Written Articles

FAIS et al, Bluechip Magazine, June 2005

FAIS et al: Are we really going to see a change in the ethics of business practices?

Disclosure letters, quotes, replacement forms, FNA’s, record of advice, licences, Inseta credits, back office support…. all these things a practicing FA needs to have in place in the new FAIS environment. But what will really change?

I still see ads in the papers seeking a motivated self-starter who wants to earn an above average income in the financial consultancy division of a leading SA Bank to apply to the address below. The individual must be able to meet sales targets and operate at a high level of activity….so the ad goes. No change yet in the approach by the drivers of the industry!

Not until these drivers; the giants of our industry; the financial consultancy divisions of our banks and tied agency divisions of our insurance companies, allow their advisors to operate as professionals instead of salespeople, will we see any real change. These tied agents / employees are given targets within complex incentivised sales systems that give greater reward when met (when certain vehicles and/or products and/or a specific company’s products are used) and that penalize the advisor financially if not met, regardless of whether he has acted in a client’s best interest or not. Example: An advisor will earn credits/commission for the number of policies sold, so it is not in his interest to invest a client’s money directly into unit trusts as that is not a ‘policy’. We have not even touched on how the policy pays life commission Vs. the unit trust direct investment, neither the fact that there are extremely few people whose average tax rate is above 30% and who would benefit tax wise from an endowment policy once the rebate and annual 11K interest exemption is taken into account! (This is often the line used to justify such a sale.)

If a bank broker underperforms on a specific target, he may suffer his commission split being altered in the Bank’s favour. So he has to find a need, (or manufacture one) in the client’s portfolio somewhere.

He has to find something to replace, or something to invest. He can’t just give him good honest financial planning advice and tell him to put his money into his debt or the money market if that’s best advice because the banks do not pay their advisors to give best advice, they only pay them half their commission. But a client coming into the bank may think that the advisor works for the bank and that he or she can get appropriate advice from them for free. Advisors in banks should rather be employed on a salary basis and banks should be custodians of honest and sound advice. There are exceptions to the purely incentive driven salesperson. Unfortunately they are just that….exceptions. These exceptions will, with client focused integrity, tell the bank to take their target and get lost!

The banks and the insurance agencies are not interested in really decent financial planning. If they dispute this, it can only be shown in altered policy practice for their agents and employees. The banks must stop being only interested in non-interest income at a client’s expense and the insurance companies must begin acknowledging business retained on the books and not just new business. Wherever advisors are under sales targets and a manager/agency owner has the ability to earn more money and / or bonuses based on the advisor’s performance, we exist in an environment that challenges integrity. It is only the IFA that can truly be committed, without fear, to a client’s need. (Not that all IFA’s are necessarily honest or running ethical practices, but at least their environment allows them the freedom to be non-target driven.)

The problem of ethical business practices gets compounded further by the vehicles used by advisors across the board, whether a linked agent as in the context of above or an IFA. Firstly, no recurring investment products through life companies should pay life commission. Period. Subject closed. Recurring investments must invest in month one with no hidden pretences to this or interest charged against commission paid. Insurance companies should sell insurance and investments should be done directly with investment companies or through platforms directly into underlying unit trusts paying as-and-when commission. Insurance companies are accepting life retirement annuities being replaced under the premise of underperforming investment funds. They are accepting endowment policies where money market, property and income funds have been selected as the fund choices. In 99% of these cases, the client’s tax rate and rebate would not make this the correct choice against the tax rate of interest income in the endowment policy. But the broker gets his commission this way. I ask whether or not the Financial Planner of the year competition checks to see if the candidates use investment platforms for products such as retirement annuities. The answer is no. How can an advisor be named a top financial planner in this competition if the vehicles are commission driven ones. A life RA rips the client off. Does the competition check for this? No. But then Personal Finance (29/05/2004) goes on to state that “these are the 6 best Financial Planners in SA”. That statement in itself is ludicrous when only 20-odd people enter. However, my point being the use of vehicles.

The controlling bodies need to change and the client needs education so as to know what to ask their advisor for. These factors will begin the change to ethical business practices being run in more than just 5% of advisor’s offices. Rewards, prizes, incentives, these will continue because the drivers won’t change. The man in the street needs to understand the vehicles at his disposal. The tenth edition of Blue Chip magazine notes how in Australia members of their Financial Planning Association may no longer accept any forms of alternative remuneration linked to product or volume sales.

