Grandfathered Commissions – what are they?

Grandfathered commissions is a term that is receiving a lot of airplay at the moment through the Royal Commission. The term is used so often and to cover so many different concepts that I thought it might be helpful to spend some time discussing just what “grandfathered commissions” actually refers to.

It’s also helpful to remember that grandfathered commissions related to accounts set up prior to 1 July 2013.

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Grandfathered commissions – what are they?

“Grandfathered commissions” is the name given to ongoing payments from within a super / investment or insurance account – that are usually paid to a financial adviser.

The account that made these payments would be an older style of account, set up before the “Future of Financial Advice” (FOFA) legislation was implemented about 5 years ago.

These payments are made from fees charged within the account. The payments were originally a form of “distribution cost” that some companies used to reward advisers who helped set up accounts with the relevant company. In other words, the accounts were “priced” into the fee structure of the particular account.

That is, the fees and costs and expenses and benefits for that type of account were calculated in a mix that would hopefully turn out to be sufficiently profitable to the company that ran the account, across up and down business cycles. You may be wondering why a company would decide to pay advisers any initial or ongoing fee?

Why did companies pay commissions at all?

By paying a fixed percentage of the account fees to an adviser, the company hoped to limit its setup and ongoing costs to a fixed percentage of an income they were already receiving – and therefore be more likely to remain profitable across booms and busts in the economy. 

After a world-record 26 years of continuous growth, many Australians are not familiar with recessions and the consequences they bring. For businesses, one of the bigger impacts is that income from business sales reduces, while fixed costs (such as rent and staff wages and maintenance costs) either remain the same or increase. The result can be very difficult and may even put the business ability to continue to operate, at risk.

By making a part of the account setup and ongoing costs a fixed percentage of income, the company can be more certain of the future, knowing that part of their costs (the “distribution” costs paid to an adviser) will also fall if their income falls.

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And the presence of a “human” adviser at local levels was expected to help keep the account with that company. Changing accounts is expensive for companies as well as individuals!

Grandfathered commissions – what changed?

From 1 July 2013, legislation was changed to ban all new trail and ongoing commission payments. The logic behind the move was to try to reduce the presence of “conflicts of interest” when advisers and institutions set up accounts.

After a number of investigations and inquiries in the years following the Global Financial Crisis (which lasted from about July 2007 through to March 2009 in broad terms), it was decided that removing the incentives provided by commissions and ongoing “trail” payments (really just another form of commission), that financial advice would be more impartial and more likely to be in a client’s best interest.

The thought behind the legislation was that advice would be better if the client were to pay their adviser a specific fee, and not through a more opaque version of commission based on the wider set of account fees.

In effect, the intent was that an adviser would only be paid any money if, and when, the client agreed that money be paid.

To ensure this occurred, any new accounts set up post 1 July 2013 would require the adviser to obtain the client’s specific consent for continuation of any ongoing payment – every two years.

This allowed the client a formal opportunity to consider whether they still wanted to pay their adviser. The responsibility is on the adviser to ask the client if they wish to “opt-in” to the ongoing fee? The client did not even have to answer if they did not wish to do so. The adviser’s responsibility is to stop the fee if they have not heard back from the client.

The client is therefore empowered to stop any adviser fee, simply by refusing to renew the ongoing arrangement. As a consequence, the adviser would usually remove their names from any accounts they would be nominated on, and the adviser responsibility for those accounts would cease.

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The client is then in a position to either find a new adviser or deal with the accounts themselves.

The government wanted people to pay fees directly to advisers

However, there were a large number of existing accounts and policies that had been set up on the basis of payments being made to advisers from the fees charged in those accounts.

The government decided to not make the new legislation retrospective – but put in place limitations on how the older accounts would continue to pay any commissions built into them.

What did the grandfathered commissions pay for – if anything?

The idea behind these payments was that the company paid part of their fees to an adviser to reimburse them for help seting up the account and to intermediate between the client and the company for help in keeping the account going.

If a client had a question on the account, they could contact their “nominated adviser”, who had direct access to the account details (usually through an “adviser portal” form of internet access).

The adviser could help with information on the account and how it worked, and with changes to the account, such as address changes, ownership or beneficiary changes, premium changes and the like.

If a client contacted the company operating the account to ask for a lot of detail then they would often be redirected to the adviser noted on the account.

If there is no financial adviser, these “internal” payments would be retained by the company that issued the account. The idea was that these payments would help cover the additional cost incurred in the institution’s client service center, as more calls would be expected than would be the case if an adviser was noted on the account.

What went wrong?

Well, a lot of things really.

Existing policies and accounts (sometimes called “legacy” policies) were expected to eventually be replaced with more up-to-date and (hopefully) more appropriate policies and accounts.

This is a process that is ongoing, and eventually, most commission-paying accounts will either close or be transferred to newer accounts, where the adviser fees – if any – are paid as a clearly noted fee.

However, the transition process has not been very smooth.

