Financial Planning Reforms

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Does It Need Reforming?Financial-Services-Minister-Bill-Shorten

There is a big battle going on between some parts of the financial planning industry and the Federal Government (Financial Services Minister Bill Shorten) about the need to reform the financial planning industry.

Firstly, I need to admit that I have operated on all sides of the wealth management industry at different times including being a senior executive in an investment management company and, in the retail market, running a superannuation/managed funds business, running a life insurance company and managing a financial planning business. These have provided me with a good understanding of the industry and also of some of the practices that have grown up on both sides of the retail wealth management business i.e. product providers and financial planners.

If we go back to basics, it is clear that we need a financial planning industry because some people simply do not understand financial matters, some are just too busy to manage their daily financial position and the interplay between investment markets, retirement planning, the tax system, the Social Security system, life and general insurance products etc make it almost impossible for any individual who  is not involved in the industry on a daily basis to  manage their own financial affairs in an optimal manner.??However, the financial planning function essentially consists of four functions which are:

  • developing a plan i.e. determining how best to structure someone’s personal finances  (advisory function)
  • sell the plan (sales function)
  • execution of that plan (administrative function)
  • maintenance of the plan (same as developing the plan and the cycle recommences)

The problem arises because:

  • many people are unwilling or reluctant  to pay for the financial plans and ongoing advice when they have to get their cheque book out especially when this involves an upfront payment
  • there is no requirement for financial planners to act in the best interest of their clients. This leads to some financial planners offering “advice” where this may be tainted by how much they themselves will receive. There have been many cases where this has happened and many can be found by simply looking on the front page of the ASIC website
  • some products are compulsory such as SGC super and do not need to be “sold”.  whereas others especially individual life (including related disability/income protection etc) insurance are discretionary involve a large amount of planning effort in determining requirements and finding insurers who will take the individual risk and need to be sold
  • in many cases there is no real ongoing maintenance of the plan but financial planners still collect trailing commissions which are hidden in the product pricing i.e. they are collected by the product manufacturer as part of the product price and are paid directly to the financial planner whether or not they actually do anything

In the area of life insurance and related products this led to the ridiculous situation where for a long time the commission payable to a financial planner on a life insurance product was more than the first year’s premium which meant that the life insurance company received no income to cover the risk taken (or their expenses) in the first year of the policy – surely a ludicrous arrangement. This situation has largely changed to a system of flat annual commissions but it shows how  the relative power balance between the product salesmen (financial planners) and the product manufacturers (life insurance companies) and their co-operation to find a solution that suits them can provide undesirable outcomes.

A similar situation to the old life insurance commission “rort” is the payment of various benefits (bribes?) to financial planners such as overseas trips (for education purposes?). I note that few of these trips are to Blacktown, Geelong, Tennant Creek etc.  but many appear to be held in Hong Kong, USA and similarly desirable overseas locations. A friend of mine in the life insurance side of the financial planning industry is off on one of these “educational trips” to Hong Kong next week.

Another issue is the payment of volume bonuses by product manufacturers or platform providers. This obviously encourages the financial planner to put all of “their” business with one company or on one investment platform in order to obtain these volume benefits from the product/platform owner. This is surely cannot always be in their client’s best interests but under current regulations they do not have to worry about that.

Going back to the question of what is wrong with all of this, it can be summarised as:

  • financial planners are not required to operate in the client’s best interest which leads many of them to provide adequate advice but with an eye of maximising their own best interests i.e. remuneration, overseas holidays etc.??NB In UK for many years financial planners have been required to operate in the client’s best interest and I understand that, in Australia,  other professionals in Australia such as lawyers have this requirement.

I would have thought that this was such an obvious requirement as to be unarguable. However,   the problem is that it leads to the need to eliminate sales commissions,  overseas holidays etc and the need to ask clients periodically if they still want to continue using the service (rather than doing nothing and collecting a commission).

Already both sides of the industry are trying to push back.

Both the product manufacturers and the financial planning industry are trying to lock in existing arrangements with the hope that they will be grandfathered. The argument is that the industry needs time to adjust. In my mind it is the usual industry tactic of ganging up to rip off the public.

There are many claims around that these new proposed arrangements will lead to even less life and income protection/disability insurance being sold and that Australia is already underinsured and that this is a bad thing. AMP recently put out a statement to this effect.  While some of this may be true, it ignores the point that when offered a product at a price a potential buyer weighs up the costs and benefits and decides whether to buy it or not i.e. in this case whether to insurance externally or to self insure. In the area of financial services, we all do this with private health insurance right now.

The actual solution we require is for the financial planning industry to operate at all times in their clients best interests including accepting the changes similar to those proposed by the Government. It should be noted that these have already been watered down by the government from their original proposals.

We also need to find cheaper ways of providing simpler and less expensive financial planning solutions and execution arrangements for those that have relatively simple requirements.

I seem to remember that a few years ago AMP developed an online financial planning system of some sort. This was discontinued for some reason. I would have thought that, with suitable co-operation between the Government, the Financial Planning industry and the funds management industry, it should be possible to provide an inexpensive technology driven solution that could still be integrated into the financial planning industry (for execution) to provide a natural up selling opportunity for clients whose financial planning requirements develop a need for more sophisticated advice.

It will be interesting to watch both the industry and political interactions over the next few months especially as the Opposition has already indicated that it will be obstructive.

The Federal Government does however have one trump card available which may get it’s proposals over the line which is that the financial planning industry would like terms such as financial planner/financial adviser to be listed in the Corporations Act 2001 as restricted terms so that only those that meet certain requirements can use those terms and the Federal Government is only likely to do this when it’s proposed changes have been introduced.

Is this un-winnable war? who will be the biggest losers if the reforms fail? Is the public getting better protection or simply less help? We have our opinion but we’d love to hear your thoughts.  Would you like our help with any of the above? Please call on +61 2 9258 1972 or go to our Contact page.

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