Comms, Costs and "The Code"
On January 1st 2020 there were 2 major changes to Financial Planning (broking) and Personal Insurance in Australia. The first was the introduction of the FASEA Code of Ethics and the second was implementing the final stage of the Life Insurance Framework (regarding commissions). In a ‘post Royal Commission world’ this means that the old way of doing business is, quite frankly, unsustainable and clients and advisers alike are tumbling down the rabbit hole of trying to understand what has changed and what this means for them. Coupled with changes to insurance products coming up on March 31st I have been getting a lot of questions. So in usual style, Friday afternoon Blog!
If you feel like your head is spinning, you are not alone.
The Cost
Providing advice and running an advice practice is far more expensive than it used to be. Almost 10 fold over 4 years by some accounts. All advice must be in written form and updated each review meeting, even if no change is required, and sufficient research must be undertaken to show the adviser has investigated all relevant options. We are no longer allowed to work on “client instruction” only. Compliance and administration, for ever-deepening product pools, require more research and a greater skill sets than ever before. Coupled with ever changing legislation, this means an adviser working alone as a sole trader is a dying breed. Plus sole advisers are facing challenges in insuring themselves for Professional Indemnity as required by law.
Advisers who may have been practising for 30+ years as a CFP have been told they need to sit an ethics exam by year end and get an approved university degree by 2024. The cost to study and the time out of their business to do so, is and will be significant. So significant that in the first half of 2019, 16 advisers took their own lives and 1,750 left the industry in the June quarter alone. Considered Total adviser numbers were around 25,000 in 2017 this is not a insignificant change and some estimates say the total number of advisers is set to nearly half in the next few years.
Edit: As of January 2023 there were 15,833 advisers remaining. Not quite as harsh as some estimates, but not far off.
The Commissions
Commissions on investments including superannuation and managed investments have been banned since 2012. There are a handful of “Grandfathered” commissions on older products and these are being phased out by the end of this year if not already. Commissions on life insurance which include TPD and Income Protection etc have reached the final stage of reforms and advisers can now choose only 2 remuneration options across all insurers:
An upfront remuneration which is 60% of the insurance premium in year 1 and 20% ongoing
A level remuneration which is 30% of premium per year from year 1 onward.
No exceptions. All insurers are the same. If a policy is cancelled or amended within the first 2 years the adviser must return these funds to the insurer. This is a far cry from the heady days where commissions in year 1 might be 120% up front and this could be cancelled and replaced every 13 months allowing clients to shop around or advisers to “churn”. Advisers can choose to rebate commissions or “dial down” so they receive nothing and charge a fee for the work they do instead.
The Code
The Code of Ethics is a subtle beast indeed
The Financial Adviser Standard and Ethics Authority (FASEA) is a newly created body that was created to lift the standard of financial advice and ultimately ensure that consumers are better looked after. Since their inception in 2017 they have set standards for education pathways and created a code that went into force this month. This process has not exactly been smooth and they certainly have their work cut out for them but most advisers agree that change is needed if financial advice is ever to become a trusted profession.
Please click here for more info but essentially The Code is an expansion of the Best Interest Duty which has been around since 2013. Advisers must now:
Identify any conflicts of interest and, if this can not be removed, not provide advice or service.
Establish if the client understands the advice given and prove this is the case
Ask themselves if the advice that they have given represents good value to the client, regardless of if they understand and agree to advice and subsequent fee
Consider and identify any broad reaching implications of their advice and the effect of this and provide evidence that sufficient investigation was undertaken to identify this.
This may sound all well and good these are creating significant “what ifs” as advisers wade though these rules and what they actually mean. Amendments and clarifications are sure to follow.
In the past insurance advice was purely commission only and advisers or brokers (both have the same license and rules) could even provide “no advice” which allowed clients to provide an amount they want to be insured for and they would simply give a few options and say “pick one”. Now extensive background work must be done to justify insured amounts. This means that in a lot of cases a client who wants perceived ”simple“ cover requires the same amount of ”work” as more complex cases and the adviser must ensure they investigate everything regardless of if the client has requested this or not.
Commission based payments meant that a “deferred remuneration” system was widely accepted, where the larger commissions paid by policies with greater premiums subsidised the smaller cases or the cases where insurance might be declined due to ill health etc. This is how insurance works at its very core, the sick people get paid for by the healthy. With relatively low operating costs, running an insurance broking service was simple and profitable and no upfront cost was the norm. Ongoing commissions are attached to policies and have little or no work required so the adviser might not have covered costs of work undertaken in year 1 but would in time. With rising costs and lower commissions payable this model is becoming unsustainable which is why a fee for service is increasingly common.
So what does it all mean?
All of these changes are meaning that advice models are changing very rapidly and both advisers and clients alike are unable to rely upon the usual way of doing business. Personally, I am optimistic that after a few years we will have a profession that is recognised as trustworthy, fair and competent and the Code of Ethics is a big part of that process. Unfortunately, in the short term this means greater cost to everyone in both providing and seeking financial advice.
As always this does not constitute personalised advice and is simply my thoughts and interpretation to help clients understand their options. Advisers, planners and “brokers” have different business models and make different offerings to their clients but if they are licensed to provide financial advice (AFSL holder) they must all follow the code and work in an ethical manner that benefits their client.