What should advice cost?

What should advice cost? That was an excellent question from the audience during the first two of our recent getting in shape series. Perhaps this seemingly simple question surprised our panel. The answer to the question is not easy. It was a kind of sub-plot in the day's event: the question of the cost of advice is part of the disclosure story, part of the story about the future of advice, part of the story about the value of advisers solidly backed up by the research shared on the day. When asked what advice should cost the panel made a good beginning - in both Wellington and Auckland the first answer was "it should not be free". This echoed John Botica's  earlier comment during the first panel in Wellington where, talking about disclosure, he asked that any advisers taking commission should not refer to their advice as free. Of course advice isn't free. Often something that is not paid for is not valued. Advice is paid for (whether by fee or commission) and it is valuable. 

The question came up in the context of a discussion about how to make advice more accessible. For people to value advice they must first know it is available, believe it is worth getting - but these are just pre-conditions. Often we know something would be good for us, but don't do it.

Many people struggle with making the time to meet with an adviser - not just because of the time for the meeting, but they fear the time the work around the meeting will take. A good portion of the population are certain that their finances are a mess, and if not, then the musty file of papers definitely is a mess. So they fear judgment. Many people struggle with making room for the cost of advice. If they believe that it will require payment at the time and their budget is already stretched they will be reluctant to make an appointment. Commission has a valuable financing role to play here - but it is not the only mechanism, of course, that can make access to advice easier. 

So although advice should not be free, we need to make it easy to start the process. Which means the initial steps should be free - and easy to do.

Most advisers offer initial discussions at no charge. More can be done to make brief trials of the value of advice accessible. Social media helps, Zoom and MS Teams helps, but nothing quite beats a meeting - and the ability to slip into a 20 minute session on KiwiSaver at lunch or hear ten top tips on managing your home loan at the local mall are probably under-utilised strategies. Now add some tools in the client's first language (which will not be English in about a third of cases in Auckland) and spoken by someone who at least knows your culture a bit... these are access strategies. They reduce the psychological costs (fear of rejection, fear of shame, fear of being exposed as not having 'enough money to qualify for advice'). 

Implications of approval of Australian advisers operating in NZ, and more daily news

The Financial Markets Conduct (Australian Licensees) Exemption Notice 2020 issued by the FMA allows Australian licence holders and representatives to operate in New Zealand. Although MinterEllisonRuddWatts special counsel Alistair Robertson says there is nothing to worry about, some advisers have expressed their concerns about allowing Australian advisers to enter the market at this time. Robertson has clarified the terms of the exemption saying that Australian advisers that choose to move to New Zealand will be able to continue servicing Australian clients.. The exemption doesn’t allow Australian advisers to service New Zealand clients. Australian advisers looking to achieve the exemption will need to:

  • “Hold a current Australian financial services licence, be in the business of providing a financial service in Australia, and not have a New Zealand place of business.
  • Be registered as a financial service provider in New Zealand, and be a member of a dispute resolution scheme.
  • Take all reasonable steps to ensure its representatives submit to the New Zealand courts in respect of the relevant financial services.
  • Give the FMA written notice that it intends to rely on the Exemption Notice.
  • Have procedures that give reasonable assurance that the licensee and its representatives comply with relevant Australian regulatory requirements when giving regulated financial advice to a New Zealand retail client under the Exemption Notice.”

“The FMA released an updated exemption that allows Australian financial service licence holders and their representatives will be free to operate in New Zealand without a local licence, following the rubber stamping of the Financial Markets Conduct (Australian Licensees) Exemption Notice 2020.

The move, which came at around the same time that politicians were scrambling to finalise a trans-Tasman travel bubble, was the finalisation of a proposal first put forward to the industry in August 2020.

Some advisers may be worried that allowing Australian advisers into the New Zealand market at such a tumultuous time of regulation change could cause trouble.

Alistair Robertson, special counsel at MinterEllisonRuddWatts says that New Zealand advisers have nothing to be worried about.