Real separation of the professions of Financial Planner and Insurance Salesman need to begin to be understood. A real Planner should not need to have broker contracts to earn a living. But that brings us to fee based practices…

I do not believe that the industry at large and the client in general is ready for fee based practices. The industry because there are still some insurance companies that cannot enable us to discount commissions on their systems and because they are not yet mentally adjusted to enabling a fee based practitioner to have support when his sales levels are low. There are still some of these companies talking about only allowing contracts to stay in place if a minimum level of FYC business is placed with them each year. So targets are set again. As I said earlier, companies do not yet acknowledge retained business. I believe that BC’s should be rewarded for supporting retained business through their broker network. After all, an insurance company only begins making money off a policy after about 2 years.

The man in the street reads about finding a fee-based planner. However, often he will still need some education as to what he will be paying a fee for and why the fee will be a certain amount. A Planner going fee based needs to have a system in place for invoicing, for collection, dealing with unpaid monies etc. They also need to establish a costing structure with an hourly rate and possibly a maximum charge for certain tasks. A client likes to know that there is a maximum to what he’ll pay on an hourly system. Otherwise you will get the event of a client challenging why some task took so long. The move to a real fee-based practice is a huge mental adjustment for both the advisor and the client. A real fee-based practice does not take commission in lieu of hours worked. It does not tell the client how many hours of time he/she has just bought from the commission and try to track that time over the next 2 years. A real fee-based practice means that a client pays us directly into our bank accounts and we are not paid by the insurance or investment companies. We quote risk products with zero commission on them and we load investments with zero commission upfront. These are the places to move to. But we place ourselves at risk if we do not collect the alternative fee upfront. This in itself is a mindset move and you need to have worked out how you will position it to the client. Do not pretend you are fee-based if you are not. Do not call yourself a financial planner if you are an insurance salesman and do not do all the proper planning tasks. Decide who you are and where you are going.

In summary, not much is going to change in the short term in terms of establishing ethical business practices. Too many commission driven industry giants and insurance salesman will see to that.

Kevin Murray CFP Licensee
Independent Financial Planner
Pietermaritzburg

RA debate issue, Money Marketing, June 2005

Dear Warrick,

I have been following the debate and letters to you surrounding the commissions, returns, costs etc regarding Life RAs as opposed to direct Unit Trust RAs. After reading the letters in the March, April, May and June issues, I have decided that I would like to offer my opinion on the debate, for what it’s worth.

After reading the letter on the subject in the May issue, my initial thoughts were that the debate was still going around in circles and was basically rubbish. We start with the March article where the letters of Rob Spendley and Gregg Sneddon are pitched against each other. In that issue we’re still nitpicking by spending time on the commission figures. Rob is trying to justify the Life product and Gregg is doing a good job of justifying the Unit Trust product.

Then in the April issue we have Shaun Ruth deciding that Rob Spendley’s commission calculations are the closest. He continues with trying to justify Life RAs because risk can be added to them, such as disability and premium waivers etc. We should be heading in the direction of modern financial planning where risk and investments are separated. The cases where the client must have them mixed are so few and far between that it doesn’t warrant bringing it up. He concludes by saying that it will depend on a financial needs analysis being performed and, let us always bear in mind, ‘what is best for the client’. I’m sick and tired of this point. If we stuck to this, the debate is also over.

Then John Wiliams (May issue) adds his opinions stating that even the professionals are confused about calculating costs and commissions and that the current levels of commissions received are well earned. We’re still skirting the issue here. Professionals are not confused, just not wanting to admit to the obvious.

In the June issue, Masthead joins the debate. I’ll pick up on two points from their letter. Firstly, they talk about short-term savings products being less effective for clients. We need to coach and teach our clients as to what a particular savings vehicle is for. A client can invest directly in unit trusts for the purpose of education in 15 years time and be coached into understanding what that is for. Then secondly, they say that the life office’s cost structures have played a huge role in the problems we’re dealing and that commissions are only a part of the problem. Well, these company’s costing structures have not dictated to me as to how I deal with clients. I have chosen not to be subject to their commission incentives. I have chosen to no longer offer these badly costed investment products to clients.

Let us establish once and for all which vehicle is best for an investor between life RAs and endowments and unit trust RAs and unit trust investing. The rest of the issues and the exceptions to the principle can follow. Now this is a no-brainer. It needs a simple understanding of some concepts, not scientific calculations. So please bear with me for a moment.

