FOFA - uncertainty is the only certainty

MT (Mike Taylor): The theme of the roundtable is FOFA and the Budget – but as Marianne pointed out, there wasn’t a lot in the Budget. So we’ll kick off with FOFA. One of the things we now know about the FOFA proposals put on the table by the Government is that we have risk, life risk, within all of super covered off in terms of commissions. So I will start with Mr Clarke from Tower (or TAL, as it is now known), and get his take, as someone dealing in that market full-on, and what he makes of that. 

BC (Brett Clarke): Through the discussions leading up to the announcement, the entire industry had given away the fact that in broad-based superannuation – particularly under the proposed MySuper arrangement – the commissions were going to be banned. The industry conceded that point, and was working towards operating fairly comfortably in that environment.

One that came out of left field was the ban on individual risk and commissions on those products and that will introduce some clear complexities in the nature of the advice and the way that the conversation unfolds with the customer, given that the conversation between the adviser and the customer generally starts with meeting a need across a number of different insurance benefits. The secondary conversation is around how those benefits are structured inside super and outside of super. Introducing this different remuneration structure within the model will create additional complexity in a conversation that most people are generally not familiar with. To make it more complex is not a great outcome, for advisers or for the industry.

We are where we are and now we need to understand how we can make it work or engage further in conversations with the government. But as it’s proposed right now it’s going to introduce quite a deal of complexity into a conversation with a customer, and that’s really going against the principles around which FOFA was established – making advice less complex and more accessible for the customers. 

MT: Brad, I know you guys were fairly worried about this leading up to the government’s announcement. What’s your view? 

BF (Brad Fox): We think they got it wrong. We can’t see how this ties to what the desired outcomes of FOFA were to be. The government keeps stating a fact that is not a fact: That half of the complaints from the ASIC shadow shopping survey illustrate – in the case of poor advice – over half involved poor life insurance advice. That is a result taken completely out of context and simply is not based on fact.

There are no merits behind this decision about splitting inside superannuation away from outside superannuation by the basis of the tax world that the advice lives in. We see it as potentially providing more confusion for consumers; it puts advisers in the space of needing to change their business models which will only add to costs, and in the short-term put perhaps a lot of older advisers in the difficult spot of whether to stay in the industry to maximise the value their business is getting out. Our chief concern is it doesn’t help consumers. 

MT: Mark what’s your view? I know the FPA has a view that the government has laid down a framework. Do you think there can be some horse-trading around it? 

Mark Rantall (MR): I’d hope that there can be some further negotiations around this particular issue. I think everybody would acknowledge that when the government announced they were banning commissions inside superannuation for risk products, it caught everybody a little by surprise because that wasn’t the general sense of the discussions until that point. Our concern is that this is not in the consumers’ best interest, for a number of reasons.

Firstly, we have an under-insurance problem in Australia and I don’t think anybody is debating that that isn’t the case. There are many examples of people being under-insured or having no insurance; the personal catastrophe that happens at the back end of that, and as a result of that, is quite debilitating for those left behind. Where we haven’t got an effective remuneration system that really will provide a solution and a good alternative to commissions in insurance, we don’t think that should be banned – for a couple of reasons.

Number one: there’s a tax deduction provided for the commission within superannuation and generally most life insurance is well advised within the superannuation environment unless there are extenuating circumstances which have been identified by the adviser. Secondly, not 100 per cent of all commissions on insurance products are rebated back to clients in all cases, so there seems to be an arbitrage there that has not been taken away 100 per cent. The final concern is particularly for low-income earners – their ability to actually fund the advice and the underwriting that is undertaken by the adviser is going to be severely tested. 

MT: Marianne, you’re at the coalface; you’ve got advisers out there and life risk is also an issue for you. 

Marianne Perkovic (MP): If we just focus on the financial planners: anything good that came out of the GFC actually helped these financial planners look for alternate revenue streams and they then turned to risk insurance to fill that gap. That’s a good thing because it has helped solve the under-insurance problem. When you’re trying to create wealth and protect it, this goes against the fundamental in trying to have people run businesses that can offer all those services. It’s already been said that we don’t agree with this and we continue to advocate to the government looking at – hopefully – relaxing the rules around the commission payments. 

