AFA response to QAR submissions from Choice and ISA
AFA News 8 July 2022. The Quality of Advice Review (QAR) has drawn a large number of submissions. Many of them have included recommendations that have the potential to make a difference in ensuring that financial advice is more accessible and affordable than is the current case. Not all submissions are supportive of financial advisers, and it is worthwhile to reflect on some who have included recommendations that would have a seriously detrimental impact on the financial advice profession and their clients.
The Choice submission to the Quality of Advice Review is full of criticism of financial advisers, unfair judgements and generalisations. In just their second sentence they start with a statement that “conflicts of interest that remain in the advice industry continue to contribute to poor outcomes for many people”. What proof do they have that this is true in the post FoFA/LIF/Professional Standards and Annual Renewal era? They make the often-repeated statement that the Banking Royal Commission exposed widespread misconduct in the financial advice industry. It might be worthwhile pointing out that only one adviser took the stand during the Banking Royal Commission and only ten advisers were the specific subjects of case studies. The Banking Royal Commission provided sensational coverage on a number of issues, many of which were already known at the time. Most of the focus was on the conduct of large institutions and not individual financial advisers or the many small business financial advice practices.
The Choice submission makes reference to a survey that they did in May 2022 which they believe demonstrated widespread distrust in the financial advice profession. This survey was an online survey directed at Choice supporters (and the general public, they claim), so it is hardly surprising that given the reporting they get from Choice, that they would take this perspective. However, it is evident from the five examples that they have included on pages 10 and 11, that none of these people are current clients of financial advisers and they clearly lack an understanding of the current regulatory regime. The comments refer to “best commission”, “bank affiliations” and “who benefits from where my money is invested”, all of which reflect a bygone era. On this basis, I think that we can safely disregard the relevance of this survey. To understand what financial advice clients really think about their advisers, they should survey real advice clients. We know from a number of research reports that the existing clients of financial advisers value their advice relationship and trust their adviser (e.g. IOOF – The True Value of Advice – December 2020).
Resistance to change
There is nothing in the Choice submission that will help to make advice more accessible and affordable for everyday Australians, other than the suggestion that a Government funded advice and guidance service should be established for low to middle income Australians. Otherwise, they are completely resistant to any form of regulatory relief that could have any consequences for consumer protections, even though it might significantly reduce the cost of providing advice. Once again, this position is not based upon the preferences of actual consumers. Choice has opposed any change to the Best Interests Duty safe harbour until ASIC has provided empirical evidence that shows it is ineffective. Seemingly they are oblivious to what is happening in the marketplace, including the decline in the number of advisers, the increasing cost of financial advice and the difficulty that many Australians are having in accessing financial advice when they desperately need it.
Choice has made two key recommendations related to adviser remuneration:
• Banning life insurance commissions.
• Banning asset-based fees.
Life insurance commissions
Choice claim that life insurance commissions “create a perverse incentive for advisers to sell life insurance to people that are not suitable for their needs”. What evidence do they have to make this claim? Well, they go on to quote from the 2014 ASIC Report 413 on life insurance advice:
“This research into life insurance advice found the way an adviser is paid (e.g. under an upfront commission model compared to a hybrid, level or no commission model) has a statistically significant bearing on the likelihood of their client receiving advice that is not in their best interest.”
Seemingly, in including this quote, they are oblivious to the fact that it is actually saying that there was no correlation between poor advice and the use of either hybrid or level commission models. Of course, the hybrid model was an 80% upfront, 20% ongoing model at the time of the ASIC Report 413. The cap is now 60% for upfront commissions, which is 25% less than the hybrid model in 2014 that generated a 93% pass rate in ASIC Report 413. To the best of our understanding, there have been no ASIC reviews of advice quality over the last 10 years that have delivered a result as good as a 93% compliance result. They go on to demonstrate their total ideological opposition to commissions, however have they bothered to ask life insurance clients about their views on paying advice fees or commissions? Surely a body that claims to advocate for consumers, would appreciate that very few clients are willing to pay an upfront fee to cover the full cost of life insurance financial advice. There are numerous research reports that demonstrate this. Our members find that even when they offer their clients the choice of an upfront fee or a commission, that clients invariably choose to pay by commission. There are a couple of good reasons for that. Firstly, commissions provide a means to spread the cost of the advice over a number of years. Secondly, clients rarely pay more than a small fee, where they go through the full advice process, however are ultimately unable to get acceptable cover, due to pre-existing or family health conditions.
Asset Based Fees
The Choice discussion on asset-based fees goes to the next level, in terms of unfounded claims and inaccuracy, as demonstrated in the following statement:
“Once established, asset-based fees do not provide an incentive to provide ongoing services to the client, because the financial adviser is paid regardless. They have consistently been a source of poor consumer outcomes for decades, and have driven disastrous business models.”
These are extraordinary claims, with no evidence provided and fail to acknowledge the existence of Fee Disclosure Statements and now the Annual Renewal obligation. Whilst there has been a recent trend in the movement towards fixed annual fees, this has not been driven by the protestation of clients. If Choice really thinks an adviser can get away with providing no service, but still get clients to sign the annual renewal and consent forms, then they are harshly judging the common sense of the hundreds of thousands of existing clients who pay for ongoing advice on the basis of asset-based fees.
