CHOICE applauds new financial planning rules

CHOICE has campaigned for reform for over two decades.
 
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01 .Introduction

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CHOICE applauds the government’s long-awaited move today to put an end to longstanding conflicts of interest in the financial advice industry. The proposed reforms target practices that CHOICE has campaigned strenuously against and that have cost consumers billions of dollars – often without their knowing it.

The industry overhaul put forward today by Assistant Treasurer and Minister for Financial Services and Superannuation Bill Shorten takes aim at what has amounted to an ongoing rort. Specifically, the Government’s most recent Future of Financial Advice recommendations would require financial advisers to ask clients to ‘opt-in’ every two years if they wish to continue to receive ongoing advice; would ban all commissions on risk insurance inside superannuation; and would impose a broad ban on volume-based payments.

CHOICE has spent more than 20 years investigating and warning about conflicts of interest in the financial advice industry. New laws to be introduced in July 2012 will help reduce biased advice, but the government's latest proposals will go a long way toward stamping it out altogether.  

The perils of bad advice

Recent research by Roy Morgan found that in 2009, the six largest financial planning groups placed an average 73% of their clients’ superannuation money into products offered by by their institutional parent, with AMP the worst offender. It confirmed longheld suspicions that conflict of interest is rife.

The status quo

As it stands, advisors routinely collect fees without accountability or oversight and without any discernable benefit for the client. CHOICE has calculated that in 2009 about $1.3 billion in commissions on superannuation alone flowed from consumers to advisers where no service was provided to the consumer.

“The requirement to gain consumers explicit consent for ongoing fees every two years will significantly address this problem and is particularly welcome,” says CHOICE Chair, Jenny Mack.

Volume payments – which encourage financial advisors to rack up sales regardless of a client’s best interest – are perhaps the most egregious example of how the financial advice industry has put profits ahead of clients’ interests. It’s a practice the industry has clung to tenaciously.

“Volume payments are particularly odious because they are very large, very hidden and impossible to disclose - they were a great big secret payment that were conflicting advice and eroding consumers’ savings,” Ms Mack says.

The Government also proposes to ban all trailing and up-front commissions and similar payments from July 2013 but to allow existing commission arrangements to remain, a concession to industry that Ms Mack called “very generous”. CHOICE believes commission based remuneration always makes the quality of advice questionable.

CHOICE urges industry not to replace commissions with asset based fees, which also puts the quality of advice into question and are not a valid foundation for fair and disinterested advice.

Mr Shorten said draft legislation for the new proposals will be released later this year. The next and most crucial step will be for Parliament to resist pushback from the powerful financial advice industry, prioritise its commitment to consumer rights, and resoundingly approve the reforms.

“We expect the industry will continue to resist these reforms and it is now up to Parliament to follow through and ensure the whole package becomes law,” Ms Mack says.

The ugliest consequences of today's corrupted industry structure have been seen in the collapses and investor losses from such companies as Storm Financial, Westpoint, Fincorp, Timbercorp, Great Southern, Australian Capital Reserve and others. Some victims lost their life savings after following the recommendations of fully licensed advisers.

In this report we:

• Give you tips on how to recognise biased financial advice
• Outline the different types of advisers and what you can expect to pay
• Explain the new regulations and what they will and won't solve

 
 

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An adviser’s ownership, level of independence and how they’re paid may influence their advice. For ownership, there are three main types of advisers.

1. Institutionally owned

An estimated 85% of advisers are owned or employed by banks, fund managers, super funds and other financial institutions, which causes enormous biases. Confusion abounds over the ownership of planning groups and influence on advice. This is particularly common around third-party brands; Hillross Financial Planning, for example, is owned by AMP, yet 50% of its super customers surveyed believe Hillross is independent. Our news piece on the latest Roy Morgan research, which exposes massive bias among the six largest financial planning groups, details who these are.

2. Independently owned

These advisers claim some degree of independence because they’re not owned by banks or other product manufacturers. This, combined with a fee-for-service approach, means many are less likely to be swayed to recommend particular investments and companies. However, where these advisers collect commissions, they cannot claim to provide independent advice.

3. Independent advisers

Legally, financial advisers can only use terms such as “independent”, “impartial” and “unbiased” to describe their services if they’re free from any conflicts of interest caused by links to product manufacturers, and if they refuse (or immediately rebate to customers) commissions and other payments and gifts from the financial institutions whose products they recommend. Theoretically, impartial advisers are much more likely to charge a fee for their services, and to recommend low-cost investment products that don’t pay commissions, including industry super funds, exchange traded funds and listed investment companies.