“The exemption is limited in scope. It does not allow Australian financial advisers to solicit New Zealand retail clients. It generally allows Australian advisers to continue to service Australian clients if they, the adviser, move to New Zealand without having disruption to those clients and without complying with the New Zealand licensing regime.” Click here to read more

In other news

From Goodreturns: Barry Kloogh not forced to pay reparations

From Stuff: Mortgage adviser client upset at $2500 bill

From Stuff: Covid-19 ended my flight attendant career, but it also taught me resilience

Clear fee disclosure prevents this problem:

Susan Edmunds, reporting at Stuff.co.nz, tells us of a client that was surprised by the extent of the fee a mortgage broker charged when they refinanced their loan early. They complained about it to FSCL, here is the essence of their decision: 

FSCL said the adviser was entitled to a fee but the terms of engagement were too vague to be enforceable. “The clause did not set out how much the clawback fee could be, or how the fee would be calculated. It simply said that, if the client fully repaid their loan within 24 months, the adviser would be entitled to charge an early repayment fee. For all [the client] knew, it could be a $25 fee, as opposed to $2500.” 

Faced with that, the adviser agreed to waive the fee. That's the problem with a vague disclosure - a few examples could have made this really clear. Glen McLeod makes a robust defence of the right to charge such a fee - which I broadly agree with - I just think it should be really clear to a client what the fee will amount to. In the absence of good disclosure, the dispute resolution bodies will rule in the client's favour. I quite like the approach outlined by Bruce Patten, of LoanMarket, in the article. I believe that would stand up to a test such as this complaint. 


Daily news update: advisory firm established by former head of BNZ Private Bank, and more stories

Investment advice businesses appear to have been experimenting with different structures to manage, mitigate, or eliminate conflicts of interest for some time. See story below. I have heard of a few in the insurance sector - usually people offering options rather than an entire change of business model - but they are rare. Models that I have see offered: true nil commission options with a fee for placement, another Advice for fee and no offer of placement, another fee and commission refund (varying terms), and others simply presented hourly paid options. We have not yet seen these coupled with environmental, social, or governance goals explicitly as in the case below, although often proprietors are concerned about those issues, they are not wired in to the business. Perhaps that's an opportunity. 

Donna Nicolof, who was the former head of BNZ's Private Bank has established Pāua Wealth Management. Donna has stated that the firm is determined to eliminate any conflicts of interest and remain independent. When analysing and making decisions, investment managers will be required to consider different external factors including environmental, social, and governance factors.

"Pāua Wealth Management has created a business model to support the independence and integrity of its advice and remove potential conflicts of interest, Nicolof says. She has said no to product commissions or referral fees in favour of a fees-for service approach.

“We believe New Zealand investors deserve truly independent advice and the better outcomes this delivers. We only receive fees agreed to by clients so they can be confident that we act only in their best interests,” she said.

“We do not manufacture investment products and our advisers are not incentivised to sell particular products or trade on clients’ portfolios, which can create conflicts of interest. We are motivated by delivering quality advice and superior service,” she said.” Click here to read more

In other news:

Brokers on lost business, insurer response and government support

NZ’s largest travel insurer restructures, halves staff

Three big things that are forcing consumers to re-think

Knowing the cost to serve each client really helps

I am suspicious of 'unlimited.' it is meant to suggest limitless, but makes me wonder whether there is really an undisclosed limit, or worse still, a failure to work out what the limits are. 

Working with some advisers that are selling their business recently, we accidentally got to talking about the limits to growth - why the business had never grown beyond a certain point. The expected maximum business size is limited by your rate of new business generation and your rate of lapses. When these two are equal the business ceases to grow. Most business development coaching works on increasing the rate of new business generation, a few then look at lapse rates. 

But even before the new vs lapse limit is reached, often businesses cease to grow.

Then I got Seth Godin's piece about interaction debt in my inbox. I think this provides part of the answer. Many businesses never properly work out the cost of serving existing customers, and as the service requirements of those rise it reduces the time available for new business generation. It is particularly difficult to manage when the same person that is responsible for new business generation does all the existing business customer service. There are big advantages to that integration, but there are trade-offs too. Godin calls the servicing requirement an interaction debt. Focusing on it in that way highlights that it is unique interaction which is particularly costly. If that's appropriately charged, then there's no problem. If it is bundled with other costs one should periodically review it, as it is possible to get into a situation where revenue is insufficient to sustain the service promised.