The 2018 Royal Commission has highlighted some of the problems that institutions have had in administering grandfathered accounts and the commission payments they make. This has led to calls for change and “remediation” or redress for those who might have been promised something they did not receive.

Financial terms can be confusing

Many people in large companies, and many advisers and many financial commentators, have become confused as to what-is-what in regards to commissions and fees and service. Here is a quick list of highly specific terms that are all often mixed as if they all meant the same thing:

  • Grandfathered commissions
  • Adviser service fee
  • Financial advice fee

These are highly specific terms, and they definitely do not all mean the same thing :

Grandfathered commissions

A payment made to a financial planner from account fees. The payment is usually embedded (“hidden” if you prefer) in the total account fees, and is not usually shown as a separately disclosed amount.

The money is usually intended to pay the “nominated adviser” a fee to be available for client queries relating to the specific account.

The client can ask the company running the account to remove the adviser from their account. This does not usually result in a lower fee to the client, as the commission amount is “built-in” to the account fee structure.

Adviser service fee

A regular payment made from an account to a nominated adviser. The payment is shown as a separately disclosed amount on statements and reports.

The money is usually intended to pay the adviser for services related to that specific account. However, each adviser may have a different arrangement as to what services are or are not covered by this payment.

Where a service fee exists, the adviser is required to confirm the fees and the services purchased – in the form of a “Fee Disclosure Statement” or FDS. The adviser is also required to ask the client, at least every 2 years, if they wish to continue this arrangement of paying the fees for those services?

This type of fee is often called a “fee for service”.

Financial advice fee

There are two types of advice in the modern world – “general advice” and “personal financial advice”.  The financial advice fee could be for either of these types of advice that is provided by a registered financial planner.

“General advice” is factual and usually “public domain” information. For example, what a policy is, how it works, what it does. Another example would be what legislation exists and the limits or obligations it requires. Answering questions on these topics is not specific to the individual person and can therefore be deemed “general advice”.

A call center would usually provide general advice. There may be a fee charged for this type of advice, and many financial advisers will charge for such information. However, a call center or institutional customer inquiries center would usually include this type of advice as “built in” to the account fees.

“Personal financial advice” is advice specific and relevant to an individual client. Such advice is very heavily regulated, and there are strong penalties for providing personal financial advice without the appropriate authorisations.

Personal financial advice should be in writing, and it must follow a prescribed format that includes specific declarations of conflicts of interest and disclosure of fees, costs, risks, benefits and exclusions.

Personal financial advice is provided in a format called a “Statement of Advice”.

A fee would be charged for providing a Statement of Advice. This fee can vary widely, and would usually be scaled in some way to the complexity of the advice being provided. Very broadly, the fee would usually range from $600 to $6,000.

What if I do not want to pay an adviser a commission?

If you hold an older style of account that pays a commission to an adviser then it is important that you understand that you have the ability to remove the adviser’s name from your account.

Should you do so, the adviser will cease to receive any payment from your account. They will also cease to have access to the details of your account. The may or may not also cease to have any responsibility for that account (although they would remain responsible for any advice and services provided for that account up to the point where you removed their name).

Your fees may not reduce – some accounts do not have this ability.

You will need to see a different adviser for advice related to that account or any other matter, should you need it. You are then free to negotiate the fee applicable for the advice and/or services you wish to receive.

Informed Consent – what is it and why is it important?

In an ideal world, any financial transaction would occur under conditions of “informed consent”. That is, the purchaser would be in possession of sufficient information to enable them to make an informed decision, and therefore a decision that is in their best interest.

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Part of the issue with most financial transactions however, is that there is an uneven access to information. That is, the purchaser is often forced to make decisions in areas in which they have no expertise or knowledge or experience. This is clearly not a level playing field. In such circumstances, the presence of conflicts of interest for those who are supposed to help the purchaser, can result in the wrong purchasing decision and potential extra costs or lost benefits for the client.

The FOFA changes and the stopping of new commissions was supposed to reduce that conflict. It has helped but it has not removed conflicts, as there are many forms of bias and conflict of interest in financial matters. Here is just a short-list of some types of bias or conflict:

  • Approved Product Lists (APL’s) can reduce the available range of options and choices
  • Bonuses and shares and benefits might flow at a higher rate to an adviser or organisation for one type of product than another
  • An organisation or adviser may use a “white label” product from which they receive a profit share or some other form of benefit
  • Investment products may limit your choices for investment and/or strategies
  • “In-fund advice” is advice provided within an institution – such as a super fund – but it does not need to consider that advice against other alternative options that may be available outside that fund

Should you wish to know more then here is a short list of resources with greater detail and far more precise information:

https://www.moneysmart.gov.au/  – This is the web address for Moneysmart – the ASIC website with a large amount of financial information, including calculators and fact sheets.

Regulatory Guide 175 – Conduct and disclosure guidelines for financial product advisers

Regulatory Guide 244 – Giving information, general advice and scaled advice

 

Communication

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