MT: Gerard, you’re coming at it from a slightly different perspective as someone from a product side, but what’s your take on it? 

Gerard Doherty (GD): I’m concerned about under-insurance in Australia, so any good financial planner should probably be recommending insurance inside superannuation because of the tax deduction. It doesn’t make sense to have a deduction in super and not outside of super. I worry that it might be the wrong choice if we are concerned about making sure that Australians who really need insurance get it. Having worked in that industry for a long time in my younger years, I know it’s a commodity that’s sold – not a commodity that’s bought. Even if you recommend it in a plan you’re not necessarily going to sell it; I think the take-up rate is lower than it should be. 

What is acceptable in FOFA?

MT: One of the things we did a week ago was a small, very unscientific survey in Money Management, trying to decide what our readers thought of FOFA as a whole. One of the findings was that it was almost universally disliked. In truth, there was enough positivity about fiduciary duty to suggest that it wasn’t 100 per cent disliked but I think opt-in and everything else gave it a bad odour with our readers – and the planners amongst our readers. A general question: As panellists, what are the palatable things about FOFA; what would be acceptable to the industry? 

BC: I was going to make one additional comment on the risk in super piece but it leads into the positive aspects of the announcement as well, and that is around scaled advice. We’re yet to see exactly what the dimensions of scaled advice will be. As a concept I think in terms of access to advice, simplicity of advice, more effective conversations between an adviser and a consumer, the concept of scaled advice seems to work, or tick a lot of those boxes.

As a centrepiece of FOFA I think it’s a real tick in the box. Going against that is what we were discussing a little earlier around the disconnect between risk inside and outside of super that’s actually taken the conversation the other way; to be less simple, less effective. Scaled advice as a concept and as a principle seems to be something which we should all be looking forward to. 

MR: We support the banning of commissions in investments. We think that’s a positive step to remove either perceived or real conflicts of interest at the investment level, particularly where commissions are embedded in product where the client doesn’t have control over that transaction. We’d also support scaled advice in principle, subject to seeing the detail of what that might look like. We support the best interest test; in fact, we’ve been instrumental in evolving our fiduciary duty into a best interest test. That’s on the right track, although the detail is yet to be determined on that as well. We certainly support broadening and making advice more accessible and effective and we think that’s a positive thing for consumers. Moving into a two-speed system for insurance is probably a regressive step, and opt-in, albeit a two-year opt-in – we still don’t support that it needs to be a law. 

MP: I’m happy with the broad principle, too. When FOFA was first talked about, it was to increase professionalism and give people more access to advice. They’re the principles when people talk about supporting FOFA – that’s what everybody in the industry wants. Only 20 per cent of people see an adviser; we want more people to get advice and we want the adviser’s professionalism to increase.

The confusion, though, is when the package comes out – there’s so much that actually tries to erode some of that work. The opt-in for the best interest is great. Remuneration and commission structures have been banned, so why is there still a need to have this annual opt-in that just adds to the cost of advice?

The way the industry has been formed from a product-manufacturing perspective is pretty complex – lots of systems trying to look after the tax side, contribution side, people getting pension payments and benefits and now this whole opt-in process is another complexity and cost to it. Great that it’s from 12 months to two years, but from a CFS perspective, we still argue there’s no need for that because the other package has progressed a lot further to increase professionalism and actually get people more access to advice.

Volume bonus payments are still a bit grey in some areas, as to treatment and grandfathering and how that will be and how that manifests. You see smaller licensees coming out wanting to be product manufacturers because that’s the way they can handle that margin. If I was the government or regulator I’d look back and ask if that is the actual intent: Are we trying to change people’s businesses and then move from their core competency? 

MT: Gerard, what’s your view? 

GD: There are a lot of good things about the reforms. Removal of commissions was necessary and we probably could have done that a few years ago. There’s been nothing more frustrating to me than this very public debate about commissions, through the advertising campaigns of the industry funds against hefty commissions. It was an argument against something they weren’t really convinced with; they didn’t really understand what the advice was about, so I think removing it was a good thing.

