A viable way forward for planning

The enforceable undertaking accepted by the Australian Securities andInvestments Commission (ASIC) in July 2006 from AMP Financial Planning (AMPFP) found on many occasions that AMPFP:

~ “planners’ files did not disclose a reasonable basis for advice;

~ failed to make proper disclosures about the costs of acquiring the recommended product and the significant consequences of replacing the existing product;

~ made statements on its website and in its Financial Services Guide that suggested AMPFP planners could consider a broader range of products than permitted, which could have misled consumers; and

~ may not have had adequate arrangements in place to manage conflicts of interest”.

Even a cursory reading suggests that the first three issues are systemic failures of process while the last goes to the very heart of the agency debate about whether planners are agents for the manufacturers of products or the client.

ASIC has focused on super switching but could, I imagine, have easily looked at all the other switches that are fundamental to investment advising and found similar discrepancies.

It is not my intention to explore the agency issue in this article other than to say that a prospective client should be able to understand whom the planner is working for at a glance before deciding to proceed toward a professional relationship.

Nor is it my intention to single out AMP. The issues raised in the enforceable undertaking are likely to be endemic across the financial planning community.

I have first-hand experience of the commercial approach to good advice. Conversations with officers of dealer groups usually go something like this: ‘We agree we are not doing things as well as we could, but changing behaviour would make some of our planners unhappy and they would not comply unless we make this compulsory. We are not keen to make it compulsory because it could result in a reduction in sales.’

In other words, we have calculated that the penalty will be less extreme than the commercial cost of imposing good process.

And now of course the consequences of opting out of good process have come home to roost.

This article explores what is good financial planning. It argues that a valued and consistent planning experience is achieved when the dealer imposes compulsion on its agents, that good process has a wide number of benefits and a simple product suite will meet the needs of both clients and the business.

What is financial planning?

For all of its avowed complexity, financial planning is a relatively simple concept.

Every person does their own financial planning, although in many cases it may be very poor. Some choose to outsource part of their planning to a third party supplier, more often than not termed a financial planner.

Personal financial planning is defined by the International Standard ISO 22222 (2005) — Personal Financial Planning as a “process designed to enable a consumer to meet his/her personal financial goals”.

In my view, in the pursuit of your current and future goals that have a financial dimension, you must work within four interrelated principles.

1. Spend less than you own or earn to create an investment pool.

2. If managed well, you can expect your investment pool (which for most Australian families must now include the family home) to grow at a rate of between 1 and 5 per cent per annum over inflation in the longer term, depending on the riskiness of the portfolio.

3. You can partially guarantee that growth in the long term through life and income insurances.

4. All financial plans have some level of financial risk. If the risk needed to achieve your goals is inconsistent with the risk you would otherwise prefer to take, you must specifically accept that risk.

Clearly there are a number of trade-offs in play here, how should they be managed?

There are two alternative planning models, paternalistic and collaborative, available to planners to deal with the issue.

Paternalism versus collaboration

In paternalistic planning the planner and their dealer take responsibility for client outcomes.

This is the current dominant style of planning where the decision on what portfolio to recommend is more often than not the outcome of a simple ‘portfolio picker’ questionnaire.

These tests are usually six to 10 questions designed more to meet regulatory obligations with a minimum of fuss than provide any meaningful insight into what the client needs or how the client thinks about financial issues.

They simplistically link the test results to a recommended asset allocation or fund.

The whole process of matching product to client needs is reduced to the answers of a mere half dozen questions mostly looking as if they were thrown together by a compliance manager over a long weekend.

This should be recognised for what it is, a perfect example of form over substance. There is no meaningful match of client needs to products.

In collaborative planning, on the other hand, decision-making is shared between the client and adviser.

In essence, the plan is the personal contract between the client and the planner designed to meet the client’s needs. Any product recommendation is the outcome of the ‘know your client’ process.

Proofs of a rigorous planning process

In order to justify decisions made and the contract agreed upon, the planner must demonstrate the rigor of the planning process adopted.

There are five proofs that a robust financial planning methodology needs to illustrate. They are:

~ that you know the client, their current circumstances, their needs and expectations;

~ that you explored alternative products and strategies available to the client;

~ that you know the products and services in the strategy selected and that if there is a replacement product it better suits the client’s needs than the current product;

~ that you explained the risks in the strategy, services and product selected; and

~ that you received your client’s properly informed commitment to the implementation of the plan.

Exploring alternative strategies

Client goal setting can be determined through an iterative process commonly known as the ‘four trade-offs’, where the cash flow consequences of alternative options can be illustrated.

They are:

~ work longer, harder, differently, perhaps set up a business, or have your partner work full time or part time;

~ spend more or save more;

~self-insure or transfer risk to a third-party insurance company; or

~decide on the level of financial risk that you and your family are prepared to accept in pursuit of your goals.