Their submission then goes on to make further extreme claims, that potentially mix up the fees charged by advisers, versus what product providers charge. If Choice is truly calling for an end to asset-based fees charged by product providers, which is almost universal, including industry funds, then maybe they could be more explicit.
“Asset-based fees also allow firms to ‘clip the ticket’ of their client’s hard earned-savings at multiple stages in the process. Consumers can be hit with an asset-based fee when they engage with an adviser. They are hit with an asset-based fee when they access an investment platform. They are hit with an asset-based fee for each product they invest in on that platform. Further, asset-based fees penalise those with more savings. With a “platform administration fee” of 0.75%, an individual with $200,000 invested in the platform would pay double the fees paid by an individual with $100,000 invested in the exact same platform. Asset based fees in financial advice should be banned and be replaced with fixed fees for service.”
Maybe someone should explain to them that the “platform administration fee” is not charged by a financial adviser and that it is actually the product provider. It appears evident that they do not understand how the charging model works.
Industry Super Australia submission
Another submission of note is the one from Industry Super Australia (ISA). We have not heard much from ISA on the financial advice front in recent times, however we certainly remember the active role that they played at the time of the FoFA legislation and the FoFA Amendments debate in 2014.
As we would expect, the ISA submission was presented from the perspective of advice and guidance provided by super funds, with an obvious industry fund emphasis. Unlike some previous submissions, there were no direct attacks on the financial advice profession.
We appreciate the important role that industry funds play in the financial services sector and we also recognise that they are an important part of the solution for providing financial advice. We also recognise the importance that default insurance plays within the group super market, which ensures that many more Australians have some life insurance, even if it is nowhere near what they require. Whilst we don’t support some of the ISA recommendations, including expanding the scope of intra-fund advice, there are other recommendations that we can agree with.
However, there are two important recommendations that we strongly oppose, and which need to be addressed. These recommendations are:
• Banning ongoing advice fees within Choice funds.
• Banning life insurance commissions.
Ongoing advice fees in Choice funds
The banning of ongoing advice fees in Choice funds has been argued by the ISA on the basis of the lack of competitive neutrality between MySuper funds and Choice funds. It was Commissioner Hayne who recommended the banning of all advice fees in MySuper funds. This recommendation came from his lack of understanding of the value of financial advice and a tight view of the application of the Sole Purpose Test. He failed to understand that the value of financial advice was predominantly with respect to strategies and the psychological benefits of confidence about a plan for the future and being held accountable for improved financial behaviours. He presumably thought that if you had your money in a MySuper option, then there was not much need for ongoing advice. The Government took a more balanced perspective and only banned ongoing fees in My Super funds.
So yes, there is an issue with the lack of a level playing field, and advisers being more likely to work with clients in Choice funds, however the solution to this is not to compound the flawed thinking of Commissioner Hayne, but instead to reconsider what has been done with MySuper fund members. It is certainly not the case that the clients in Choice funds are calling for the banning of ongoing advice fees. There needs to be some common sense applied in this context.
Life insurance commissions
The call for the banning of life insurance commissions is equally based upon flawed logic. It is seemingly once again founded on the protection of the life insurance offers of the industry funds, however, more than in any other sense, there is a complete lack of comparability of the default life insurance in industry funds, compared to what is available in the individual advised retail context.
The ISA submission refers to the poor client outcomes illustrated by the 2014 ASIC Report 413, however as noted above, the compliance outcome for Hybrid (80% upfront commission and 20% ongoing) and level commission business in Report 413 was that 93% of files passed, which is far higher than any other recent report on advice quality. It should also be noted that this was advice provided back in 2013, before the full impact of all the recent reforms. The December 2019 ASIC Report 639 on advice provided by super funds (including industry funds) revealed that only 49% of the advice complied with the Best Interests Duty and related obligations. Given that the current 60% cap on life insurance commissions is much lower than the hybrid products that existed prior to LIF, this further highlights the lack of evidence to argue for the banning of life insurance commissions on the grounds of consumer protection. To be blunt, on the obvious difference in compliance results between the 93% pass rate for hybrid and level commission business in Report 413 and the 49% pass rate for super funds in Report 639, life insurance advisers should not be lectured to by super funds. And that is before we talk about the conflicts that exist in vertical integration.
In terms of presenting an incentive for advisers to recommend clients move their insurance out of group super funds, there are some key points that need to be made.
• The level of default cover in group super funds is vastly inadequate for most Australians. A recent report by ASFA/Deloitte states that the average group super payout for death cover is $137k, and $136k for TPD.
• Default cover is typically around $160k – $180k for a 40 year old, declining to around $55k – $80k by the age of 50. These amounts are simply not going to meet consumer needs.
• Typically advisers will recommend as a minimum, that clients have enough cover to payout their mortgage and to cover living costs for a few years. In this way the member, or the surviving spouse, will not be subject to being forced to leave the family home.
