'Why commissions should be banned'

Opinion: Why Simon Power should go the whole hog and ban financial advisors from taking commissions

10th Nov 10, 7:03pm by Bernard Hickey

By Bernard Hickey

New Zealanders have lost faith in financial advisors.

That's the clear message in RaboDirect's Financial Confidence index for September, which showed confidence dropping again from a year ago as the fallout from the collapse of the finance company flows through to Mum and Dad investors.

Interest.co.nz's Deep Freeze list of failed finance companies shows that more than 200,000 investors now face losses worth more than NZ$2.8 billion of the NZ$8.5 billion frozen in such finance companies over the last four years. Many of these investments were recommended by financial advisors who received a commission from the finance company.

These advisors and those companies were not regulated and many did not fully declare the extent or the type of commissions they were paid. Not surprisingly, given the experience, a whole new generation of investors are deeply disillusioned with New Zealand's capital markets and the quality of their so-called independent financial advisors. Sadly, many of the same investors in their 50s and 60s were the ones who lost faith in the share market in the late 1980s and early 1990s.

The government has been grinding its way through reforms of the legislation around finance companies and financial advisors over those same four years, but I don't think they've gone nearly far enough to win back the faith of investors. Financial advisors will need to be accredited and trained, but they are still allowed to take commissions from finance companies, fund managers and insurers.

They do have to declare these commissions up front, but the very practice of taking commissions has been discredited by the actions of so many of those same advisors over the last decade. Many made their fortunes shuffling Mums and Dads money into those finance companies that offered the highest commissions without a smidgen of research or care for the outcome for investors.

They recommended that money be put into Strategic, Hanover, Bridgecorp, South Canterbury Finance, Dominion Finance, MFS Finance and many others. They had no idea these companies were lending second and third mortgages to speculative property developments, or worse.

The blew their chance to retain the faith of investors by accepting these commissions. They lost their license to operate in the minds of investors. Now it's time for the government to stand up for investors and ban the practice of awarding commissions to financial advisors. Australia is planning to ban such commissions from July 2012 and the industry there has already started phasing them out.

AMP took a major step last month with its announcement that it would also phase out commissions from July next year in New Zealand and replace them with fees for advice. These could be hourly fees or a fee to build a savings plan. The onus is on the advisor to choose what is best for the customer rather than which finance company offers the biggest commission or the best golf trip or the best tickets to the rugby.

Commerce Minister Simon Power is still considering whether to take the full step and ban commissions, including so-called soft dollar commissions where the finance company or fund manager offers trips and conferences to resorts.

In Australia these commissions included tickets to Disneyland and tickets to speed dating events for single advisors.

Financial advisors will have to earn that trust back with good advice. They may have to pay for their own golf games and speed dating in future.

Fair enough.

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6 Comments

by steven | 10th Nov 10, 10:47pm 1289382461

Why not do it yourself?

Educate yourself on what to do....its your entire life.....if not just your retirement....and actually it can be very interesting.....

Personally Im now going the way of my own research and buy as I think is sound and for the long term........I dont think most economists or experts are worth the oxygen they consume....

AMP, AXA, Tower, etc all take "management fees" for naff all IMHO....we dont need them....if they were good, sure but they are mediocre at best....

When I look Ive been saving for 30 years, my biggest losses are these so called professional funds.....some have done OK.....sure.....some have lost double digit %d's in a year...........

regards

by memememe | 11th Nov 10, 8:27am 1289417266

Hi Bernard,

How much does BNZ pay you for the 90 at 9? How much did ASB before that? Does this influence your 'impartial' view on reporting?

Are there any other conflicts of interest?

Did you accept any advertising payment from any Finance Companies?

Please disclose all. Better still ban all payments from all 'related' Companies and ask for subscriptions from readers, only then can you be untainted and remove bias.

by Bernard Hickey | 15th Nov 10, 4:25pm 1289791539

Memememe

Fair point. I don't give financial advice or take commissions.

We do accept advertising from all sorts, including banks, car companies, IT companies, finance companies, the government, insurers and even google.

They don't influence our opinions or comments.

There's a big difference.

cheers

Bernard

by Gavin Jones | 11th Nov 10, 10:05am 1289423134

This is why so many NZ's stick with property. At least you remain very much in control if your not overgeared. Even a 30% drop beats losing everything at the hands of some other clown as sadly has happened to many NZ's!

