Facing the end of grandfather commissions

7 December 2018

Loss of commissions may be a blow to advisers as they transition to new revenue models,  writes Zoe Fielding.

Advisers derive 9 per cent of revenue from commission on non-risk products, and a further 24 per cent from commissions on risk insurance.

Associations, institutions and regulators have come out this year in vocal opposition to advisers’ trail commissions (also known as ‘grandfather commissions’), which remain a significant source of revenue for them.

This widespread movement against, and debate over, these commissions, has been accelerated by this year’s royal commission into Misconduct in the Banking, Superannuation and Financial Services industry with the conflict of interest they pose the clear point of contention.

Australia’s Future of Financial Advice reforms in 2013 banned commissions on the sale of new superannuation and investment products. But commission arrangements already in place were allowed to continue under ‘grandfathering provisions’.

These grandfathered commissions were expected to die a natural death over time, to be replaced in financial-planning businesses with fee-for-service revenue models.

But five years on, the royal commission has highlighted how slowly this transition is occurring. Grandfathered commissions are still a key source of revenue in many advice businesses, creating perceptions of conflict between the client’s best interests and what benefits advisers.

The case against grandfathered commissions

“Any exception to the ban on conflicted remuneration, by definition, has the ability to create misaligned incentives, which can lead to inappropriate advice,” the royal commission stated in its interim report released in September.

As far back as 2006, the Australian Securities and Investments Commission found consumers were six times more likely to receive “unreasonable” superannuation advice when an adviser had a conflict of interest over remuneration.

ASIC looked at retirement advice in 2011 and again found conflicted remuneration, such as product commissions and percentage asset-based fees, influencing adviser recommendations and lowering the quality of advice. In 39 per cent of its samples, ASIC found the advice given was “poor”.

“[They] have led to an environment where some financial advisers are receiving ongoing commissions and yet providing no services,” says Financial Planning Association chief executive officer Dante De Gori.

Bringing an end to grandfathered commissions would quickly stop this practice, he concludes.

The royal commission revealed numerous examples of advisers receiving payment without providing services. ASIC expanded on this point in its submission to the commission: “Grandfathered commissions operate to incentivise advisers to keep clients in legacy products with a continuing commission structure, even where there may be better products available to meet the client’s needs.”

Bringing grandfather commissions to an end

These findings have led to renewed calls for grandfathered commissions to be banned. As yet, no formal decisions have yet been made on when or how this would be done.

ASIC clearly expressed in its submission that it wanted grandfathered commissions to “cease as soon as reasonably practicable and to the maximum possible extent”, allowing for a “short transition period” to let licensees and advisers adjust their businesses.

The FPA has suggested a three-year transition period for superannuation and investment products and a “long-term timeline” for commissions on life risk products.

Major financial institutions also support a ban, and several, including ANZ Bank, National Australia Bank, Westpac Banking Corporation and Macquarie Group, have already moved to cut grandfathered commissions.

From the institutions’ perspective legislative change will be needed “ make it clear that the payments are prohibited and that product manufacturers can have no liability to financial advisers or licensees (in contract or otherwise) for not paying the commissions”, as ANZ puts it in its submission to the royal commission.

The effect on advisers

But not everyone agrees. The Association of Financial Advisers, for example, says the loss of commissions as a revenue source would be too damaging to businesses and would make advice unaffordable for consumers.

A ban on grandfathered commissions would hit some advice businesses harder than others as businesses rely to varying degrees on the payments as a revenue source.

Grandfathered conflicted remuneration makes up between 9 per cent and 19 per cent of advisers’ total revenue, according to estimates cited in the federal Treasury’s submission to the royal commission.

Financial services industry research group Investment Trends, shows, on average, that advice businesses derive 9 per cent of revenue from commission on non-risk products, and a further 24 per cent from commissions on risk insurance recommendations.

“On average, FPA members receive less than 10 per cent of their remuneration from grandfathered commissions,” De Gori says. “The majority of financial-advice businesses have transitioned to fee-for-service models since the introduction of the Future of Financial Advice reforms, which will help in this final transition away from grandfathered commissions.”

Focus on new advice revenue models

It seems inevitable that grandfathered commissions will be brought to an end in the near future. Advice businesses that are still relying on these income streams will have to execute contingency plans now to survive after the revenue source dries up.

There are three fee models advisers are choosing to replace commission payments, which will become more important as these commissions are discontinued. Many advisers use a combination of the below.

  1. Fixed fees – Under this model, advisers have a set upfront price for developing a financial plan and a fixed rate for ongoing service. This style of payment accounts for an average of 32 per cent of adviser revenues, according to Investment Trends.
  2. Asset-based fees – Industry-wide, 29 per cent of adviser revenue comes from fees charged as a percentage of client assets, Investment Trends data shows. ASIC criticised this model in its submission, as having similarities to commissions “in that they are recurring, are practically ‘invisible’ to the customer and may bear no relation to the work actually done”. The outcome of this fee structure, ASIC says, could be that clients continue to be charged without receiving advice services.
  3. Hourly fees – This arrangement is common with other professionals such as lawyers. Around 5 per cent of advisers use this model, Investment Trends reports, steady from about 4 per cent in 2010.