I am particularly worried about the idea that a high upfront commission followed by a very small renewal should pay for an unlimited amount of future client service. That's a big promise. If you have run the numbers and you are happy with it, good for you. If you haven't checked, then you're just hoping it will be okay. 

Professional IQ to be holding clawback-related fees workshop

Professional IQ have announced that they will be holding a workshop to discuss clawback-related fees, or a fee contingent on the customer sustaining a product (usually a home loan or insurance) for a period of time. Virginia Douglas will be presenting. She will be using case studies from complaints about clawback fees to discuss the issues for advisers and what they should be considering when charging a clawback fee and what problems advisers should be looking out for. Click here to register


Ask a stupid question, get a stupid answer

Ask people what they would be prepared to pay for a house in Auckland and I doubt you will get an answer equal to the current median price.

There is a well known economic concept called revealed preference, which is a way of saying that what people say they will do and what they actually do are two quite different things. People involved in fast moving consumer goods find it hard enough to get people to imagine whether they will buy something quite ordinary - like a new brand of frozen cheesecake - let a lone a complex proposition like financial advice, which varies so much, and is in large part created in collaboration with the client.

The point being: the thinking around fee-based advice remains immature. In an effort to quantify the challenge - and make no mistake, I am agreeing that there is a challenge - the questions being asked are quite simplistic ones. So the comparison between a notional "$2,000" required for advice (whatever is meant by that) while consumers are perhaps happy to pay "$500" seems to completely miss some significant features of the client experience today. 

Financing is a concept incorporated in the commission model. If you want to challenge the commission model, sure go ahead, but consumers frequently like to spread lumpy costs, so no need to abandon that idea, and assume that fees must be lump sums.

Imagining the future is difficult. We are not the only ones struggling with it, clients do too. They don't necessarily say in answer to our research questions 'I am struggling to see how that would work' - humans are notorious for not owning up to a lack of knowledge.

Revealed and stated preferences are not the sole domain of clients, either. Many advisers say that they are motivated by annuity income, but their actions reveal a preference for upfront income.

So the future is much more likely to be created by experiment. Advisers will try things, clients will respond.

In the current environment, the financing of much financial advice through commissions, has some great features - and some pretty bad ones - but it works well for lots of people. Alternatives seem limited. But I am an optimist for more ways to give financial advice, and more ways to collect a fee that makes advice provision viable. There are lots of ways consumers pay for expensive intangible services right now. In fact, many, many, more than they did just a few years ago. Whether they are lawyers, accountants, nutritionists, beauticians, fitness instructors, therapists, architects, planners, designers, you name it, there are loads of services being delivered in ways that consumers are happy to pay for right now. While that goes on, commission will also remain an important and valuable way to finance and pay for an important and valuable service.

The difference between an investment customer attitude to fees and an insurance customer

Recent research from Cerulli Associates has found that after surveying over 8,000 investors clients prefer fee-based advice as opposed to the commission-based option. Click here to read more.But these people are demographically different to insurance clients. Being older, and having capital, they can usually afford a large fee. They can easily rationalise self-financing: the expected return in an average year should well exceed the expected fee. The challenge will be how we get typical insurance clients to get to the same place - and all the while recognising that most of them do not have the money of lump sum investors. For those that offer fee-based research, and they are few, even fewer are tackling the financing of advice. This can be done, but takes effort.

Culture and Conduct Review of Insurers

There was a hard choice for someone in designing the FMA and RBNZ’s report on culture and conduct. At some point they had to decide whether to specifically identify insurers associated with specific issues – or leave them anonymous. They chose to leave them anonymous – which was probably considered a good choice by most insurers, but it has created a problem. By listing all the sins of the insurance industry and not naming who does what the casual reader might think everyone is doing everything wrong – and that’s not the case.
Although our regulators were aiming for some publicity, I don’t think damage to the industry was intended. Quite the reverse, as their carefully worded report clearly states that there is no evidence of systemic issues.

