Experienced professionals who have been doing their job for any meaningful period of time will have developed general rules of thumb that help them efficiently perform their role.
For example, GPs know that in most circumstances the best remedy for the common cold is plenty of rest and fluid.
An accountant will tell you to keep receipts for everything, however, if your record keeping is lax, there are shortcuts they can take to estimate deductions.
Similarly, financial advisers have rules of thumb too. For example, people with a mortgage and dependents probably need life insurance, young people can accept greater investment risk and retirees prioritise income and capital preservation over capital appreciation.
The human tendency to form rules of thumb is centuries-old and has a scientific name: heuristics. In ancient times, much like today, heuristics helped people navigate complex conditions and make decisions quickly such as the safest route home.
For decades, rules of thumb helped financial advisers to assess a client’s needs and determine a satisfactory course of action.
Advisers also formed views on the types of products that suited most people in most circumstances, based on their experience. They didn’t go to market and conduct due diligence for every client.
These mental short-cuts kept the cost to serve down and made professional advice affordable for the average Australian.
But today, rules of thumb can’t be used as a starting point for advice. In order to fulfil their best interest duty and related obligations, the law requires advisers to be completely open-minded. Nothing can be definitively ruled out, effectively discounting years of experience.
Under the best interest rules, advisers must research and consider a client’s existing financial strategy including any insurances and investments, in the context of their personal circumstances.
They must then research and consider alternative strategies, stress test the efficacy of each strategy against multiple scenarios, make a recommendation, document the basis of that recommendation and demonstrate why it is likely to deliver the optimal client outcome.
In short, they must justify the advice they give and the advice they don’t give. The catch-all in safe harbour creates this challenge.
This added complexity is driving up the cost of advice. It is adversely impacting the productivity and profitability of businesses, sapping the joy out of being an adviser and ensuring fewer and fewer Australians can afford the advice they need.
Sadly, that is the real cost of proving best interest; a much higher requirement than simply meeting best interest.
Who’s to blame?
In financial services, the answer to that question – whatever the context – is usually, ‘the problem began with Storm Financial’.
As I pointed out in my previous column Three regulatory must-haves for an advice investment service, Storm turned advice into a product. Every client got the investment equivalent of Panadol, regardless of their personal circumstances.
But what Storm did was not completely dissimilar to what was happening across the broader industry, only it was dialled up to the extreme.
Inside many advisory firms, advice almost always leads to a preferred product or vehicle. The best interest duty admirably aims to ensure clients receive advice that meets their unique circumstances and objectives but, under the current rules, advisers are being forced to consider every possible advice permutation.
Given advisers are not schizophrenic, they’re spending a lot of time ruling out options over and over again in order to come to the same conclusion they would have had they been able to exercise their professional judgement.
Admittedly, many of the deficiencies in advice documents are not about the recommendation or the work done to justify that recommendation but what hasn’t been done. The problem is not so much what a file says but what it doesn’t say. This is bought to the fore if there’s a client compliant.
There is no question that advice must be in a client’s best interest but there are significant repercussions if we cannot get the balance right.
Consider what’s already happening in the life insurance space. Anecdotally, advisers are turning people away because it is not economically viable to service them, given the legal obligations.
Once upon a time, advisers could safely direct their clients down some well-trodden paths to arrive at a suitable destination.
For example, a young couple with children and a mortgage will probably need enough life cover to clear their debt and support dependents until at least age 18, as a starting point.
For a single professional, their most pressing need will likely be income protection insurance to maintain their lifestyle and cover any medical expenses, in the event of accident, illness or injury.
Nowadays, advisers must investigate every possible path and the sturdiness of each path, under different conditions, at the client’s expense.
Unfortunately, this means most people are excluded from the advice journey, which surely is in no-one’s best interest.