Issues around risk tolerance testing

A reliable risk tolerance report is one of the primary steps in understanding what makes each client different.

Using the test report as the basis for a detailed questioning of the client’s preferences and aspirations, the planner can develop a coherent logic for linking client needs to recommended product and service characteristics.

Better commercial outcomes

The benefits of a robust process designed to deliver quality advice based on an in-depth knowledge of the client include:

~ enhanced levels of client and planner intimacy;

~happy clients who are generally pleased to give referrals;

~greater persistency and lower levels of product churn leading to enhanced profitability for both planner and product manufacturer;

~ a consistent, transparent and compliant business process;

~ a solid argument for lower professional indemnity insurance premiums;

~ an infinitely more valuable planning business; and

~ Australians who better understand their financial objectives and how to achieve them.

A more detailed understanding of clients’ needs and aspirations delivers the triple virtues of profitable and better sales in a highly compliant manner.

The battlelines are drawn

The current battle over what constitutes good advice can be defined as the clash between the immoveable demands of consumerism versus the irresistible forces of business.

The regulator, representing both the general community and the client, has a clear agenda to bring a fiduciary perspective to the process of product selling. The product recommended must meet the needs of the client and there must be a robust argument in the supporting sales documentation explaining why that is the case.

In essence, everything starts with the client’s needs and works through to the service and product recommendation.

The key term here is justification. There must not only be a clear pathway and logic from the client’s needs to the recommendation, the advice must also be clearly justified in the Statement of Advice.

How does this sit with institutionally related financial planning?

The vast majority of institutionally related financial planners work within relatively tightly defined commercial constraints. They must be able to do their job, satisfy their clients and make a profit.

Profit making here is a critical issue. Profit ensures that there are sufficient funds to invest in new technology, training and the myriad of things required to continuously deliver a meaningful client experience within the competitive environment in which they must live.

It is only after making a profit that a planning entity can have confidence that it will still be there, in the future, when the client needs them. But here is the rub; profit only emerges from product sales.

Many financial planning businesses have invested heavily in recent years in integrated product and service offerings so they can profitably deliver better outcomes for their clients.

Many understand that investment products have become commoditised and that much of the benefit they create for their clients is through the introduction of disciplines such as diversification through funds of funds and model portfolios, rather than simply through access to unlimited investment choice.

Most would also argue that the best service they can offer their clients is to work with the smallest number of platforms and products they can.

There is scant evidence that fund managers deliver consistent outperformance against acceptable benchmarks, there is virtually no evidence that planners constructing portfolios from those funds add any value at all.

If we follow ASIC’s logic, planners will have to prove that the portfolios they are recommending are better matched to their clients needs than those found in the fund they are switching from.

This will necessarily require objective evidence that over the previous five or 10 years, for instance, they have at least met a previously agreed performance benchmark.

Integrating the conflicting goals of regulators and business

The crux of the argument is that the regulator and the businesses in financial planning must find a way forward where the goals of each are met. The regulator is looking for client-centric advice and business is looking for a sustainable, profitable business process.

The commercial sector has a defence against the claims levelled against it by the regulator, the media and, increasingly, the general community. That is to industrialise the advice process to remove the errors that are endemic in the hand-crafted solutions that are symptomatic of current financial planning and to radically simplify the product offering so that prospective clients can readily understand that in an AMP shop they sell AMP products. And they will do well if the AMP product is good value.

There is a huge opportunity for institutional financial planning firms to meet the needs of customers, although it will come at the cost of significant disturbance to the current method of manufacturing and distributing product.

Reducing choice will reduce costs and ultimately deliver better financial outcomes to clients.

Meaningless product proliferation hiding under the skirts of investor choice has proven simply impossible to manage.

Large institutional fund managers should focus on using their intellectual strengths and buying power to deliver one or two balanced funds at the best possible price.

These are more likely to deliver the predictable outcomes that most customers need than planner constructed portfolios from a long list of funds.

Good advice, adherence to disciplined processes and happy clients are all measurable performance indicators that can be built into a remuneration structure to replace commissioned selling.

Of course, it’s not easy to tell your agents that the game has changed and it is a substantial business risk, but the rewards for the first major to break with the past are great.

The clock is ticking down. The AMP enforceable undertaking is telling all institutional planning businesses that they can no longer be ‘licences of convenience’ for self- directed financial planners and fronts for product pushers.

It is time for radical surgery, not band-aid solutions. Australia and Australians can ill afford the growing loss of confidence in this critical component of the financial system.

Paul Resnik is a financial services industry consultant and commentator. He has interests in a number of tools designed to industrialise financial planning. He can be contacted at [email protected].