Ending Grandfathered Commissions – What is the Policy Objective?

Banning grandfathered commissions without first having a definitive policy objective speaks to ideological and simplistic motivations, writes Phil Anderson.

In her concluding submission at the end of round two of the Hearings at the Royal Commission, Senior Counsel Assisting, Rowena Orr asked participants 28 questions. One of those questions was whether grandfathered commissions should cease.

This question has generated a number of interesting submissions and debate - some of which have called for a quick end to grandfathered commissions. Other perspectives, like those of the Association of Financial Advisers (AFA), have called for more balance - because ending grandfathered commissions is unlikely to be a cure-all and turning off trail commissions usually does nothing to improve outcomes for clients.  

What’s the objective?

What has not been addressed in the discussion so far, is the policy objective behind a call for a ban on grandfathered commissions. Is it simply to pursue an ideological view that all commissions are bad? Is it to cut off this revenue stream for advisers? Or is it to better ensure that clients are being serviced by their advisers?  

We hope the core reason is to help clients currently caught in poor, high cost, legacy products. But we are concerned that those calling to end grandfathered commissions are throwing a broad net over this complex issue. The debate should be driven by the interests of clients and their ability to choose whether they want advice and how they want to pay for that advice.

The basis for the calls for a fast decision

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Those who have called for the banning of grandfathered commissions have not explained the basis for such a change or the consequences of something so broad and blunt in its design. There also appears to be confusion with respect to the data to support making such a hard and fast decision. Some of the submissions relied heavily on a comment made by one person in the witness stand: that 60 per cent of their licensee income comes from commissions. This figure presumably includes life insurance commission and perhaps also some mortgage broking commission. Other research from Investment Trends suggests that grandfathered commissions are a substantially smaller percentage of total practice income (nine per cent). This fundamentally changes the argument. It is essential that we have an agreed starting point for such an important decision.

What is an acceptable timeframe? 

The Explanatory Memorandum for the FoFA legislation clearly stated that changes to grandfathered commissions would be gradual. There was no statement about a deadline or timeframe. 

In its submission, ASIC’s stated position in relation to grandfathered commissions was that “ ... those arrangements should not continue in perpetuity (as do the current arrangements), [and] ought not to extend to new clients or new arrangements ... ” It might be argued that a regulator should regulate rather than express statements about what their position was with respect to legislation passed by the Australian Parliament. In any case, the Investment Trends research suggests that the financial advice sector is already making good progress towards the removal of grandfathered trail commissions.

We agree that grandfathered commissions should not continue in perpetuity. We also agree that grandfathered commissions should not apply to new clients or new arrangements. To the extent that this exists, we certainly support regulatory action. This was not part of the intent of the legislation.

The core issue

If we accept that the core issue is clients sitting in uncompetitive products, then we need to understand that there are some poor, high cost, products and there are other products that are pre-FoFA with inbuilt trail commission, that are otherwise competitive. If clients in these competitive products are getting service for this trail commission, then in most cases this will be working in their best interests. Clients who are stuck in uncompetitive products or who are not being serviced are another matter. The focus of this debate should be how to enable these impacted clients to move to more competitive products. We don’t believe a ban on trail commissions will achieve this objective.

When trail commissions are turned off, the payment is generally retained by the product provider, rather than returned to the client or used to reduce the product fee for the client. This would mean that the client receives no benefit through a product fee reduction and would also lose access to the financial adviser unless they agreed to establishing a new ongoing fee arrangement, that would involve a material additional cost. Where the product remains competitive, other than for the incorporation of the trail commission, and the client is still being serviced by their adviser, why move? Clients may, quite reasonably, want to stay where they are and feel comfortable with their adviser continuing to receive a trail commission.

The consequences of banning trail commissions

In our submission to the Royal Commission we highlighted a number of reasons why it may not be in the client’s best interests to move from a trail commission paying legacy product to a new post-FoFA product. These reasons include:

• The legacy product may have an exit fee. Forcing the client to move from a trail commission paying product to a post-FoFA product could result in the payment of a large exit fee and would not be in the client’s best interests;
• The client’s existing product may contain significant capital gains that would be crystallised if the client moved to a new product. Recognising the capital gain and paying capital gains tax at that point in time may not be in the best interests of the client;
• Grandfathered Centrelink treatment of older pension products may be lost, which could result in the loss of the age pension or a reduction in pension benefits; and
• Insurance in bundled superannuation products may be lost which could be difficult to replace for people whose health has deteriorated. The additional cost of insurance could far exceed any saving in reduced fees.

The simplistic ideological calls for a ban on grandfathered commissions are just that – simplistic and ideological. In reality, the matter is much more complex. We should be focussing on what the core policy objective is, which must be to assist clients caught in poor, high cost, legacy products. If we accept this as the objective, then we should be arguing for regulatory changes that help these clients, including banning exit fees, capital gains tax relief and Centrelink exemptions, rather than placing all the consequences and obligations on the financial adviser community.

The AFA is ready to work with all key stakeholders to help clients move from uncompetitive products, however we think that the process needs to start with a comprehensive review of the state of play which addresses:

• How many clients are in old uncompetitive products;
• How uncompetitive they are; and
• The extent to which there are valid reasons why it is not in their best interests to move (ie. the current regulatory, tax and social security regimes).

It is not so simple to ideologically call for a complete ban on commissions. If that were to happen the level of insurance for Australians would greatly decline and some clients would be stuck in poor quality, high cost superannuation and investment products with no one to help them. The decline in grandfathered commissions is well underway for superannuation and investment products and reforms for life insurance have recently commenced which need to be given the chance to play out.

It is essential that we understand the facts and the consequences before we call for major reforms.

Phil Anderson is the Association of Financial Advisers general manager, Policy and Professionalism