And that's why many love to hate property!

by Horace the Grump | 11th Nov 10, 11:46am 1289429214

Well yes.. banning commissions would be an ideal outcome, but the issue remains as to whether investors would pay a fee instead. AMP are taking a chance here and testing the market. But I expect that if clients baulk at paying an up front fee then AMP will want to revert back to commissions.

The problem with commissions has been that these have been hidden from investors, mainly because these same investors have not been willing to 'pay' up front for the services rendered. Commissions evolved into being because it suited both the advisors and the investors and reflects in part the way most of the insurance industry still works (quite happily I would note).

So if, as you demand Bernard, Simon Power ban commissions that may risk the financial advisory industry as a whole. Of course there is a possibility that it may not, but I've not seen any research published anywhere that looks at investors propensity to pay an up front fee instead.

There seems to be an assumption in your commentary and others of the same ilk that changing the payment basis won't matter - but tell that to an investor who suddenly finds they have to write a cheque for $2,000 - $3,000 for the advice they have received.

No one likes paying their lawyer or accountant bills but we all have to meet our legal and tax requirements... can't see the same imperative for financial advisers though.

by Bernard Hickey | 15th Nov 10, 4:31pm 1289791891

FYI a letter in response from Ginger Group's David Whyte

Bernard,

Your column caught my attention and I felt it merited a response.

You cited the commissions paid by finance companies as the driver for many advisers’ investment recommendations to consumers, and I wouldn’t disagree with this assertion. However, I take issue with the implication that the commission compensation model is inherently flawed. Criticism of the model, while not unjustified, doesn’t reflect the full picture of how insurance is sold in New Zealand.

Attaching commissions to investment products – payments made to intermediaries – which are deducted from a capital sum inevitably affect yield. In other words, the balance of the sum invested after deducting the commission has to work harder to achieve a return.

The recent volatility in the global investment scene has accentuated the impact of commissions on such products. Reaction in Australia and New Zealand has been to have all such commissions – initial payments and ‘trail’ commissions – banned or in the process of being banned.

Cost of access and methods of billing the client for that cost will be debated, but, like you, I’m not sure that disclosure is the panacea in which regulators have so much faith.

Nonetheless, my view is that to put insurance companies in the same category as the failed finance companies is wrong. As can be correctly concluded, the inflow of money to buy the finance companies suggests that little or no ‘selling’ took place. Indeed, evidence suggests most finance company investments were made directly, without the services of a financial adviser.

However, the old adage of risk insurance being sold and not bought holds as true today as it has ever done. Life insurance and the additional financial protection mechanisms, such as income replacement and trauma cover are not intended to enrich the lives of their owners, but to protect a financial position which supports the owners, or the owners’ dependents/business partners.

In the absence of such protection, it is likely that many families and businesses would be rendered bankrupt or insolvent. The tried and tested means of stimulating distribution by the inclusion of compensation in the product pricing was plagiarized by investment product providers – many of which in the past were life insurance companies.

However, that era is over, and most insurance companies concentrate on the provision of risk benefit protection. Those still operating in both spaces do so with separate and distinctive product structures.

Removal of commission from risk products is quite simply wrong. The rate of underinsurance in Australia and New Zealand is shameful and an indictment on the industry, and any reduction in the stimulus to reduce this blight on the community would be disastrous.

In the past 20-plus years, starting with the arrival of Sovereign, the underinsurance malaise has not been addressed. The life companies, Australian or otherwise, have seen their prime responsibility as lying with their shareholders, with the policyholder lower on the priority list. Therefore, leaving control of distribution in the hands of the product providers will merely maintain the status quo and leave the private and corporate citizens of New Zealand without adequate exposure to the appropriate financial protection mechanisms.

The ‘dealer groups’ that dominate the Australian distribution scene and have emerged in New Zealand over the past few years seek to provide support services for advisers and advisory firms. This distribution support for distributors by distributors is a sensible initiative which should be encouraged and stimulated by all product providers.

Regarding the life risk product range deployed by dealer groups and their subscribers, removal of the billing collection method would have catastrophic consequences for the community. The obligation to disclose earnings should be mandated across the board for all distribution sources, empowering the consumer to make a more informed judgment.

Despite regulatory noises about the removal of commission from risk products across the Tasman, the debate has only just commenced, and will be vigorously opposed. We should do likewise.

Yours sincerely,

David Whyte, CEO, Ginger Group

http://www.gingergroup.co.nz/