Blueprint to reform planning

Whatever else the market regulator ASIC might be accused of in the coming months, it will not be criticised for failing to thump “the big end of town”.

In hitting AMP, the largest institutionally owned financial planning enterprise in Australia, with an “enforceable undertaking”, ASIC is making history: the order will change the nature of financial planning forever. Outlined below is one possible business model for an institutionally owned planning business that would meet the regulator’s goals and deliver good commercial outcomes.

The enforceable undertaking found that on many occasions AMP Financial Planning:

• Planners' files did not disclose a reasonable basis for advice.
• Failed to make proper disclosures about the costs of acquiring the recommended product and the significant consequences of replacing the existing product.
• Made statements on its website and in its Financial Services Guide that suggested AMPFP planners could consider a broader range of products than permitted, which could have misled consumers.
• May not have had adequate arrangements in place to manage conflicts of interest.”

Even a cursory reading suggests that the first three issues are systemic failure of process, while the last goes to the heart of the agency debate '” are planners agents for the manufacturers of product or the client?

The enforceable undertaking is telling all institutional planning businesses that they can no longer be “licences of convenience” for self-directed financial planners. It is time for radical surgery not Band-Aid solutions.

Is there a way forward in which everyone can win '” the regulator, planners, their dealers (not just AMP) and investors? Yes, there is. It means planners becoming more honest. In reality, it involves being direct with customers and telling them that even broad, let alone unlimited investment choice, has many downsides and that professionally constructed portfolios are more likely to deliver the returns that investors really need. We also need a seachange in our financial planning culture, from paternalistic planning (where clients are told what to do) towards collaborative plans (where clients and planners agree what to do).

I have first-hand experience of the commercial approach to good advice. Executives of dealer groups often tell us things like: “We agree we are not doing things as well as we could, but changing behaviour would make some of our planners unhappy and they would not comply unless we make this compulsory. We are not keen to make it compulsory because it could result in a reduction in sales."

In other words, it is cheaper to pay the penalty than risk the potential loss of revenue that could result from imposing good process.

This attitude is simply no longer acceptable. Financial planning is too important to the Australian community to continue to be so commercially pragmatic

What is Financial Planning?

For all of its avowed complexity, financial planning is a relatively simple concept. Every person does their own financial planning, although in many cases it may be very poor. Some choose to outsource part of their planning to a third-party supplier, more often than not termed a financial planner.

I believe that anyone pursuing current and future goals that have a financial dimension, must work within four interrelated principles.

• Spend less than you own or earn, to create an investment pool.
• If managed well, you can expect your investment pool to grow at 1–5% above the inflation rate in the longer term, depending on the riskiness of the portfolio
• You can partially guarantee that longer term through life and income insurances whose cost will impact on your spending and saving.
• All financial plans have some level of financial risk. If the risk needed to achieve your goals is inconsistent with the risk you would otherwise prefer to take, you must specifically accept that risk

Paternalism versus collaboration

In paternalistic planning, the planner and their dealer take responsibility for the client outcomes. This is the current dominant style of planning where the decision on what portfolio to recommend is more often than not the outcome of a simple “portfolio picker” questionnaire. These tests usually consist of 6–10 questions designed more to meet regulatory obligations with the minimum of fuss than provide any meaningful insight into what the client needs or how the client thinks about financial issues. They simplistically link the test results into a recommended asset allocation or fund. And of course, as a consequence, all of the liability for the advice sits with the planner and their dealer.

In collaborative planning, on the other hand, decision making is shared between the client and adviser. In essence the plan is the personal contract between the client and the planner designed to meet the client’s needs. Any product recommendation is the outcome of the “know your client” process. The planner needs to collect sufficient information to be able to prove that the product and service being recommended meet the individual needs of the client and his or her family. Clients bring their goals and aspirations and their commitment to not only prioritise any lifestyle trade-offs but to live with the plan, the product decisions and any behavioural changes needed. The adviser brings knowledge of financial products, the markets, regulation and, of course, other clients in similar circumstances. The outcome is what is commonly known as the “properly informed commitment” of the client to the plan. In the end there is a shared responsibility.

Clearly, collaborative planning is closest to the approach preferred by the regulator and any sensible manager and owner of a planning business.

Informed consent

The focus going forward for the more commercially perceptive institutional dealer groups will be to move from the outmoded paternalistic model to collaborative planning. It is only through collaborative planning that important client decisions can be made within a highly transparent process leading to their “properly informed commitment”

There are four components of a properly informed commitment to a plan:

• A clear articulation of the client’s goals and the plan to achieve those goals.
• A transparent explanation of the risks, costs and limitations within the product recommended and the plan.
• The capacity of the client to make decisions.
• The personal commitment of the client to what is required to achieve their goals.

Transparency is clearly part of Financial Services Reform Act and the many reforms instigated by the Financial Planning Association over the past few years. The client’s personal financial literacy and commitment are also necessarily tightly intertwined.

Better commercial outcomes

The benefits of a robust process designed to deliver quality advice based on an in-depth knowledge of the client include:

• Enhanced levels of client and planner understanding and empathy.
• Happy clients who are generally pleased to give referrals.
• Greater persistency and lower levels of product churn, leading to enhanced profitability for both planner and product manufacturer.
• A consistent, transparent and compliant business process.
• A solid argument for lower insurance premiums.
• An infinitely more valuable planning business.

A more detailed understanding of clients’ needs and aspirations delivers the triple virtues of profitable and better sales in a highly compliant manner.

Battle lines are drawn

The current battle over what constitutes good advice can be defined as the clash between the immoveable demands of consumerism versus the irresistible forces of business. The regulator, representing both the general community and the client, has a clear agenda to bring a fiduciary perspective to the process of product selling. The product recommended must meet the needs of the client and there must be a robust argument in the supporting sales documentation explaining why that is the case. In essence, everything starts with the client’s needs and works through to the service and product recommendation. The key term here is justification. There must not only be a clear pathway and logic from the client’s needs to the recommendation; the advice must also be clearly justified in the Statement of Advice.

Integrating conflicting goals

The crux of the argument is that the regulator and the institutional businesses in financial planning must find a way forward to where the goals of both sides are met. The regulator is looking for client-centric advice and business is looking for a sustainable, profitable business process.

The commercial sector has a defence against the claims levelled against it by the regulator, the media and increasingly the general community; that is to industrialise the advice process to remove the errors that are endemic in the hand-crafted solutions that are symptomatic of current financial planning, and to radically simplify its product offering so that prospective clients can readily understand that in an AMP shop they sell AMP product.

There is a huge opportunity for institutional financial planning firms to meet the needs of customers, although it will come at the cost of significant disturbance to the current method of manufacturing and distributing product.

Reducing choice will reduce costs and ultimately deliver better financial outcomes to clients. Meaningless product proliferation hiding under the cloak of investor choice has proven simply impossible to manage. Large institutional fund managers should focus on using their intellectual processes and buying power to deliver one or two “balanced” funds at the best possible price. These are more likely than portfolios constructed by planners to deliver the predictable outcomes that most customers need.

Good advice, adherence to disciplined processes and happy clients are all measurable performance indicators that can be built into a remuneration structure to replace commissioned selling. Of course it’s not easy to tell your agents that the game has changed and it is a substantial business risk but the rewards for the first major to break with the past are great.

Paul Resnik is an industry consultant at presnik@carm.com.au