The best advice businesses I’ve seen have done a great job of transitioning to fee-based. I think their clients like it, so it’s not ultimately a difficult thing. Opt-in can be a bit clunky. I agree that if you’ve created a greater fiduciary responsibility and you’ve removed commissions, conflicting remuneration, you have to ask: Why is there a necessity to have an opt-in every two years? Two years is better than one year; however, the ability to get out at any time would have been a better solution. As long as we have the right, once a year, to stop paying for advice – and that is built into the contract –would have been a better outcome.

The rebating is also interesting; you either had to allow rebates to go through to dealers or you had to stop rebates completely. Leaving it to platforms might simply make people change their business model to try and get their remuneration back to where it might be; it may be an unintended consequence but I’d suggest that’s just going to layer-up more costs.

There’s an advantage to it; an integrated player, the large banks, have an advantage over the smaller player because they’ve got an integrated model and they don’t mind where the revenue comes in – whether it comes in at a dealer level or at a product level; whereas the smaller dealers who are focused more around a dealer model have to become the product manager. It’s created a slightly uneven playing field and I’m not sure that was the right outcome overall. 

MT: What’s your feeling on it Brad? 

BF: The parts that people agree on are consistent. We really haven’t got any closer to having the consumer at the front of the decisions. What the minister has done is put some decisions out there, some of which sound good. But in practice they just haven’t been thought through: How an advice business is going to be able to deliver, and whether there is any discernible benefit to the client.

If we looked at something like opt-in, I would have thought it made more sense for a client to be able to opt-out of paying for an arrangement. A client already has that ability; I get a letter saying, “this is what you’re paying” and it gives them a stronger reminder that they’ve got that right. When it comes to choice of payment, we think that’s been taken away from the client, as are some of the tax benefits of being insured – when we’re the most under-insured of the developed nations.

There’s not a lot there that says that the minister has really addressed the problems that led to FOFA. There’s nothing about better policing of the financial advice world, nothing about product failures being prevented, there’s nothing about ASIC taking action when they hear that things aren’t right in the advice space. There’s really not much there that changes – in practice – what actually led to FOFA. As a by-product, we’re just going to make it harder for people to have a financial relationship where their personal needs are taken into account in giving of the advice, rather than a broad-brush, simplified, dumbed-down style that will come with scaled advice. 

MR: A couple of by-products of FOFA that none of us have touched on are subject to different sorts of discussion papers and are out there for consultation now. They are: the last-resort compensation scheme, and the educational and testing regime housing CP153. It’s interesting that they weren’t actually captured in the announcements and yet are going to have a major impact, both financially and time-wise, on an adviser’s business. If you roll those into it, potentially they can be positive initiatives, but once again the detail hasn’t been seen. We’ve still got a lot of work to do; whilst we thought we were nearing the end of the consultation period, perhaps that consultation period needs to be opened up and continued. 

FOFA’s impact on practice valuations

MT: I saw something from Radar Results and one of its findings. I know they were pushing their case, but one of the interesting findings was that the multiples by which you value a financial planning business had actually declined 10 per cent as a result of the uncertainty around FOFA. The broader question is: Is FOFA clouding the business minds of the financial planning industry so that they’re not making the sort of decisions that they should be making? 

GD: Decisions for their clients, or decisions for their businesses? 

MT: Both I would think, but probably primarily for their businesses. 

GD: Our guys who talk to financial planners would say there’s a lot of inward looking – there has to be. There’s been uncertainty; there’s nothing worse in any business, waiting to find out what a government is going to do to the rules. Uncertainty, coupled with the difficult financial period we’ve all been through, has made it very inward-focused and you’d probably get that from your members, and from your financial advisers.

I’ve been around long enough to have seen this sort of thing happen many times in the past. The strong guys will emerge from this quickly, they’ll make a mental decision: “I’ve just got to cope with this and I’ll rebuild my business around whatever the new rules are and I’ll go motoring ahead to get an advantage.” A lot of them are thinking, “I don’t want to be in here anymore.” If it’s only a 10 per cent drop on valuations, that’s not a bad outcome. 

