Financial Planner Remuneration Discussion Paper 28 February 2014 Background In 2011 the FPI formed a Remunerations Working Group ( WG ). The objective of the WG was to investigate, analyse and formulate a position regarding the remuneration of financial planners and financial advisors, by establishing a remunerations framework which would take the FPI s Professional Body mandate into account. In November 2013 the draft findings of the working group were presented to the Technical Committee for comment and this discussion document has been approved for membership discussion. When one considers the principles of the FPI Code of Ethics and Professional Responsibility ( the Code ), it is apparent that being a professional financial planning practitioner is about more than just remuneration. It is about the manner in which you engage with your clients, the openness and transparency of your disclosures, diligent execution of your fiduciary duties, the relationships with your clients and your employer and your commitment to on-going learning, all of which are relevant to enhancing the profession and the benefitting clients we serve. That being said, any debate around planner remuneration is a contentious one. One must balance the rights and needs of the consumer whilst ensuring the sustainability of the profession in order to provide much needed and valuable financial advice to the consumer. A financial planner provides three services to a client: Financial Advice delivered by the provisions of a financial plan; Implementation of the recommendations in the financial plan, that may involve the sale of a financial product; On-going advice relating to the financial plan and maintenance of any solutions that have been implemented. Page 1 of 8
In the current environment a financial planner is only remunerated for the implementation of his or her recommendations, that result in a sale of a financial product and the on-going maintenance of the product solutions implemented, unless he or she charge fees for the provision of financial advice. In this current environment the financial planner s behaviour will naturally be driven to a focus on selling products, in order to be remunerated for the work done. Introduction The following are methods of remuneration for financial planners: Commission: is defined as The compensation received by a professional member, calculated as a percentage of the amount of his or her purchase transactions. 1 Currently this is the most common method of remuneration for financial planners Fee Based: is a method of remuneration where the financial planner will charge a time or activity based fee, but the collection of the fee is offset against any product commission earned if a product is implemented. This method of remuneration allows for a transition to a fee only practice, but facilitates the collection of the fee. If a product is not sold the client would remain liable for the agreed upon fee and this would be payable in cash. Fee Only: is defined as A method of compensation where only a fee is received from a client, with neither the professional member nor any related party receiving compensation contingent on the purchase or sale of any financial product. For this purpose a related party shall mean an individual or entity from whom the professional members derives any direct or indirect economic benefit, as a result of the party implementing a recommendation made by the professional member 2 In the current commission environment there is an inherent conflict of interest. If a planner is not paid for the advice that is provided, but only for the sale of a product, it is logical that a planner would have a bias towards the sale of a product. Having said that, the FPI does not seek to establish the amount that should be charged for professional services, nor does it seek to stipulate a method that a member should use. We rather seek to set out principles that are aligned to the Code. 1 FPI Code of Ethics and Professional Responsibility at pg. 5 Commission 2 FPI Code of Ethics and Professional Responsibility at pg. 5 Fee Only Page 2 of 8
Principles for financial planner remuneration Principle 1 It is the client, in consultation with the planner, not a Regulator or product provider, who should determine the quantum of remuneration payable, as well as the method of remuneration for the services provided. Principle 2 The remuneration charged by the planner must be fair and transparent to the client and the client must understand what services they are paying for. Principle 3 The client should understand which portion of the fee is in respect of advice and which portion is in respect of product implementation. Principle 4 Client s must be able to switch off the remuneration if the agreed service is no longer been provided. These principles are discussed further below. Principle 1 - It is the client, in consultation with the planner, not a Regulator or product provider who should determine the quantum of remuneration payable as well as the method of remuneration for the services provided: In the case of an employer sponsored retirement fund, the trustees of the fund should be considered the client, and in the case of an umbrella fund, the management of the participating employer. In all other cases, client refers to the individual client; Maximum remuneration earned by a financial planner, in most cases, is currently regulated; Due to regulation, consumers are often unaware that they are able to negotiate planner remuneration; Planner remuneration should be determined, as with any other profession, by the client, based on negotiation with the financial planner; Regulation can help the consumer by regulating the method of disclosure for comparability, but the quantum or method of remuneration should not be regulated. Page 3 of 8
