Fee-based advisory service the way to go

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B us ne ss T me s - 3 1 M ar 2 01 2 Bu siin es s Tiim es - 31 Ma r 20 12

Fee-based advisory service the way to go

Doing away with commissions would make the Singapore marketplace much more nancially sophisticated and serve the nancial advisory industry well in the long run
B y G EN EV EV E C UA By GE NE VIIE VE CU A P ER SO NA L F NA NC E E DIIT OR PE RS ON AL FIIN AN CE ED TO R THE prospect of an advisory landscape sans commissions has generated an intense buzz in the nancial advisory (FA) market, following the announcement by Ravi Menon, managing director of the Monetary Authority of Singapore (MAS) that a Financial Advisory Industry Review (Fair) is about to take place. Not surprisingly, many advisers have reacted with consternation as the new rules threaten their rice bowl. On the other hand, consumers (based on letters to The Straits Times Forum page) appear to have generally welcomed the changes. They are appalled, for instance, to learn of the quantum of commissions earned from the sale of insurance policies. More than 10 years ago, the Committee on Efcient Distribution of Life Insurance (Cedli) generated just as intense a reaction. Cedli sparked a number of major changes such as more rigorous training requirements for insurance advisers, and greater transparency in benet illustrations. In those days, agents bristled and responded vociferously to the charge that they are commission-driven. Today, based on what was publicly said by the Association of Financial Advisers (Singapore) this week, the association head actually admitted to being commissiondriven. But many of the arguments in favour of commissions and against a fee regime actually do a disservice to the nancial advisory industry at large, even though the state of advisory today leaves much to be desired. Today, only one rm (Providend) operates on a fee-only business model - which chief executive Christopher Tan says was 10 years ahead of its time. 'Many industry players say that Singaporeans will not pay a fee for advice. Our experience tells us this is not true; Singaporeans will pay a fee for advice as long as they see value in our work. And we must prove that our work is of value to the clients. Our existence after 10 years is a testament to that.' He adds: 'We persisted because of our deep conviction that if you truly want to give professional advice, you must not take commissions. We have a strong desire to see our profession accorded the same respect as lawyers, accountants and doctors.' Life Planning Associates (PA) CEO Benny Ong says the rm derives 80 per cent of its revenue from fees and 20 per cent from commissions. He does not take on new advisers who are reluctant to transition to a fee model. His clients, he says, are happy to pay a fee. Not all of them are high net worth individuals. 'You must sit down and nd out what they really need, not what you want to sell,' he says. Here are some recently published arguments against a fee-only regime.

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Fee-based advisory service the way to go

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If there are no commissions, the adviser has no incentive to actually sell a plan, so the argument goes. This assumes a scenario where the adviser actually charges a fee to do an insurance needs analysis. It envisions that the client walks away and no sale is made. Again, the implicit assumption here is that the adviser is incentivised only by commissions which is an indictment of the industry. An adviser who takes the time to map out a client's needs, survey the available products and explain all options should surely be able to convince clients to take the next step to actually address the needs. This assumes, of course, that the proposed products are affordable and gives maximum mileage for the premiums. A fee-only model suggests that advisers are paid a salary. This is said to kill creativity and entrepreneurship. Tied agents take pride in being entrepreneurial. But this argument is a fallacy. Not all agents are entrepreneurs, although the agency owner who risks capital is arguably entrepreneurial. Just as one can run a successful agency with commissions, one can also run a viable business with fees and salaries for advisers. The latter is admittedly more challenging. But it all boils down to two different models and philosophies: the salesperson versus the professional. Both models incur market and operational risks. In fact, the fee-only model incurs higher risk and arguably demands more entrepreneurial drive as it takes great commitment to make it a success. Not all agents can become fee-only advisers. In fact, separating fees from commissions actually increases accountability. Today, clients pay a commission and believe advice is free. But the commission actually compensates the adviser for advice as well. Separating the two crystallises the fact that the client demands and deserves advice. It is said that a fee-only regime may skew the marketplace towards term assurance or pure protection plans. This may or may not be the outcome given Singaporeans' preference for policies with a savings element and return guarantees. But a preference for term assurance is surely welcome as it goes a long way towards addressing Singapore's under-insurance gap. The danger is that the extent of under-insurance may actually rise. Australia and the UK are mature markets which are accustomed to paying portfolio fees, yet the under-insurance gap is alarmingly wide. In their markets, term assurance is commoditised - that is, premiums are low and undiffferentiated. Plans can be bought online. Insurance advisers in the UK and Australia at the moment still receive commissions from sales of protection policies. But the commissions may not compensate them enough for the time taken to advise clients. The truth is that term assurance is the answer to Singapore's insurance gap, as a fairly modest premium goes a long way in terms of protection. Here's an example from a recent benet illustration: A roughly $2,400 annual premium for a whole life plan will buy just $110,000 in death benet for a 35-year-old man. Almost the same premium will buy a death benet of $1.4 million, based on a 30-year level term plan with no cash value. Based on these plans from a particular insurer, the distribution cost is actually higher for pure protection, debunking the notion that commissions for term plans are very low. Clearly, the plans were designed with the objective of actually encouraging sales of pure protection plans. In this case, the total distribution cost of the whole life plan is over $4,800 - about 198 per cent of the annual premium. For the term plan, the total distribution cost is more than $5,300 - more than 200 per cent of the annual premium. It is said that the absence of commissions may cause insurers to offer fewer par plans; this is unlikely. Instead, insurers are likely to have to reprice policies to accommodate lower

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Fee-based advisory service the way to go

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distribution costs should commissions not be allowed. This should be a boon to policyholders as it implies lower premiums. There is no reason why insurers should veer away from par plans if the market continues to demand them. In the UK and Australia, the fall in sales of par plans is due mainly to two factors: lower interest rates and poor equity markets have made it difcult and costly for insurers to deliver attractive returns. In fact, the failure of Equitable Life in the UK and mis-selling of endowments caused the UK market to shun participating or with-prot plans. Insurers in those markets have preferred to shift investment risk to investors. And consumers there also have voted for transparency, investing their own funds according to their risk prole and preferred asset allocation, rather than going with the 'black box' of a life fund where the allocation of bonuses isn't transparent. The debate on fees vs commissions raged hotly more than 10 years ago. It continues to rage today with one big difference: Australia and the UK have taken the giant step to ban commissions in the interest of greater professionalism and transparency. The Singapore marketplace may be some steps behind them in terms of nancial sophistication. But greater professionalism and transparency are surely the way forward. Copyright 2010 Singapore Press Holdings Ltd. All rights reserved.

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