By Tony Vidler, CFP  CLU  ChFC

I’m calling it:

Soft dollars for financial advisers as we know them today is officially “terminally ill”.  Their death is not quite guaranteed, but the odds are very high that they shall die soon’ish…  But I personally think they will die far faster than most expect.  And thank God for that.

Incentivising financial advice is finally firmly in the spotlight, and the professional conduct of financial advisers is being questioned.  While many industry participants are already lamenting the terminal illness of their beloved soft dollars, others are calling for rapid euthanasia.

Driving the death notice was the NZ regulator, who released a much anticipated report last week on the issue of “replacement insurance business“, which was the result of its investigation into insurance selling practices in this country.  Much of the initial reaction to the report, and its limited conclusions, has been almost entirely what one could expect.

Many advisers are critiquing the report for its poor analysis and an unfair focus on the independent business model to the exclusion of institutional distribution.  They are naive if they believe that matters.

Many with only a consumer focus have lambasted the industry as a whole in classic style: take simple conclusion from limited data and apply the conclusion to the entire universe.  They are idiots, and one hopes the regulator realises that.

Many industry observers with their own commercial agendas have headed down the path of “distribution costs are too high; we should reduce commissions“.  That is convenient for them.

As an aside, I find it interestingly when it is claimed by a consulting firm for example that distribution costs are too high they do not include all of the distribution costs, just the commission directly attributable to gaining new business.  I know of organisations where something like half of the staff have “manager” in their title…that’s a pretty big cost.  A significant proportion of those are engaged to drive distribution of their product.  That could perhaps be a distribution cost couldn’t it?   Then there are the “conferences”, rewards schemes, corporate gifts and functions….all designed to drive distribution of product….and which largely get ignored whenever discussion centres on “distribution costs”.  Such one-dimensional reports are not actually helpful in reality, and should be openly labelled as what they are: merely the lobbying of a particular position by a particular interest group.  Somebody trying to disproportionately influence decisions.

Essentially, every interest group appears to be pursuing its own agenda and taking out of the report only what supports its own pre-existing position.  However, we need to acknowledge that virtually every interest group has a fair point in part, and those points need to be taken into consideration.

There is no doubt that some of the conclusions reached by the regulator in this latest report are tenuous, or perhaps just assumptive, and the report does have the feel of “making the data fit the desired conclusion” in part given that some fairly basic aspects of the industry appear to have been overlooked, such as a natural attrition rate in any book of business.   A simple comparison is made for example between overall market growth and new business rates from individual suppliers, and a conclusion drawn from the comparison.  It is the classic apples & oranges comparison in that they are 2 different measures for a reason. They are not comparative at all, and are actually counting different things.

Yet, in fairness to the regulator much of the data provided to them will have been of very poor quality – often little better than mere guesswork on the part of industry suppliers.  The product manufacturers typically just don’t keep the type of data that the regulator needed for this piece of work.

It must be acknowledged that this effort to understand a key industry issue is also the first legitimate attempt to focus on genuine data where it can be found and then actually analyse what has really been going on.  So while we can critique the construction of the conclusion perhaps, we need to be mindful that good points are made by the report which deserve attention and resolution.  So on balance one has to conclude that in fairness this report has been as well constructed as it could be, and enough data has been gathered on some critical areas to make some valid observations of industry practices.  It is useful in other words.

Nowhere is this more notable than in the “soft dollars” area.

“Overseas trips appear to be an effective sales incentive for advisers. Policies no longer subject to clawback were 2.2 times more likely to be replaced if overseas trips were offered as an incentive. Even new policies still subject to clawback were 8% more likely to be replaced if an overseas trip was offered”

That is an observation which industry cannot ignore.  It gives validity to every argument about product sales taking precedence over advice, or self-interest being placed above the consumers, or the cynical approaches to attracting market share….

It cannot go on.  However, it cannot stop either.

The issue for regulators now is finding the appropriate intervention.  Incentives to drive behaviour are an integral element of business, so incentives will never disappear.  Virtually every consumer carries loyalty cards for everywhere they shop, or expects free airline tickets as a reward for choosing one supplier over another…so consumers themselves are incentivised to shape their purchasing behaviour.  In professional services there are numerous stories of junkets to the Bahamas or whatever for recommending particular medicines or buying treatment equipment from one particular product manufacturer….buying the construction material for a new home from one retailer rather than another results in builders getting overseas trips…..so soft dollars in business are endemic.  They are a feature of commerce in the free market which will not be entirely eliminated.

Financial services will not be any different.  Soft dollars can not and will not ever be entirely eliminated.  You cannot regulate out of existence the ability for two parties to get together for a dinner where only one of them pays the bill for instance. You can not regulate that out of existence simply because there is no genuine ability to police such things.

So the question that must be asked is “what problem are we trying to fix?”

The answer surely is “to stop aberrant behaviour where the salespersons interest becomes paramount“.  If that is the case the problem really is proportionality.  A free dinner out is unlikely to heavily influence a professional to drive customers to a sub-optimal product….but 2 all expenses paid trips to the next Rugby World Cup in Japan complete with entertainment, accommodation and all the bells and whistles probably would tempt any adviser who happened to be a rugby aficionado.  The potential reward is disproportionate to the product recommendation, so it is likely to influence behaviour when it comes to identifying recommending product solutions.  That of course was the whole point of having such disproportionate rewards in the first place – to tilt the decision-making process or influence on the product selection.

Product manufacturers know this of course, and in many cases they are victims of competitive forces.  In the continual hunt to outbid the competition for favouritism there has been a steady progression of escalating incentives.  WAAAAAAAY back in time I remember being motivated to achieve sales targets.  The first one I was motivated by, and worked very hard to attain, was a trip for just 10 couples to a perfect pacific island.  Just 10 would qualify – number 11, whoever that happened to be, would miss out.  Of course, we only had one company’s products to recommend at the time and were clearly labelled as product representatives of that particular company, so there was no moral dilemma.  It was a sales job, and it had sales rewards.

Today the rewards are essentially unlimited in that an adviser can conceivably qualify for any number of volume based incentives to incredibly exotic and once in a lifetime experiences.  In fact, as soon as Richard Branson gets his commercial space junkets up and running you can bet that an insurance company will be promising seats on it to its top producers….

The point is that the product manufacturers are caught in a trap which they would rather see scaled back too.  Their problem is “the first to move loses”.  The first one to not come up with an even more exotic incentive loses support and production capability.

Intervention is the only answer, and the regulators must see that.  Remember that the objective of regulation is to increase the confidence and participation in the use of financial services by consumers.  The whole point of it was to create confidence on the part of consumers to be able to engage in better personal planning and self sufficiency.  THAT outcome is good for the advisory side of the industry, IF it can be achieved.   There is no doubt that in order for this to be achieved the disproportionate influence of extreme soft dollars has to die.

Advice can never be viewed as a profession while they exist in their current form.  While many in the industry have known it instinctively for years, there is now sufficient evidence to indicate that disproportionate soft dollars are unduly influencing product recommendations.  That must undermine confidence in the industry as a whole, and that must be remedied.

Death to soft dollars I say!

You might also be interested in this related article:

 Churning of insurance business: Always Right? or Always Wrong?