The real cost of complying with the new Future of Financial Advice (FOFA) rules may be much higher for financial planning practices than the Government had thought; and as a consequence, some of the fundamental reasons for introducing FOFA may not be achieved.
Banning commissions is obviously the most radical change, but unfortunately it has come 20 years too late. Changing the entire remuneration system to fee-for-service is merited and will provide certainty of fees paid to the financial planner; and, therefore, added security for the investor. However, it will be difficult for the public to adopt a fee-for-service system which is similar to that used by accountants, since most financial planning clients are used to receiving advice, and not being invoiced. From 1 July 2012 onwards, the effect of FOFA on financial planning revenues could be damaging.
The annual opt-in cost of $11 per client was the result of research conducted by an actuarial consultancy firm, commissioned by Industry Super. Earlier in the year Treasury officials indicated to a Senate Committee that they had seen industry research which suggested opt-in would cost around $100 per client per annum; possibly even $200 per client per annum.
Irrespective of the opt-in cost, the new opt-in reform will only apply to new clients who join a financial planning practice after 1 July 2012. The grandfathering rules have finally been confirmed and they will help maintain the value of financial planning practices; particularly those with many inactive clients, known as Cs and Ds or ‘orphans’.
Research by our consultancy firm, Radar Results, reveals that each of the 71 financial planning practices selling today contains, on average, 544 clients. When you further analyse the figures, these practices can have up to 5 times more inactive clients than active. Over the past few years many financial planning practices have been selling off their inactive clients, wanting to concentrate only on the higher-revenue clients and ignore the inactive ones.
There’s a concern that the sale of a client register from one adviser to another after July 2012 may stop the flow of trail commission and trigger the start of the opt-in rule. On this matter, a spokesperson from Treasury said, “At this stage, I don’t think that transferring the book would necessarily turn the grandfathered commission off or trigger opt-in, but circumstances might vary.”
Inactive clients are usually not offered any service or advice and can be rated either as a C or D grade client or classed as an ‘orphan’. It’s going to be very difficult to have inactive clients sign a renewal notice; or, for that matter, even find out where they are now living in order to issue a renewal notice. And if the trail commission ceases because you can’t get a renewal notice signed, then the value of the client register may disappear.
Inactive clients can make up a large proportion of a practice’s revenue and the cost to make contact with all these inactive clients may be prohibitive. With grandfathering still allowing for the passive trail commission to continue, there’s little incentive to contact them. When FOFA was first announced, the Government said, via the former Minister for Financial Services, Chris Bowen, “These reforms should ultimately encourage more people to seek financial advice”. I suggest the opposite may occur.
Born out of the inquiry into the collapse of Storm Financial and Opes Prime, the intention of FOFA reforms was to make financial planning advice more affordable to a larger number of people within the community, improve quality of advice and strengthen investor protection by having a less conflicted playing field in relation to commissions and volume bonuses. Unfortunately, the opt-in rule will not encourage more people to seek financial advice and neither will it improve the quality of advice; but it will offer more investor protection and certainty of fees. The ban on commission and other volume-based incentives will be a real bonus for the public and offer a high level of protection. FOFA will improve the quality of advice to the public, but not make it more affordable to a larger number.
Clients of Radar Results have been acquiring inactive clients by the thousands and are taking a positive stance on FOFA, providing service and advice to as many of these clients as possible; and, at the same time, growing their practices by cross-selling other products and services.
The insurance industry and life insurance agents and advisers, who specialise in risk products, are blessed. The FOFA reforms will basically have no impact on them – and rightly so. The reversal on banning risk commissions made common sense. Possibly opt-in may be now be reversed?
The Government’s reforms will have little or no effect on fee-for-service practices, particularly those with only A Grade clients; but the majority of financial planning practices are not pure fee-for-service yet and the reforms may be onerous.