The high cost of bad advice
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Secret bidding wars and cosy commission deals are distorting the advice the public is getting. Rob Stock reports from the front lines of this hidden battle.
Time is running out for the financial advice sector to keep its commission skeletons in their closets and away from the eyes of the public.
Revelations that collapsed property finance company Bridgecorp was paying double market-rate commission to advisers have once again got the public questioning the quality of the advice they are getting.
And they are not alone. Finance company bosses, the heads of the largest insurance companies, and even some financial planners are calling for regulation which could end, or at least make public, commission bidding wars among financial product providers, free junkets overseas, cash-in-hand payments, and other inducements to advisers which are being kept secret from the public.
One sector crying out for greater disclosure is the personal insurance sector.
A secret bidding war in recent months has driven up commissions for insurance advisers, with some firms offering up-front commissions of more than 200% of first year premiums.
That's been fuelled by an aggressive war for market share, say insiders, in advance of the tougher adviser regulations expected in 2010.
So bad have things got that the bosses of some of the largest firms now openly claim commissions are distorting advice, stunting product development, and misleading the public.
Naomi Ballantyne of ING Life, which pays up-front commissions of up to 220% of the first year's premiums on personal insurance, says if all insurers paid the same commission, for example, "the focus would be on companies competing on their offering to the client as opposed to this dual competition of competing for the adviser and the client".
Sean Carroll, chief executive of Asteron, which pays up-front commissions in the range of 0%-160% on personal risk products, agrees. "The level of commissions has created some biases in advice. You can see that in some cases people giving advice put commission above the best interests of their clients."
AXA said it paid up-front commissions of up to 163%. Tower paid up to 170%. Sovereign paid up to 192%.
In most cases, the highest levels of up-front commission are available only to those meeting "volume" quotas, which are often not revealed by advisers to their clients. There are also ongoing annual trail commissions available, and "retention bonuses", although to get the highest levels of those, advisers have to take less up-front commission.
When full disclosure was required such complex commission arrangements might have to be simplified, said Sovereign's David Drillion. There's also an expectation that commission levels would have to drop in the face of public criticism.
So touchy is the subject of commission that all the companies spoken to by the Sunday Star-Times warned that their rivals might not answer our questions truthfully.
But for advisers, commission is just one part of the "support" they get from insurers - other perks include free trips overseas, "training grants", subsidised loans, and software and systems support.
New regulations are expected by the end of the year requiring mandatory disclosure of commissions - currently under weak consumer protection rules advisers have to tell clients what they are pocketing only if asked -but no one yet knows whether advisers will be required to disclose all commissions, details of volume agreements and all financial and non-financial gratuities and support they receive.
If Ballantyne had her way, the country would also follow the South African example, and make up-front commissions illegal when an insurance adviser was moving a client from one insurer to another.
That would put an end to brokers continually churning business, periodically moving clients from one insurer to another so they can pocket new up-front premiums, a practice which could be adding 10% to the costs of some forms of insurance.
It's not just in the insurance industry where commissions stand accused of distorting advice.
Bridgecorp paid what were thought to be unusually high commissions of up to 3% to induce advisers to put clients' money with them, but it was not alone.
A survey by the Star-Times found most finance companies did claim to pay lower commissions to brokers.
Prospectuses from some of the riskiest finance companies in the game suggested they paid the same levels of commission as the highest quality finance companies such as Marac, South Canterbury, and Hanover, many with good credit ratings from international ratings agencies.
But industry leaders say they don't believe those figures are strictly accurate.
The better quality firms are paying commission of around 1% for advisers putting clients into two-year debenture investments, and between 1.25% and 1.5% for three years, but there are those paying higher commissions.
Capital & Merchant for example, pays an up-front commission of up to 3% on three-year debentures, although its prospectus suggests it calculates commission at 0.5% per year. Riskier firms, such as Geneva Finance and Clegg & Co, pay up to 2%.
Owen Tallentire, chief executive at Capital & Merchant, said he believed many finance companies actually paid rates similar to its own, despite what their prospectuses were saying.
Finance firm bosses are convinced higher commissions from some riskier firms are being chased by some advisers, to the detriment of their clients.
Lachie McLeod, chief executive of BBB-rated South Canterbury Finance, said: "What has annoyed us is to see advisers have taken money from ourselves and put those funds into finance companies that are paying higher brokerage. What's driving the advice? Why would a financial planner take money from ourselves and put it with a finance company with no rating and much higher risk? You have to ask the question. The answer, possibly, is brokerage."
Brian Jolliffe, chief executive of Marac, also cast doubt on the figures disclosed in prospectuses. He said there was a correlation between the commissions paid by finance companies and the risk of them running into trouble, something a study of the prospectuses did not convincingly show.
And he said there were non-commission payments to advisers, made by some finance companies, which were not disclosed to the public.
He said the Commerce Commission had been acting aggressively to clean up illegal and unscrupulous lending practices. It was time to do the same for payments to advisers.
Michael Reeves, chief executive of Lombard, which pays 1% brokerage on two-year investments, said some larger financial planning companies had compromised themselves so badly in their pursuit of higher commissions that they had been acting more like marketers for finance companies than professional advisers.
"In the past 24 months there have been large advisory chains who would say to a finance company `we can provide you with $20 million, but we are going to want 1.5% commission and get renewals (ie be paid the commission again) at the end of 12 and 24 months'. It has gone on quite a bit.
"You can't help but think that they are not thinking about the risk profile of their investors, but who pays them the most."
It's a practice McLeod, Reeves and Sam Stubbs, the new chief executive of Hanover Group, say their firms never get involved in.
So worrying have been some deals that Reeves said: "I could be forgiven for thinking that some of what I have seen would have fallen under the Secret Commissions Act."
It's clear some finance companies are playing fast and loose with commissions and other financial incentives.
Colin Austin, from Decision Makers, a fee-based financial planner on Auckland's North Shore, said he had recently been offered a $500 cash gift from a finance company because it was "their birthday", something he turned down in disgust.
One of the least palatable commission-heavy products, old style super savings schemes, are dying, not thanks to new regulation, but the advent of KiwiSaver.
Asteron chief executive Sean Carroll said KiwiSaver would mean the end for the last of the front-end loaded super savings schemes which once paid up-front commissions to advisers of up to 100% of first year contributions.
- © Fairfax NZ News
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