Think of the car industry, some make inefficient cars, some make noisy cars, some make very expensive cars, some make ugly cars, some make cars that aren’t quite as safe as others. But no one makes inefficient, noisy, expensive, ugly, and unsafe cars.

So how does it break down?

The legacy book issues are mainly with older insurers. Commission issues apply to less than half of the policies sold in the industry. Service issues around things like renewals, or termination dates could be found anywhere – but are not universal. Problems around supervising advisers only apply to those that sell through them. Questions about how to ensure suitability when there is no adviser, apply to direct or bank insurers.

Add up all the problems and you’d think that the industry never listens to consumers, or surveys them, or responds to their concerns, or designs products with them in mind. Which is simply not true.

Lots of people work to ensure effective products with the consumer at the heart of the decision. But not all of them. Regulators are not established to hand out gold stars to the winners in the market – success is its own reward. Regulators are there to point out the problems, and there are problems.

Take non-underwritten insurance as an example.

The product is expensive, because there are no health questions asked. Anyone can buy it, even if you are dying when you apply. It is very useful for two specific types of buyers, the busy, and the sick. It is a poor solution for people who are not in those markets. Good conduct consists of making sure the product is appropriately sold.

Look at the busy segment. For someone so busy that they just want some cover and cannot take the time to get it properly underwritten this is like paying $5 for a bottle of water at the airport. Some people say, ‘what a rip off’ and walk on by. Others grab the cold drink, and accept they paid a premium for convenience.

The second market for this cover is the group of people who have just received a bad diagnosis and have not previously bought any life insurance. They want to cover the cost of their funeral, and the insurer and them are taking a bet.

The conduct problem comes up when someone in good health, with plenty of time and ability to get an underwritten product, gets sold an expensive non-underwritten one instead. I want a market where every consumer gets the right deal – but I don’t want to ban products like this because that would disadvantage the people it was designed to help.

A simplistic view is to label guaranteed issue product as ‘shonky’. in fact, it depends on what your needs are.

For the regulator to identify that there are conduct problems and recommend a conduct regulator is welcome, and is something the industry has been seeking.

I have participated in groups last year where insurers have discussed the value of an insurance conduct regulator and have made submissions as part of the insurance contract law review in favour of such a regulator being appointed – those are a matter of record – which is why I have little patience for people who accuse the industry of wilful wrongdoing, or trying to avoid these issues.

Go back further and you will find people in the insurance industry arguing for review of insurance law, much earlier. I recall people considering the law commission paper back in 2003 and 2004. At the time some joked that those parts of the Life Insurance Act 1908 that were not reformed in the 1970s were going to be updated on the centenary – 2008. What was considered a priority by government went into the draft insurance prudential supervision law, but many recommendations were not taken up. Those recommendations are the kind of change that the industry cannot lead, as they require new rules, and an empowered referee. It’s one reason why many insurers are cautiously welcoming the current report.

The management issues in the Conduct and Culture report are probably the most significant, and yet have received very little media attention. That’s because they are among the most difficult. For the insurer that had incorrectly priced some increase options, and not completed the remediation, that is not because they were rubbing their hands together with glee over the money – there were systems problems. Insurers owned up to those issues themselves as part of the review. Good. That’s another example of an industry co-operating with the regulator and seeking to do the right thing. The regulator makes a fair point when it describes the under-investment in systems. As a consumer I am glad the regulator checks and doesn’t leave it solely to the goodwill of the industry – I think most people drive safer because they are aware of people charged with enforcing the road rules.