BC: There’s been a period of tremendous instability for a couple of years really: The GFC, then, flowing out of the GFC, the regulatory debate and discussions, the consumer impacts as well. If it’s only been a 10 per cent reduction during this timeframe, I would argue that is not a bad outcome. One of the first questions advisers will ask these days is your view and assessment of the recent announcements, what you believe it means for the industry and how you can help them modify their businesses. 

GD: If you were valuing a financial planning business, we now face the one unknown of no experience of what’s going to happen in an opt-in environment. So if you’ve got 100 per cent of clients today that go through the first two years of opt-in, is that 100 per cent going to be down to 80 per cent or 70 per cent? 

MR: With all these changes there’s real potential to have a pre- and post-valuation mechanism. If there is proper grandfathering – and these are prospective rather than retrospective changes – then you might have a valuation model on your grandfathered portion of the business that might well differ from your going-forward situation. The two big impacts are the revenue impact and the sustainability of that impact. Also, whether or not there’ll be more clients coming to the business as a result of FOFA – and you’d have to question that. The second big impact is the expense line and there’s absolutely no doubt that FOFA, CP153 and, particularly, last-resort compensation scheme, is going to add to the cost – and opt-in is going to add to the cost of running these businesses. 

BC: A big point is the grandfathering provisions. It’s difficult to unpack that right now on the strength of the announcement but if they evolve, as is indicated in the announcement, and they’re reasonably strong, it will mean that the post-FOFA impacts will emerge more slowly over time. 

MR: I’m still to see the fine detail. I’m a little sceptical. 

BC: I am as well, but as it’s written today they do look beneficial. 

MR: We’re advocating that if there is to be grandfathering, it’s at the client level – not at the transactional level. That single decision will make a big difference as to how strong these grandfathering provisions will be. 

BF: We need to go one step further when we start thinking about business valuations and that is to the lenders who have been financing business acquisitions and succession plans. We’ve got falling business values, we’ve potentially got borrowers who are no longer meeting their conditions and then we’ve got loans being pulled in, books put on the market.

The people in the best position to buy those books are the large institutions and that could lead then to greater concentration in the advice space – another poor consumer outcome. What the AFA is doing is trying to provide practical leadership, in that we’ll help people work through those issues. But none of us can draw those conclusions fully at this point because there is too much grey in what’s been put out there, so far as to how any of this is actually going to work in practice – opt-in being a key one. 

MP: In buying businesses people are very cautious; being part of a large institution, we have lots of businesses coming to us to buy them and there’s a lot of caution because the businesses that come have got those revenue streams that they’ve heavily relied on – commission and commission structures. If FOFA tried to eliminate the financial advisers who practice in some certain way, then it may have done a good thing to remove those businesses.

But there are still some businesses out there that we’ve had a look at that people would be happy to buy because you can see the clients have been engaged; they’ve got very good review processes and they have fee-for-service models. If they’ve got the right platform structure, the client has had to have bought into that fee structure on an annual basis. There’s probably the majority that have lots of issues but I think you still have to focus. There are still really great quality businesses out there that will strengthen with these changes. 

BF: There are. But we had to be very careful that those advisers who have spent 30 years building up their business – and were perhaps in their early 60s four years ago – and then wore the GFC and saw business values fall because of their charging model, then they see FOFA affect the business value again. If they’re looking for a way out into retirement, it might just be getting really difficult for them to be able to afford to take that step, depending what their personal circumstances are. We need to have an eye on that when we’re looking at how the valuations are affected by any of the legislation. 

MP: We’re the by-product of how the industry operates, and the reality is advisers use the mechanisms that have been put in place in industry, so the industry has had products that had commission in them, and facilitated that. I agree for people who have been part of the industry for a long time, who have only done what actually has been offered, it is hard to change the rules now and for those people to retire – I appreciate that. Unfortunately, businesses won’t go near those because of concern as to how the business will survive post-2012. We probably won’t get a good sense of the impact to businesses until 2012 when we start to see it all playing out.