• With the average mortgage in Australia being around $564k, according to the latest Census, default super is never going to be enough cover, and is often substantially inadequate. Advisers are forced to consider other options, including increasing the level of cover in the current product (including the super fund).
• The cost advantage for default group super cover typically disappears when larger insurance amounts are needed, and underwriting is required. The individual advised options can be cheaper, and in some cases significantly cheaper.
One of our risk adviser members recently compared the cost of cover for a 40 year old white collar worker seeking $500k of death and TPD cover and $4,700 per month of Income Protection Insurance. They compared the offer from three of the largest industry funds with the ten retail, individually advised products for both males and females. The results were very interesting and particularly contrary to what many people might expect. For males, the four cheapest products were individual advised products. For females, the seven cheapest products were individual advised products. The industry funds were certainly not cheaper, and one was substantially more expensive than all the other options.
Importantly, it is the retail advised products that can offer the better terms, including the option for own occupation cover, level premiums, portability of cover and super linking to avoid restrictions around conditions of release. And of course, individual advised products are guaranteed renewable, whereas group super products are subject to changes in the terms, typically every three years.
An adviser is forced to act in the best interests of their clients. If the existing fund can provide the best cover, then they must recommend this and seek to charge a fee accordingly. If the best option is to place the insurance through an individually advised policy, then they will need to do that. It is certainly not the case that the best option for the client is always to stay where they are. Knowing the options, and understanding what suits the client best, is part of the value that comes with getting financial advice.
Another justification put forward in the ISA submission is that the clawback of commissions, when a product lapses in the first two years, does not apply to renewal (trail) commissions, which they think reduces the disincentive to recommending switching products within the clawback period. This is a nonsensical suggestion when you look at the detail. If an adviser was to recommend the client move to another insurance policy within the first year, they would lose 100% of the upfront commission, and would not yet have received any servicing commission. If they were to recommend moving during the second year, then they would lose 60% of the upfront commission through the clawback, but would retain the first servicing commission. So, let’s look at a simple example. For a client with a combined premium of $4,000, the upfront commission would be $2,400, which would not cover the cost of providing the advice (estimated at $3,000). If they received the first servicing commission of $800, at the end of year one, but recommended moving to a different product in year two, and needed to repay 60% of the upfront commission ($1,440), then they would have earnt a net $1,760 by this point, which is still $1,240 less than the cost of the provision of the initial advice (let alone the cost of servicing at the end of the first year). If anyone thinks that this is a good business model, then they know something that we don’t. The lack of clawback on servicing commission is largely irrelevant.
Is underinsurance an issue?
Commissioner Hayne, in his coverage of life insurance, made a reference to the issue of underinsurance, and this is an important consideration in assessing any further reduction in commission rates. The ISA submission has addressed this issue and challenged the existence of underinsurance, referring to research by Rice Warner issued in February 2019 that states the level of underinsurance has reduced over recent years primarily due to the increase in default insurance benefits provided by superannuation funds, which they suggested represented 70% of all life insurance benefits. The problem with quoting this report is that since early 2019, the impact of the Life Insurance Framework, the Protecting Your Super Package and Putting Members Interest First reforms have all kicked in, with a 17% reduction in the number of Australians with individual advised death and TPD cover and a 35% reduction in the number of Group Super death and TPD insurance accounts (APRA’s Life insurance claims and disputes statistics report). There has been a huge decline in insured Australians.
As of the end of 2021, the Individual Advised channel represented 38% of the lump sum insurance benefits (versus 55% for group super) and 25% of disability income insurance (versus 57% for group super). Group super cover is important, however it has declined significantly since the Rice Warner report. The removal of life insurance commissions would have a devastating impact on the advised channel, putting the overall life insurance market into a destructive situation.
APRA data (Biannual Life insurance claims and disputes statistics report – 19 April 2022) show that there are 5.2 million Australians who have disability income insurance. This means that 38.5% out of 13.5 million working Australians have disability income insurance. A disturbing 61.5% of Australians would be reliant upon their sick leave and cash savings in the event of an injury or illness that prevented them from working. This statistic alone is enough to demonstrate that Australia has a problem with underinsurance.
The debate on the issue of underinsurance needs to be a bit more substantial, and not just a reference to a dated report that does not reflect the current situation or the likely future situation if commissions were banned.
Industry Fund submissions
It is important to note that in our first scan of the submissions from the large industry funds, there is no similar call for the banning of life insurance commissions. Much has changed over recent years and advisers are increasingly working with industry funds and considering existing group super insurance arrangements as part of assisting clients. It is not uncommon for an adviser to recommend that a client retain their industry fund and the default insurance within it, particularly where they have reduced insurance needs or where they have health issues. Financial advisers have the Best Interests Duty and as part of that they need to consider a client’s existing insurance arrangements, and only recommend moving them where to do so would be in the client’s best interests.
We welcome the Quality of Advice Review consultation process and the open debate on how to fix the problems in the current financial advice regulatory regime and operating model, however the debate needs to be based on the facts and submissions should be subject to challenge. We look forward to further constructive debate as the Review progresses.
For any questions on the QAR submissions, please email firstname.lastname@example.org.
Issued 08.07.2022. AFA Policy & Education Update