The great commisison debateDolfinwise Financial Planning

An opinion from Jason Bragger, principal of Dolfinwise - a genuine fee for service business - 25 September 2009

Download full article

A concise history

The financial planning “profession” grew out of the life insurance industry. This industry consisted for many decades of insurance sales people who professed to be nothing more than that. They were generally tied agents who sold one companies products for commissions. During the 1980’s and early 1990’s many of these agents started to sell investment products along side their traditional risk offering and continued to be paid by product providers for intermediating with clients. Again, as a general rule these sales people did not claim to be other than representatives of the product provider.

During the 1990’s the concept of a “financial planner” or “financial adviser” started to gain prominence and some of the previous Insurance sales people started to expand their offer to include selling products for more than one company. Some also started to profess to be more than sales people and part of the industry set its eyes on being recognized as “professionals”

The most fundamental event in time that has led to the current controversy was the 2001 introduction of the Financial Services reform bill. This made most financial product sales people “authorised representatives” of an Australian Financial Services Licensee. These licensees based on history were almost all owned by financial product providers and as per history provided their licensed “advisers” with numerous incentives to recommend their in house products.  Nearly all authorised representatives dealing with investment products started to use the term financial adviser or financial planner whether or not this was a reasonable description of the service they were providing the client.

The result is a flawed industry where product providers pay, incentivise, train and encourage their “authorised representatives” to sell their products while presenting themselves to the market as “advisers”. Consumers needing advice go to these product sales people thinking they are getting impartial advice when the real agenda of most advisers in the industry is to sell products for their product provider parent to be rewarded via commission and other payments.

The present

While most advisers argue they do provide great benefit to their clients through their advice, the advice is generally filtered through a screening process that is seeking to sell the client a product rather than simply provide the client with the absolute best outcome for their circumstances.

There is a conflict of interest between what the client wants and needs and the mechanism by which the “financial adviser” earns their living.

Despite legislation requiring full disclosure of these conflicts the reality is that the complexity of financial issues and the industry is so great many clients simply do not understand that the “advice” they are getting may not be in their absolute best interests.

Obvious examples of the impact of these conflicts of interest are as follows. Few commission based advisers will consider recommending clients pay down their home loans, cash in managed funds to buy term deposits, buy investment properties, buy direct shares, or retain or use industry superannuation funds when these are all solid strategy options that are appropriate for many clients.

Client benefits of a pure fee for services business model

Client of pure fee for service advisers can be assured that the adviser is attempting to provide advice to a client that is in the clients “best” interests. As opposed to most authorised representatives who currently attempt to improve the client’s situation in some way while justifying a product sale thereby not necessarily creating the optimum solution for the client.

Dolfinwise believe that those professing to be “financial advisers” or “financial planners” should be obliged to provide to the best of their skills and knowledge the “best possible advice for the individual client based on their disclosed circumstances. It is arguable in this situation, whether product providers would derive any benefit from licensing this type of adviser and in our view should be banned from doing so to ensure no conflicts of interest. “Advisers should operate on a fixed (hourly, monthly or annual retainer).  Once the fixed rate or fee is agreed with the client then method of payment can be chosen based on convenience, tax efficiency or other. The fee should not be asset linked as this creates a bias towards the adviser increasing investments possibly even encouraging excess risk taking in the portfolio as per the recent well publicised Storm Financial model

At Dolfinwise we believe there is still a place for sales people selling wrap accounts, managed funds, and life insurance. However these people should be required to call themselves product sales people and be limited in the scope of advice they provide to the products they represent. They should be required to offer the client a referral to an independent “financial planner” as they are not able to consider whether their product is suitable to the clients overall situation. These salespeople could then be remunerated via commission from the provider whose products they sell.   

Trying to create one playing field for all authorised representatives is going to cause consumers to be limited for choice and have some unintended negative consequences. Most current “authorised representatives” do not have the technical skills or knowledge to become advisers who can charge sufficient for their advice to cover the cost of running a practice in the current FSR regime. Therefore if all are forced down a pure fee for service path there will be a dramatic exit from the financial services industry and that will be bad for Australians who need advice.

We believe strongly however that the current regime needs changing so clients are not misled by sales people masquerading as financial advisers who are driven by sales targets and the need to place funds in commission based products.

 The government could help with the suggested transition above by reducing the onerous compliance burden on practices imposed by the FSRA.

If genuine financial advice practices as described above are free form conflict of interest many of the protections and documentation required under FSR in giving advice could be pared back. Once the conflict of interests are removed there should be no need to provide detailed comparison of product analyses and produce such large compliance documents. Lawyers and Accountant have managed for centuries giving advice without as a general rule needing to produce massive disclosure documents. Thus if the rules were altered to reflect this “free from conflict” world, the cost of genuinely independent advice should be able to be reduced significantly making it affordable to more Australians.

Our expected outcomes

It is fairly apparent that upfront commissions and inbuilt trailing commission will be banned. This is a very small step in the right direction but not a major shift if asset based charging via a product is left as an option. While advisers will have to disclose to a client what their upfront cost will be, a large part of the industry already does this and many who don’t, if forced will be able to make this adaption with some coaching.

Asset based charging via product if not banned will largely allow business as usual. Advisers will build an ongoing % fee into product they submit meaning the bias towards the parent companies products will remain, Also there will remain a bias away from strategies and products that don’t pay adviser remuneration. Consequently the public will still fail to get the independent “advice” service they desire.

There is growing momentum for asset based charging to be banned however it would be a significant issue for the industry if that were to happen as advisers would be required to negotiate an actual fee with each client they engaged. As mentioned above, many will simply not have the skills to convince the clients of their value proposition and their businesses will fail if forced to charge direct fees.

Our preferred solution is that all who claim to be “financial planners” moving forward should be required to agree a fixed fee for both the upfront and ongoing work with their clients. Once this is agreed the client would be given the option of paying the adviser directly via annual cheque or monthly direct debit or if the client had a suitable product from which a monthly debit could be received then they could choose to pay the agreed fixed fee from there. Fees should be required to be signed off by clients each 12 months. 

Volume bonuses that are currently paid to licensees by product providers to encourage loyalty also distort the market and encourage adviser to recommend products that may not be in the client’s best interests. They also create a layer of fat added to the product fees that client’s pay and fund amongst other things, overseas junkets and excessive hospitality to encourage advisers and advice networks to stay loyal to a product regardless of its relative merits for the client.

In our view these payments need to be phased out over a set period of time to allow licensees to adjust but ultimately force products to compete for adviser attention based solely on their attributes.

While a number of industry commentators have suggested a duel licensing system as I have advocated above, there does not appear to be great momentum for this view at this point in time. This has been attempted in the UK but without great success.

Whatever the outcome of the various current regulatory reviews, I hope the industry is given reasonable timeframes to adapt to the changes. Having said this, I hope client outcomes are ultimately put above the lobby groups vested interest in maintaining their product sales at all costs. Products need to stand on their own merits to compete for market share and not rely on anti-competitive forces such as volume rebates and commission terms to encourage advisers to recommend them.

For the record, due to historical practices the author’s business still receives a small amount of trailing investment commissions. The author rebates any volume bonuses he receives to clients who have agreed to pay an annual fee for service.

Jason Bragger CFP DipFP BSC BA
Director - Dolfinwise

(07) 3831 5990