Banking royal commission points to fee-for-service

12 February 2019

It’s becoming clear there’s only one viable business model for advisers, reports Zoe Fielding.

For advice firms that heavily rely on grandfathered commissions the next few years are going to be incredibly difficult.

Government adoption of the recommendations of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry will push advisers to more quickly adopt transparent charging models and abandon conflicted remuneration.

Financial-planning businesses have been transitioning to fee-based service models for several years. The shift has been steady but slow as commissions continue to contribute to the bottom line of many advice businesses. Now that is coming to an end.

Royal commission: transparent fees, no commissions

Regarding fees, the royal commission recommended:

  • a ban on continuing trail commissions on investment and superannuation products (known as grandfathered commissions) – which the government agreed to from January 1, 2021
  • renewal of ongoing fee arrangements annually, by the client’s express written authority, who must receive a record of services they’ll receive from the adviser with a total fee figure
  • commissions on life-insurance products be reduced (eventually to zero) unless the Australian Securities and Investment Commission can find a “clear justification” for keeping them.

Financial advisers face revenue pressure

There’s no doubt advice businesses’ revenues are under pressure.

Firms with established fee-for-service models will feel little effect from a ban on grandfathered commissions while other businesses will be hard hit, says Association of Financial Advisers policy manager Phil Anderson.

Between 9 per cent and 19 per cent of total advice revenues are derived from grandfathered commissions (even though there’s already a strong movement against them), estimates cited in the federal Treasury’s submission to the royal commission show.

“Practices that have a medium level of reliance on grandfathered commissions will need to look at how they can diversify their revenue streams. They will need to look at which clients might be appropriate to convert to ongoing fee arrangements and which they may no longer be able to service,” Anderson says.

“For [practices] that are heavily reliant on grandfathered commissions the next few years are going to be incredibly difficult.”

Life-insurance commissions, another major revenue source for advisers, are dwindling. Upfront commissions are capped at 70 per cent this year and will drop to 60 per cent from January 1 next year.

There are provisions for 100 per cent clawback of commissions if the policy is cancelled in the first year and 60 per cent if the policy is cancelled in the second year. Further restrictions may be on their way following the royal commission’s recommendations.

These caps on life-insurance commission will have a widespread effect. On average, advisers derive about 24 per cent of revenues from this source, according to financial services industry research group Investment Trends.

Reinvigorating income streams

There’s no doubt the strain on traditional revenue sources will force advisers to review their business models to ensure they are sustainable. On the other side of the ledger, advisers can cut costs by improving efficiency.

Technology is an important contributor to being able to cost effectively deliver advice, particularly to lower value clients,” Anderson says.

Conducting meetings via Skype rather than face-to-face and introducing hybrid-service models that incorporate robo advice to meet simpler client needs are examples of how technology can help cut costs.

But income streams must also be sustainable.

“An ongoing revenue stream is essential for a business to succeed. If services are being provided they need to be paid for,” says Australian National University school of legal practise academic Tracey Mylecharane, who specialises in financial regulation within the Australian financial system.

Advice likely to be more expensive for clients

Getting clients to pay for advice, without using commissions to subsidise the cost, is something advisers often struggled with. Some advisers fear that restricting risk-insurance commissions would make insurance advice unaffordable and deter clients from reviewing their policies.

Deakin University associate professor Adrian Raftery warns reduced take up of insurance would increase premiums for the remaining customers, which would put insurance out of reach for an increasing number of people.

Raftery says tighter regulations in general may encourage advisers to be more selective about which clients they will take on.

“[Advisers] will have to spend more time on each client, keep more in-depth client notes, and have more contact with clients … there’s a lot more risk to being an adviser compared to a decade ago,” he says.

Experience from Britain gives reasons for his concern. The UK Financial Services Authority (now the Financial Conduct Authority) banned commissions at the end of 2012. In a review three years later, the authority and Her Majesty’s Treasury found fewer consumers were seeking investment advice as it was unaffordable, and several banks had shifted to advising wealthy clients only.

The significant upside of fee clarity

But Mylecharane is optimistic that Australians will benefit.

Fees-for-no-service was a problem highlighted by the royal commission. This was partly blamed on a culture created by the legacy of trail commissions. Mylecharane says such cultural issues have damaged consumer confidence in financial advice and changing fee models is a good start to improving trust.

“The change in model could mean consumers are made aware of what they’re paying for and what's available, which means they can shop around and procure advice that best suits them,” she says.

To that end the royal commission recommendations could be of benefit. In an initial response, the Financial Planning Association acknowledged the commission’s final report highlights the need for strong consumer protection and oversight that builds trust in the financial-planning profession.

“If planners are transparent about the services they can provide and the cost, if they can be competitive, then like any other business they will gain clients,” Mylecharane says.