The list of genuinely independent advisers is small; 10 are named by Independent Advice, a website run by SMART Compliance, a service provider to advisers. The website lists some (not all) independent advisers.

How much can I expect to pay?

There are three main types of payment for advisers.

1. Commissions

This is the most common and usually attracts the highest fees. An adviser will get a commission from product providers such as managed funds when they sell their products: an initial (entry) fee of up to 5% of your initial and subsequent investments, and a trail commission of about 0.5% of the balance of your portfolio each year. Commissions are much higher on life, income protection and disability insurance – our case study's adviser (see below) would have received a payment worth 100% of her first year’s premiums and 14% of annual premiums after that if she’d followed his advice.

2. Asset-based fees

A second form of payment, similar to trail commissions and agreed between investors and advisers, is a percentage “asset-based” fee. It’s charged as a proportion of your investments or portfolio.

3. Fee for service

A straight-up fee-for-advice, based on a set or hourly fee. This attracts the fewest conflicts of interest. There is an increasing number of fee-based advisers, and groups including the Financial Planning Association, AMP and MLC are moving to this model ahead of the July 2012 regulatory deadline. However. even with fee-based advice, there are traps to watch for. Some advisers may like to appear independent by charging fees, while continuing to rake in product commissions as well.

A full financial plan usually costs $3000-$4000, with smaller ongoing review fees applying in subsequent years. Some advisers provide more basic services for a smaller fee, and free limited advice and information is sometimes available from super funds.

Case study: Lessons learned

CHOICE members Denise and her husband were talked into having a fresh look at their finances by an adviser. They were charged $1250 up front. “We were advised to borrow $200,000 against our house to invest elsewhere, to switch our super funds, and to take out extra life insurance to cover new debt,” Denise says. “They ran through it as if it was a win-win situation and expected us to sign on the spot.”

The couple didn’t sign as they felt uncomfortable with the recommendations. The adviser would have taken a large cut of their money – not only the $1250 upfront fee, but a further $6600 from the loan for “initial advice”, $3800 in initial insurance commissions, $2700 per year in insurance trail commissions and $2200 annually in superannuation investment commissions. All up, the strategy’s fees were almost $12,000 up-front and $2700 annually. Denise’s super fees would have doubled if she’d switched, as recommended, from her industry fund, REST Super.

“All I wanted was advice on how to minimise our tax, pay off the mortgage and boost our super. We also wanted some advice on a property investment, but were advised to invest in a managed fund with lots of adviser commissions. Our bank felt it was risky and that the expected returns were a bit inflated, so we didn’t follow through. I wish we hadn’t been pushed into the appointment, as that $1250 could’ve been spent on my mortgage.”

Following a Parliamentary Joint Inquiry, to which CHOICE provided evidence and a submission, in April 2010 the federal government announced a comprehensive reform package to clean up the industry. The detail is still being finalised, but what we do know is that from July 2012, financial advisers will have a legal “fiduciary duty” to place clients’ interests ahead of their own. While some professional bodies, such as the Association of Financial Advisers, have long placed a fiduciary duty on members, legally there was no explicit obligation to put their customer’s needs first. 

At this stage, the reforms are expected to include:

  • A ban on investment commissions: at present, the predominant form of remuneration for advisers is a behind-the-scenes payment by fund managers and other product providers whose investments the adviser recommends.
  • A ban on payments to advisers for meeting or exceeding volume sales targets. These payments encourage advisers to sell more investments than the consumer needs, and to favour product providers that pay the biggest sales bonuses.
  • A ban on percentage-based fees for “geared” financial products – for example, margin loans. This will reduce the likelihood of another Storm Financial disaster, where clients were encouraged to take large loans to use for investments. The leveraged nature these arrangements magnified consumer losses and increased investor liability when the investments turned sour. Some people lost their homes.
  • Consumers will be required to renew their fee arrangements on an ongoing basis (after an initial period where the adviser’s payment will be guaranteed), otherwise the fees will stop.  

The CHOICE verdict 

These reforms are enormous steps forward for consumer protection - CHOICE has campaigned for many years for such improvements. However, we have reservations, which we hope will be addressed in the final arrangements. Of most concern are the following:

1. Asset-based fees

Percentage “asset based” fees - where the adviser’s fee is based on the value of your portfolio - are slated to continue. While some argue that percentage fees “can be useful in aligning the best interests of advisers and their clients”, we have concerns. Firstly, the adviser’s work should be much the same for a consumer with a small or big amount to invest, so why should the latter investor pay more? There’s also the temptation for advisers to recommend the sale of non-financial assets, such as property, to free up more money for financial investments and earn higher fees. But most importantly, percentage figures mask the true impact of fees – 1-2% of assets may seem harmless enough until the long-term effect is revealed.

