The final report of the Financial System Inquiry (FSI), released yesterday, is no game-changer for the financial planning profession, but it continues a clear course set by recent regulatory reforms and singles out risk commissions, education and ownership disclosure for special attention.
If there was any lingering doubt as to who holds the whip hand now when it comes to determining financial planner competency, standards and behaviour, it should now be put to rest: it’s the consumer.
However, lest financial planners fear that the FSI’s final report is entirely one-sided, it notes that when consumers have been “treated fairly” by the various parties in the system, then they have “a responsibility to accept their financial decisions”.
Among the 44 recommendations contained in the report, those that relate to financial planners – both individuals and businesses – seek almost uniformly to address what FSI chair David Murray yesterday described as “an information asymmetry and a knowledge gap and information imbalance between consumers and the financial system and product providers and distributors”.
The FSI recommendations, Murray said, do “a lot to rectify that”.
It recommends limiting upfront commissions on risk products to no more than the level of ongoing commission, to eliminate the incentive for churning; better disclosure of the ownership and alignment of financial planning firms; and rasing the minimum educational standards for individuals advising on Tier 1 financial products to a relevant tertiary degree.
Read industry response and reaction from: the Financial Planning Association (FPA); the SMSF Professionals’ Association of Australia (SPAA); the Association of Superannuation Funds of Australia (ASFA); the Financial Services Council (FSC); CHOICE; the Actuaries Institute; regional banks; and the Australian Centre for Financial Studies (ACFS).
Just recommendations
For now and for the foreseeable future, however, the recommendations of the FSI remain just that – recommendations. It could be years before any of the recommendations see the light of day – in the case of the Campbell Report, two years elapsed between its publication, in 1981, and recommendations being enacted.
The Treasurer, Joe Hockey, said yesterday the Government would “carefully consider” the final report, and “in the same way that there was bipartisan support for the implementation of the Wallis inquiry, we are looking for bipartisan support for the implementation of the Murray inquiry”.
The shadow Treasurer, Chris Bowen, said the Opposition welcomed a bipartisan approach, at least on the recommendations affecting superannuation.
Much of the FSI final report’s approach to regulation of financial planners and financial advice reflects closely the issues and approaches foreshadowed in the FSI interim report, released in July this year.
A better way to regulate financial planning
Following the release of the interim report, Murray told Professional Planner that the question of how financial planning is structured and regulated within the broader financial system is a complex one, but there is a better way of doing it.
“Disclosure and financial literacy are not of themselves sufficient in [establishing] the client’s best interest,” Murray said. “You need something more.
“That is actually a big statement. The consequence of it is to take financial services, as a product set, and put them in the same category as other services in the economy, where we argue very clearly that there will always be a knowledge gap between provider and client.”
As an example of how the final report addresses issues of this kind, it recommends changing the term “general advice” to something less prone to misunderstanding or misinterpretation by consumers.
“[The term] ‘general advice’ should be replaced with a more appropriate, consumer-tested term to help reduce consumer misinterpretation and excessive reliance on this type of information,” it says.
“Consumer testing will generate some costs for Government, and relabelling will generate transitional costs for industry — although these are expected to be small. The Inquiry believes the benefits to consumers from clearer distinction and the reduced need for warnings outweigh these costs.”
Perceived and actual conflicts
And the report recommends that perceived and actual conflicts in the vertically integrated business models of some institutions be addressed by clearer disclosure of ownership and alignment.
“Although stakeholders have provided little evidence of differences in the quality of advice from independent or aligned and vertically integrated firms, the Inquiry sees the value to consumers in making ownership and alignment more transparent,” the report says.
“In particular, these disclosures should be broader than Financial Services Guide and Credit Guide rules currently require, and could include branded documents or materials. The Inquiry believes the benefits to consumers would outweigh the transitional costs to industry of effecting branding changes.”
The report adds that “the high concentration and increasing vertical integration in some parts of the Australian financial system has the potential to limit the benefits of competition in the future and should be proactively monitored over time”.
The Treasurer, Joe Hockey, said yesterday the recommendations of the inquiry were “focused on five specific themes”, one of which was “to enhance confidence and trust in the financial system by creating an environment in which financial firms treat customers fairly”.
Quality of advice
Recommendation 24 of the FSI is to “better align the interests of financial firms with those of consumers by raising industry standards, enhancing the power to ban individuals from management and ensuring remuneration structures in life insurance and stockbroking do not affect the quality of financial advice”.
A key element of this recommendation is to limit the quantum of upfront commission on a risk product so it’s not higher than the ongoing commission on that product.
“This would reduce incentives for churning and improve the quality of advice on life insurance,” the report said.
Apart from group life insurance policies inside superannuation funds, and individual policies for members of default funds, life insurance was carved out of the commission ban under FoFA.
“This allows individual life policies to be sold with high upfront commissions, creating an incentive for advisers to make a sale, rather than provide strategic advice,” the FSI final report says.
“For example, these policies can have 100–130 per cent of the first year’s premium payable as upfront commissions, with an ongoing trail commission of around 10 per cent.
“Upfront commissions can affect the quality of advice. ASIC found that 96 per cent of advice rated as a ‘fail’ was given by advisers paid under an upfront commission model. ASIC also found high upfront commissions encourage advisers to replace a consumer’s policy rather than retain it. In some cases, this may result in inferior policy terms. To date, industry approaches to address the issues in life insurance have not worked.”
Benefits are significant
The final report notes that “the benefits of improving the quality of advice are significant”.
“To achieve this, the Inquiry believes that minimum competency standards should be increased and the current Government process to review these standards should be prioritised,” it says.
“In advance of the completion of the Government process, some adviser firms have recently announced they are increasing their own qualification requirements. However, low minimum competency standards have been a feature of the industry for a substantial length of time, and change is needed across the board.
“Many stakeholders are highly concerned about the low minimum education standards of financial advisers, with most supporting lifting education requirements to degree level.”