The commission issue is one in which I have some struggles. Of course, I work with a lot of insurance advisers and that makes me partial to their arguments. I work with some excellent advisers, and I also see some very poor ones. That commission pays for access to advice there is little doubt. Some people would not get advice if it were not paid for by those high upfront commissions the report criticises. The report is absolutely correct in stating that it can drive bad behaviour – but the FMA’s own investigation into the issue of ‘churn’ found that surprisingly little of it actually happens. After trawling through five years of data for thousands of advisers only about two dozen were subject to any regulatory action. As with others in the industry, I was surprised it wasn’t more.
I want to share with you the views of one adviser I spent some time with recently. Alan Borthwick, an AFA based in Wellington, talked about a case that was replaced by another adviser, badly, and the client has a downgrade in cover as a result. He and his staff are now compiling a complaint about the adviser who didn’t follow current FMA guidance on replacement business. That is an enforcement issue. Borthwick says it makes him angry. “That guy is the reason I’m being tarred with the same brush. They are screwing it for the rest of us”.

It’s the idea that commission is not paying for anything valuable that upsets him, and me. The assumption is that it is just dead money for the consumer. But many advisers are giving good value. Borthwick’s model is one of full financial planning, including a complete claims management service. Much of that work is paid for by those high up-front risk commissions. It won’t be that way if they are cut. Because the cost of financial advice won’t fall just because we decide to pay less for it, it will mean more fees, which will mean, for lots of people, less advice – because often the people that need help most of all are in a mess financially and don’t have a thousand dollars spare to pay for advice.

Insurers are, in effect, the default funder of advice – allowing consumers to pay off the cost of their advice over time. The terms are very generous, compared to consumer credit. Of course, there are ways that this can be managed if commissions change – but it will have an impact on advice provision, and it isn’t all going to be good.

More compelling on the commission issues was the chart of the cost as a proportion of premium. Some consumers, with poor advisers, may be getting not much for that money. Because that money is paid to the insurer, who pays it on to the adviser, it is reasonable to ask what they are doing to ensure some value is being received for it.
But the issue of legacy products is very, very, complicated. Again, from a consumer perspective, if I have an old mobile phone plan, and a new one is being offered which is better and cheaper, I am justifiably unhappy about being left on the old one…

…but insurance is different to mobile phones. Risk pools exist, and the effect of the move may not just be felt on my plan alone – but also on the premium rates of others that are in the risk pool. Nevertheless, the concept of monitoring product suitability throughout life is an important one which insurers must address. It’s one of the most valuable parts of the report. It even has application wider than ‘just’ financial services. It should be applied to lots of modern services from gym memberships to internet access. The world over, complex subscription products are being designed without enough thought for consumers that can struggle to assess their value. I note that the Ministry of Business Innovation and Employment is consulting on unfair practices right now. While journalists are right to ask insurers why they haven’t dealt with these issues sooner, and call it complacency, we aren’t exactly alone in being where we are, right now.

I also want to comment on the FSC response to the report. Some unkind comments were made about Richard Klipin’s handling of the questions asked by journalists recently – check the comments log on many of the stories. It’s not fair. The FSC has done an enormous amount of work on these issues, and their role is very valuable.

Commission is one issue where the Financial Services Council has tried to work in the past. It gets flack for not having “fixed” this before, but competitors acting to fix a price (the commission paid to advisers) would be a breach of competition law. We must all take care to avoid such behaviour.

The second point the FSC likes to make is that it has worked on the FSC Code for two years, which was then launched in September last year. Although its effects have not been fully realised it is an important piece of collective action – and, crucially, does not breach competition law. What it enables is insurers to take important steps to invest and develop services without worrying too much that someone will breach the rules and undercut them.

Having said that, there are wider issues for corporate conduct, and consumers and the Minister, should consider them as a whole. Whether the contracts are complex consumer credit, gym memberships, mobile-phone plans, or the terms and conditions for a social media giant based in the USA… they have certain features in common that make them prone to the kinds of conduct issues we have seen identified by the FMA. In what environment is poor conduct more likely? When several of these factors combine:

  • Complex services
  • ‘Set-and-forget’ services
  • Information asymmetry
  • Subscription or regular payments
  • Hard to compare features
  • Distant call-centre sales process / faceless bureaucracy
  • Reduced competition

I see and hear a great deal of willingness to address them from the insurance sector.