Deen Sanders, acting CEO of the Financial Planning Association, defends asset based fees. “It’s not true to say that the same amount of work is required for big or small investment amounts,” he says. “Higher amounts can involve more work and time for an adviser, especially if complex investments and arrangements are involved, such as estate planning and family needs. And for people with smaller amounts to invest, an asset based fee can work out cheaper than fee-for-service.”

2. Trail commissions

Commission arrangements already in place before the July 2012 cut-off may continue. There's speculation that these investments will be “grandfathered” from the new rules. After July 2012, consumers should look carefully at the commissions being paid from their investments, and consider whether they should switch to lower-cost arrangements, or arrange to have the commissions (and fees) “dialled down”. In anticipation of this, when buying investments now you may wish to ask for the new lower-cost commission-free versions. FPA planners are already required to turn off the commissions on investments if consumers don’t want them, and what’s currently proposed is that from 2013 consumers will have to “opt in” each year if they want to continue paying adviser fees and commissions.

3. Risk insurance left exposed

The ban on adviser commissions may not include risk products, such as life insurance. This is despite the fact commissions of up to 120% of the first year’s premiums are paid to advisers, with trail commissions of about 10% in subsequent years. Or advisers may receive a flat commission worth as much as 30% for every year you have the policy. These are staggeringly high commissions that potentially encourage advisers to churn people into new policies in order to receive the high initial kick-back. Already we’re seeing reports of an adviser “flight to risk products” to earn commissions in anticipation of the new laws. So far the government seems to be leaning towards the industry’s argument that removing sales commissions will reduce the amount of insurance sold. “My concern is to make sure we don’t exacerbate the problem of under-insurance in Australia,” Minister Chris Bowen said in May. “There are good arguments validly made on both sides of this discussion about whether risk insurance should have its commissions banned. We also need to ensure that were we to exempt risk insurance in the ban on commissions, we didn’t allow some sort of back door mechanism to allow commissions to continue to exist for financial advice more generally, so that, if you like, large commissions might be placed on risk insurance to counteract the loss of income from the banning of commissions on more general products. So I have a genuinely open mind about this.”

The FPA also chose not to voluntarily ban life insurance commissions. “We’re concerned where we find malpractice – that’s where we act,” says Deen Sanders. “But we found no bias caused by commissions in risk insurance, and without the ability of consumers to pay by commission, we’re concerned that people won’t buy enough insurance. I think it’s possible that in the future there will be a shift away from life insurance commissions, but it will take time.”

 

Underinsurance is undoubtedly a real and important problem, but paying high kick-backs to advisers is not the way to solve it. It can also be argued that fat commissions make insurance more expensive so people buy less cover – which exacerbates underinsurance, rather than helping to address it.

By addressing the fundamental conflicts of interest in the industry, the government reforms should give consumers a lot more confidence in the system. But at the end of the day, you still need to educate yourself about the advice provided, and the strategies and products recommended, and be satisfied they’re right for you. Use the following checklist to minimise the risk of poor or biased financial advice.

 

Assessing your adviser

  • Licence: Check your adviser’s authorisation to provide financial product advice with ASIC.
  • Read the financial services guide to find key details such as ownership and independence. Licensed advisers must provide an FSG before you start dealing with them. 
  • Ask about your adviser’s qualifications, training and experience. According to the FPA, “the minimum standards required under RG146 [the legislation] are inadequate for the delivery of quality advice and therefore create a risk of consumers acting on information provided by providers that are not appropriately or professionally qualified, may not have the skills required to explain complex concepts, and may pass on inappropriate advice without consideration of the principles of financial planning.” The FPA's Certified Financial Planner designation is a higher qualification.
  • Professional association: Are they a member of a reputable professional financial planning association? Codes of practice, accountability standards for members and internal complaints systems for dealing with complaints may give you extra assurance. However, association membership is not a guarantee of good advice.
  • Find out which types of financial products, and which providers, the advice covers. Many advisers owned by large banks, for example, do not recommend industry super funds and other investments that don't pay commissions. 
  • Check what research is used by the adviser to create their lists of recommended investments.
  • Study the product disclosure statement(s) (PDS) for any recommended products.
  • Get a written Statement of Advice and clarify any parts you don’t understand.
  • Get a second opinion if you’re in any doubt about the advice you receive.  
  • Coming soon: check complaints about advisers and companies with the Financial Ombudsman Service.
  • Due diligence: Educate yourself about the advice provided and the strategies and products recommended, and ensure you’re fully satisfied that they’re right for you.

