The Future of Financial Advice

Financial advice is advice provided to an individual or family to assist them to grow, manage and protect their wealth.  It includes strategic advice, recommendations about suitable investment classes, appropriate products (investments, superannuation and insurance) as well as explanation of the impact of legislation, taxation and other external factors on the individual’s financial position.  Advice is essentially strategic with the choice of a product being made to fulfil a consumer’s needs.  So, why has such a large part of the industry failed to meet these needs?

The financial advice industry grew out of the life insurance regime of the last century.  Sales people were engaged by life companies and other financial institutions to sell products.  They received initial commission for procuring business and renewal commission for retention much like mortgage broking operates today.  While the product sale met some personal financial needs, the provision of any advice was often incidental and focused on the use of the product being sold.  The financial institution generally did not take on a duty to ensure appropriate advice was given nor that the product was suitable for the consumer’s circumstances.  While this might have been accepted in the past, community expectations have moved on, and many institutions were slow to recognise this.

Government intervention

Prior to the Royal Commission, there have been 3 waves of intervention occurring roughly every 10 years.

1. In 1992 the Trade Practices Commission (now the ACCC) reviewed the practices of the life insurance industry. This review noted that the remuneration structures encouraged sales but that there was no emphasis on servicing clients.  Amongst other things, this led to requirements for full disclosure of fees on financial products.
2. The Financial Services Reform (FSR) Act of 2002 formalised the provision of financial advice and standardised it across all investments, insurances and superannuation.  For the first time, financial product advice was defined to mean a recommendation that is intended to influence someone to make a decision in relation to a financial product.  This includes both Personal Advice which takes in to account an individual’s circumstances and General Advice which does not and must limit itself to generalisations and information.
3. In 2012/13, the Future of Financial Advice (FoFA) reforms banned conflicted remuneration including commissions on retail investment products and superannuation. These reforms included legislation requiring financial advisers to act in the interests of their clients.  Consumers must be told what they are paying for advice and this notification must be renewed every two years.  If consumers do not elect to continue receiving advice services at least every two years, then financial advice fees cease – preventing situations where consumers can continue paying fees for advice which they are no longer receiving.

What is advice?

A layman would not usually understand the boundaries of what does and does not constitute personal financial advice.  They rely totally on their adviser to guide them efficiently and honestly.  One of the problems we have is that many aspects of strategic advice are not covered by legislation.  For example,

• advice about budgeting or saving for a holiday or car;
• advice from their accountant about their tax position;
• advice about the right type of health insurance cover they should hold (yet trauma cover is a financial product as it is issued by a life company);
• advice about Aged Care options;
• buying a telephone under a time-based contract;
• advice about bank deposits or other fixed interest investments such as company debentures; and
• advice from a mortgage broker (We believe mortgages should be added to the list of financial products – they are complex, highly material to the financial position of consumers, and open to abuse if not regulated effectively. For a previous Insight blog on this topic, click here.).

The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry has highlighted that the transition to this consumer legislation has not been a smooth one and that FoFA now needs a thorough review.  It has publicised an issue that has been percolating within the financial services industry for years, namely how to separate financial advice from recommendations of financial products.  Clearly, there will be a fourth wave of intervention following its findings.

Intra-fund advice has been carved out of the law to allow superannuation funds to offer specific advice relevant to their fund membership.  Even this has some grey areas.  For example, most funds offer intra-fund advice when moving a member into a pension under the same fund.  However, it is critical to discuss retirement with the member’s partner to know the family’s full financial circumstances.  If the adviser recommends putting the partner into the fund, it is no longer intra-fund advice – and they should have an Approved Product List for these contingencies!  It does appear reasonable to extend intra-fund advice to deal with this set of circumstances.

Goals

Advice is about helping clients to meet goals and developing financial strategies which help achieve them, but it is difficult to focus on goals with the current ownership and product structures in the industry

The Royal Commission seems likely to be the catalyst for fuller separation between remuneration for advice and choice of product.  This should mean an adviser would be agnostic about any product and should be paid by the client.  This is the situation which occurs with most other consumer dealings with professionals – they receive an invoice for services rendered.  It should be possible to arrange for this fee to be debited against a financial product, but this should be the consumer’s choice and under their control.

Of course, we will need to educate the public about the value of advice and we would need to ensure governance standards are developed, but that challenge is one we should take on.