9 September 2018

JENNIFER HEWETT

The royal commission hearings into insurance starting Monday will no doubt provide even more scandal and drama than the return of Parliament under Prime Minister Scott Morrison this week.

The banks are now well used to playing their roles as the main villains of the piece, including during the last hearings into superannuation. What's less obvious is that underneath the theatrical performance directed by Kenneth Hayne, the revolution in financial advice as well as the banks' role in wealth management generally is already well under way.

To general public outrage, for example, the royal commission explored how most banks and financial advice businesses attempted to hold on to to lucrative trailing commissions and conflicted business models long beyond what was reasonable or even moral. But the main players had been forced to accept the game was up even before their failings were made so embarrassingly evident on the stand.

It was not just that banks belatedly acknowledged the dream of being able to cross-sell products turned into a reputational nightmare that never delivered the returns anticipated when they took over wealth management businesses a couple of decades ago.

ago. It turns out selling their own in-house products as well as charging for financial advice, even after the demise of commissions, just created too many conflicts of interest. Who would ever have thought?!?

That's behind the decision by CBA, NAB and ANZ to exit their wealth management businesses, leaving only Westpac to remain a solo act with BT. Now Westpac also is believed to be reconsidering its commitment to the original version of full service, with a review into the future of its inhouse financial planning arm.

That's even though Westpac is sticking with other parts of wealth management, including life insurance, superannuation products and about $12 billion in funds under administration on its Panorama investment platform.

AMP, of course, has been facing its own spectacular financial reckoning. But the meltdown in AMP's share price and leadership after a disastrous royal commission appearance are really only the delayed symptoms of trying to hold together increasingly contradictory forces.

Real costs hidden

The fundamental problem is that the institutional business model of providing advice to a mass market was never financially viable without the structure of commissions and cross-selling to subsidise it and to hide the real cost to clients.

It meant a sales culture became hopelessly confused with the notion of advice – with often damaging results for clients. The best interest duty of advisers to their clients was frequently observed in the breach.

But only about 20 per cent of Australians are currently willing to pay thousands of dollars for "independent" financial advice. When MLC became the first of the big players to end the system of commissions more than a decade ago in favour of a fee-for-service business, they lost advisers, clients and market share.

The mud flowing out of the royal commission will ensure there is even less public trust in advisers, particularly those linked to retail institutions. The recent outflow of money from retail funds into industry funds in part reflects a new level of scepticism about the for-profit business model.

But for the majority of customers in either retail or industry funds, that still doesn't come with any increased willingness to pay more. Nor do most industry funds have much of a financial planning arm or provide more than limited or "scaled" advice given the difficult economics of any financial advice business operating on a fee for service business, particularly given the relatively modest balances of most members.

One exception is First State Super in NSW, which paid about $1 billion two years ago to acquire StatePlus, a financial advice business. There are still questions about how effectively this will work given the cost of providing advice. One retired couple, for example, were recently offered a pretty standard plan in exchange for a $6000 set-up fee. Ongoing annual advice fees based on a percentage of their $800,000 added up to around the same amount for mainly being channelled into fairly vanilla First State Super products. The couple went elsewhere.

Many older advisers are already leaving the industry as the requirements on qualifications become more onerous and the flood of grandfathered commission payments slows to a trickle or is cut off altogether by royal commission recommendations. The percentage system of payment based on the amount of client money involved – as opposed to a flat fee – is also under challenge.

Yet the need for advice will only increase, particularly as a generation of Baby Boomers retires. For many high net worth individuals, that will obviously come with the ability to pay. That market is increasingly likely to be filled by truly independent adviser groups offering more tailored services and at least the promise of higher returns and greater flexibility.

Some in the industry – and the government – believe that the bifurcation of the market and the advance of technology will also allow the development of cheaper, more restricted advice models that can still satisfy the "best interest duty" to their clients. That remains an open question despite increased consumer awareness.

Veteran industry players like Paul Heath, former head of JBWere and now chief executive of Koda Capital, a completely independent advice and wealth management firm, predict a new model where the licence to operate as an adviser will be held at an individual level rather than by dealer groups or big institutions.

He says the "best interest" duty is still central and suggests that if this is not possible to manage in a vertically integrated model, the firms newly spun off from the banks will face much the same problems they did under bank ownership. Advice, anyone? 

Read more at afr.com