning and how their members should be involved in this growing industry. The view from most of the profession’s influential “visionaries” was that financial planning should remain the province of salespeople. It was said that accountants, if involved at all in financial planning, should simply be referrers of business.
This shortsighted, disengaged attitude is still widespread in the accounting profession. It is a significant factor in explaining why the financial planning industry has failed to transform itself into a professional occupation. In an ideal world, financial planning should have become an important subset of the accounting profession and a principal activity of all general practitioners.
The fit is obvious. Instead, the accounting profession was so distracted by the complexities of taxation and compliance, and so convinced of the unprofessionalism of financial planning, that it “missed the boat”. So the financial planning industry remained (and remains today) substantially under the control of fund managers, who (understandably) view it as a product distribution network, in which the provision of strategic advice is a means to an end, rather than the end in itself.
The principal reason that reform is so strongly resisted is that removal of commissions and asset-based fees will break the stranglehold that financial institutions have always had over the distribution side of the industry. The only way to create lasting trust in the minds of consumers is to break the nexus; and the only way to do that is to remove commissions, asset-based fees, and any other forms of remuneration that encourage financial planners to sell products and accumulate funds under management.
Unless this is done, financial planners will never achieve the professional status that they so desperately want; the FPA’s proposal to phase out commissions will amount to very little; the industry will continue to be heavily regulated; and, most of all, the quality of financial planning advice will continue to be compromised – which is a tragedy for those consumers who need good advice.