If, in the one product, an investor’s money invests from month one, properly invests from month one because there are no up-front loaded costs, invests directly into unit trust funds where the investor’s money is actually in unitised portfolios, if, in the same product, an allocation amount of about 95% of an investor’s money invests every month, from month one, if, in the same product, an investor’s money is able to experience real compound growth from day one of month one, if, in the same product, the costs are transparent and easily uncovered, if, in the same product, I can use listed unit trust funds where I am able to check on the mandate of the fund and understand it’s direction and lastly, if in this same product, I can increase or decrease my contributions at any stage without complications, month by month if I want to, stop them and then add a lump sum for tax deduction purposes, surely this product has a clear advantage over the other one. A clear advantage from an investment, flexibility and cost perspective. This one product would be, yes you’ve guessed correctly, the unit trust product. By the time the life product has dealt with costs and the fund value begins to grow, the unit trust product has already begun the compounding thing. Surely it does not require calculations of commissions and costs etc to realize which product must be better. Just a bit of simple logic can see this.

When we select products for ourselves and our own investing, I should hope that advisors look past commissions to find the best vehicle for themselves. I have two unit trust RA’s. The one is directly with an asset manager who has no entry fees. I obviously don’t pay myself the 3% as-and-when commission on the premium and so this product has a 100% investment allocation. I also do not pay myself the trail fee. The asset manager takes annual performance based fees, which are taken off the closing price of the units on a daily basis before the net asset value price is declared. No buy-sell pricing structure anymore in unit trusts. So again, this vehicle has very low costs with no units ever being sold to pay those costs and is therefore going to get off to a much better start than any, I say again any, life company’s RA product. The debate around choice of fund and fund manager is a separate one and goes to an advisor’s knowledge in a different field.

My second unit trust RA is through a LISP. A LISP that offers a RA from R150pm. They take on average 2% entry fee on each premium. Again, I don’t pay myself the 3% as-and-when or the annual trail fee. Why, because it’s stupid to pay yourself from your own investment. The LISP takes their annual fee monthly by selling units. The costs are still much lower than a life RA. Furthermore, whenever I do a unit trust RA for a client, including this one of mine, I select two to five percent of the premiums to go into a money market fund and I instruct the management company to pay any and all costs, commissions and fees from this fund. In this way they sell money and not units of a unit trust fund to pay the costs. You cannot do this with a life RA. The underlying Manco’s fees are built into the NAV unit price before closing and average 1 to 1.5% ex VAT per annum. Again, whichever way you look at it, this vehicle will be able to invest earlier and more directly and at a lower cost than any life RA.

Do I need to carry on? Can we agree, whether we like it or not, whether it suits our business model or not, whether is suits our sales machine or not, that a unit trust based RA and unit trust investing, as opposed to life product investing, is the better vehicle for the client? Whichever way you want to look at it, whatever your argument is, from an investment point of view, it cannot be beaten. Subject closed. Done.

Now, can you afford to sell such vehicles? That, I understand, might be a problem for you. But this is a separate subject and must not be confused with which vehicle is better.

For the last couple of years now – and since unbundling myself from tied agency and bank brokering commission targeting conditions, although I begun this even in the bank brokering world and told the bank I did not care about their targets – I have not done any investments with insurance companies. I have been building an annuity based income model through being paid the 3% as-and-when commission on retirement annuities or discretionary unit trust investments where someone else would sell an endowment policy. I have just decided that these are the correct vehicles for clients and then allowed my income to grow. I also take the 0.5% trail fee. Even when taking these commissions, the argument does not change. The products are still better. The client has flexibility, transparency, no penalties, real growth from month one.

Then I also offer my clients the option to pay me an ‘implementation fee’ to put such an investment in place. It’s a set fee scoped out again x hours at y rate per hour. If the client chooses to pay this fee, then I do not take the 3% as-and-when commission. Now if you cannot cope with changing your earnings model to that of as-andwhen, then simply share the issue at hand with your clients and inform them that if they would like the unit trust product, then you will need to charge them a fee.

Lastly, from a fund allocation point of view, most LISP’s or asset managers will ensure that your RAs are PIGS compliant. Insurers, to my current knowledge and past experience, do not do this. So through unit trust RAs you’re being forced to ensure that you’re keeping to the rulings on retirement fund portfolio allocations as well.

Let’s move on.

Kevin Murray CFP™
Independent Fee-Based Financial Planner
Pietermaritzburg