Last year, Karen Chester, the Australian Securities and Investments Commission (ASIC) Deputy Chair, released a report compiled jointly by ASIC and the Dutch Authority for Financial Markets.  She used the opportunity to challenge the financial markets about whether disclosure on documentation was working efficiently for consumers, stating:

“Disclosure can and has backfired in unexpected and harmful ways. It’s been asked to do too much and can’t solve the complexity of the financial system.  The over-reliance on disclosure in some ways proved an enabler of poor conduct and poor consumer outcomes revealed by the financial services royal commission”.

While we concur with the thrust of this sentiment, a significant contributor to the problem has been the quality of the disclosure.  In other words, product statements have been largely unintelligible for laypersons.  This has arisen in part due to the prescriptive nature of product disclosure.  Financial institutions and superannuation funds have used legalese to respond to their statutory legal requirements and regulators’ guidelines.  The total failure (over many years) to materially raise financial literacy standards in the community has also been a contributing factor.

In this context, it is worthwhile revisiting the delivery of financial advice.  This has changed dramatically in the last 25 years following the introduction of mandatory superannuation and the succession of changes to legislation around “advice”.

Before the introduction of the Superannuation Guarantee (SG) system in 1992, the life insurance industry dominated the provision of long-term savings.  Life agents helped people plan for retirement, build investments and protect themselves with life insurance.  In this era of voluntary saving, many people ended up with little savings at retirement.

Further, from March 1985 until September 1993, the taper rate on the Age Pension means test was $104 p.a. for every $1,000 of assets.  For people trapped in the means-testing levels, there was arguably no encouragement to save more for their retirement, so indirectly the tax and social security structure advantaged the wealthy in saving for their retirement.

The life companies paid upfront commissions to salespeople for procuring business (policy sales) and a renewal (trail) commission for keeping the policy in-force.  The investment community used similar remuneration structures – in the 1980s, it was not uncommon to pay a fee of 8% of the purchase price to buy into a property trust.

One of the consequences of this structure was an industry focus on selling products with little attention paid to real financial strategies.  Further, consumers were ignorant of the cost of advice as it was built into product fees and the commission structure was hidden (undisclosed).

Financial advice today

Today, we have a much more mature industry:

• Most consumers have superannuation coverage, including life insurance.  Many don’t realise these benefits might be short of their financial needs, but without guidance and advice, they won’t find out until close to or even during retirement.
• The mandatory superannuation system has taken savings away from personal investments, which remain a small part of national savings.
• Financial advisers are now required by law to act in the interests of their clients. Their primary focus should be on financial strategies, including setting and monitoring goals for consumers.  Selecting products is less important than getting the strategy correct (but this is still where many advisers tend to spend much of their time).
• Consumers pay advice fees to financial planners for an agreed service.
• The cost of delivering any financial advice is perceived to be too expensive by most consumers.

Despite these secular changes, the legislation has not been changed to reflect modern conditions.  It still assumes financial advice is all about putting people into products.  Consequently, there is a major emphasis on product disclosure.

Disclosing useful information to consumers

Disclosure documents, quite rightly, form part of the contractual terms between the supplier and consumer.  They are drawn up by the supplier, unquestionably the stronger party to the contract, and as such, any anomaly or uncertainty in them will be interpreted by courts in favour of the consumer.

This puts significant pressure on suppliers to err on the side of COMPREHENSIVE and meticulous precision when drafting disclosure documents.  Marketing departments try to write brief clear documents, but legal departments take over and expand the documents until they are comprehensive – voluminous to the point where no one can really be expected to read them in their entirety, and complex to the point where no layperson can really be expected to understand them.

Product disclosure is therefore an extremely difficult and complex problem and may well be insoluble – if it were simple, it would have been solved a long, long time ago.

So, what can be done?  First, much of the legal jargon in a Product Disclosure Statement (PDS) is unintelligible for a layperson.  It would be better to rewrite most of this in common English and put all the standard terms and features on ASIC’s website.  People can be directed there if they have any interest in reading the material (which most people won’t).  The PDS can then just state the facts pertaining to the product being offered – fees or premium rates, or level of investment risk.  It can also highlight any variation from standard terms.

Some might argue that we are removing valuable information from consumers.  In fact, it is more likely to be read if it is issued by ASIC – and the common or “standard” concepts can be explained properly.  PDS documents would then be very brief which means they would often be read by consumers.  Further, comparisons would be easier to follow.  Think of car insurance where people provide a few simple facts and get quotes from two or three companies (online or by telephone).  The comparisons keep the companies honest and the consumer makes a quick decision.  Even though the tortuous policy documents are available, the language is universally incomprehensible, so they are never read.

While we are thinking about improving the system, we should remove simple comparisons such as ASIC’s comparison of fees on products for someone with $50,000.  While this provides an example to consumers on how to calculate the fee for their situation, it would be better if they were required to show 2 or 3 examples to demonstrate that it varies depending on size, such as $10,000, $50,000 and $250,000.

Using only one standard comparison makes it easy to adjust fees to look good at that size or to insert fees that are not compared in the standard comparison.  That is why new start-up super funds and exotic investment options often have extortionate buy/sell margins.  These are a crude entry fee undisclosed by being omitted from the comparison formula.

Eliminating poor products

The Australian Prudential Regulation Authority (APRA) has stated that it is going to weed out under-performing MySuper products, and it will later extend its heatmap to cover life insurance within superannuation, choice and retirement products.  At the same time, ASIC has issued guidance for its Design and Distribution Obligations (DDO) and Product Intervention Powers (PIP).  This will lead to major product rationalisation with all surviving products (theoretically) meeting a reasonable standard.

In time, advisers will be able to focus on their strengths – setting goals and financial strategies, then monitoring progress against targets, with product selection being secondary.  The price of financial advice will come down as many of the inefficient product comparisons and descriptions will be greatly simplified.  Advisers will be able to use technology to support many of their services whereas the current regime often precludes the ability to do this.

In summary, product disclosure is currently a major problem, but let’s move much of the work away from lawyers back to the regulators and then we can simplify the system.  This will be one key step in improving the value of financial advice for consumers.