Contacts

A review of CHOICE research and investigations over the last two decades vindicates our public statements that the industry needed urgent reform to protect consumers. Twenty years later Minister Chris Bowen's changes will uproot entrenched practices that harm investors, but how many victims could have been saved if our advice has been heeded earlier by his predecessors?

1990
“Many financial advisers are simply agents for fund managers and investment companies; although they claim to offer impartial and independent advice, their main priority is to sell as many investments as possible, so the client’s needs are often pushed into the background.” (In) vested interests, CHOICE, March 1990.

1993
“The further we delve into the industry, the less attractive it appears. All of these arrangements are structurally corrupt." Australian Consumers' Association chief executive, Louise Sylvan, in the Australian Financial Review.

1995
We launched our first “shadow shop” of the advice industry, with disturbing results. Less than 10% of the 58 financial plans examined were classified as good, based on the scores of our expert panel. 65% ranged from acceptable down to bordering on poor, while a quarter were sub-standard. “This is extremely alarming and compelling evidence that the regulatory system is simply not functioning to protect consumers and needs urgent, radical overhaul. Thousand of Australians are in the hands of incompetent, sales driven and in some cases, dishonest financial advisers right now. Forceful action is urgently needed to protect them.” Take my advice? CHOICE, April 1995.

1998
Our shadow shop found finds many planners falling short of the industry’s own best-practice standards. “The best comprehensive plans were generated when a client had a significant amount of money available for immediate investment,” we wrote. “It’s unacceptable that the quality of advice is determined by the amount of money you have to invest. Everyone who seeks financial guidance should have access to professional, independent and comprehensive financial planning services. The industry won’t be able to provide this access until it addresses some deep problems, in particular the fact that many advisers are still commission-driven and restricted in the range of products they can or are prepared to recommend. On the other side of the coin, expect to pay a professional fee for service if you want a planner to properly assess your financial needs and objectives and come up with comprehensive, suitable strategies and recommendations. If you’re getting cheap advice, it’s probably poor advice.” Who do you trust with your life savings?, CHOICE, October 1998.

2003
Another large-scale shadow shop, this time a joint project with ASIC. “The quality of advice given by some financial planners in our survey is frighteningly poor. The ‘advice’ given often seemed like thinly disguised product selling. Far too many planners behaved more like salespeople for fund managers than impartial financial guides. Plans graded poor or very poor (27% of the total) were grossly inadequate.” Too many poor plans, CHOICE, January/February 2003.

2005
“Financial planners want to call themselves professionals, but they don’t want to commit to the fundamental underpinnings of a profession – the fiduciary duty to the client. This would require the elevation of the client’s interest over and above the industry’s and require the removal of all conflicts of interest. Structural conflicts in the industry undermine consumer confidence, destroy trust and suggest the industry is without integrity. My message to you is this: unless the industry reforms itself, change will be imposed.” Jenni Mack, CHOICE Chairperson, in a speech to financial advisers.

2006
“There’s no valid justification for trail commissions and fund managers should abolish them as a payment method to planners. Trails paid by fund managers create a conflict of interest for financial planners.” Unhappy trails, CHOICE Money & Rights, October/November 2005..

2009
“Conflicts can mean that advisers are effectively salespeople of product providers. Conflicts can encourage advisers to sell products instead of providing strategic advice. Conflicts may provide incentives to recommend products that are inappropriate. They can encourage advisers to churn clients through products. Worse yet, they can encourage clients to borrow inappropriately to invest. Upfront and trail commissions, asset based fees, soft dollar commissions and volume bonuses all exhibit one or more of these conflicts. This is not a marginal problem. Around 85 per cent of adviser revenue is generated through these payments.” CHOICE evidence to Parliamentary Joint Inquiry, September 2009.

2010
“Consumers will be the winners as a result of the federal government’s decisive action to end commission-based remuneration for financial planners. CHOICE has argued over many years that commissions create an unacceptable conflict of interest for financial planners which can lead to dangerous or poor quality financial products being sold to consumers. The government’s plans incorporate many of the recommendations we made to the parliamentary joint committee on financial services. We are particularly pleased that asset-based fees will not be levied on geared products. But we remain concerned that the industry is attempting to transition from commissions to asset-based fees. Our preference is for fixed fees which could be either a fixed lump sum or hourly rate charged by the adviser to the client.” CHOICE Media statement.
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