Principle 2 - The remuneration charged by the planner must be fair and transparent to the client and the client must understand what they are paying for: To quote from the Code3: 3.1.3 In determining what constitutes a fair remuneration, professional members may take into account the value of the professional service to the client, the customary charge for similar services by other professionals, banks, and management and business consultants, and any special circumstances. No single factor is necessarily the determining factor. Agreeing on an acceptable fee is primarily a matter for negotiation between the professional member and the client. The following factors should be taken into account when determining the fee: 3.1.3.1 The skill and knowledge required for the type of professional service involved; 3.1.3.2 The level of training and experience of the persons necessarily engaged in performing the professional service; 3.1.3.3 The time necessarily taken by each person engaged in performing the professional service; 3.1.3.4 The degree of responsibility and risk involved in performing this service; 3.1.3.5 The level and extent of investment in technology and infrastructure to support the advice provided. Where possible remuneration should be disclosed in monetary terms; Where it is not possible to disclose the exact monetary amount, then the calculation or formula should be disclosed, together with examples relevant to the consumers situation must be provided; The consumer should be able to compare the fee across charging models; The remuneration quoted to the consumer must be the total remuneration including any fee, commission or rebate that the planner may earn, whether monetary or non-monetary. Principle 3 - The consumer should understand what portion of the fee is for advice and what portion is for product implementation The consumer must be made aware that there is a financial planning advice charge, which charge encompasses the financial planning activities undertaken on behalf of the client, including: the 3 FPI Code of Ethics and Professional Responsibility at pg. 14 Remuneration Page 4 of 8
initial investigations, the identification of needs and goals, the analysis of the financial information and objectives and the preparation and presentation of the financial plan; It should be clear to the consumer that the financial plan is not a free service; Where a recommendation is implemented, additional remuneration will be earned either by means of a fee or commission; The Financial Planner must ensure that the difference between advice and implementation is clearly delineated and that they are not paid twice for the same work. Principle 4 - Clients must be able to switch off the remuneration if the agreed service is no longer been provided The client must be aware that they are in control of the payment of the remuneration; Where on-going remuneration is being charged, particularly by way of a deduction from a product implemented, the client must be made aware that the deduction can be stopped if the promised service is no longer delivered. Fee methods Much has been debated around what qualifies as a fee and what qualifies as commission. In our mind the most important distinction is that in the case of fees, it is the client that makes the decision regarding both quantum and method of charging of the fee, once presented with a quote from the planner. Whereas in the case of commission, the quantum and method of charging, is determined by the product provider and is based on Regulation. While the client may be able to negotiate the commission, they often do not do so as they are led to believe that the quoted commission is set. The following are accepted methods of determining a fee: Activity based model: Clients are charged according to the individual activities undertaken by the planner. For example, where the planner assists in drafting a will, a flat fee is charged in respect of the activity of the drafting of a will, and this fee applies across the board to all clients in need of this service. Every service offered is assigned a fee value. Time based model: Clients are charged according to a pre-determined hourly rate, regardless of the type of activity undertaken by the financial planner. The financial planner monitors the time taken to complete all tasks on behalf of the client, and then charges the client his hourly rate multiplied by the time invested into activities on behalf of that client. Page 5 of 8
Annual/monthly retainer model: The client pays a pre-agreed amount on a regular basis to the practice. This pre-agreed amount will cover all fees due by the client in respect of work undertaken on their behalf, regardless of the time those tasks take to complete and regardless of the number of such tasks. Asset based consulting fee: The client is billed for initial or on-going financial planning advice and product maintenance as a percentage of the client s assets, where the rate of the fee is specifically agreed between the financial planner and the client. In the case of on-going fees the client is made aware that the fee can be switched off if the services are no longer provided. Conclusion When one considers the negative public opinion that seems to surround the financial planning profession, it is difficult to imagine that the current commission model has not played a large role in fuelling that perception. It is clear that a change to remuneration structures is needed, for both the benefit of the consumer, and the profession as a whole. However the solution is not to simply overhaul the system as has been done in jurisdictions such as Australia and the United Kingdom. Rather, we must recognise that South Africa is a unique economy, with both first world and third world characteristics, and thus we need a remuneration system that takes cognisance of this. Perhaps the fairest system is a fee based system whereby the fee explicitly agreed to by the client can be deducted from a product that is implemented, should the client so choose. Page 6 of 8
Advocacy points for any change to the remuneration model: The value of financial planning should be a factor considered in the debate, not only the cost of advice. Proof points on the value of financial planning must be collated. Presently only the advice relating to the selling of a product is defined in FAIS. For a meaningful debate to occur around financial planner remuneration a definition of financial planning services needs to be agreed upon. The definition should be broad and not merely limited to process. Any changes in the model of financial planner remuneration needs to be phased in/out to allow planners to make the necessary adjustment in their practice over time. Any change in a remuneration model should only apply for products sold after the effective date, meaning that existing arrangements would remain in place. It is the lower to middle income groups who will benefit most from financial advice and the remuneration model must not be structured in such a way that these groups are excluded from obtaining financial advice due to the cost. It is therefore important that even though the consumer will have negotiating power in terms of fees or commission payable, the payment should be able to be facilitated through the product provider if requested by the consumer. Fees should not be regulated or capped. Ultimately the fee payable will be decided on by the consumer based on the financial planner s value proposition. This negotiation should be allowed to take place in an open market environment. Page 7 of 8
Questions to enable feedback: Please respond to the questions below to assist us to determine if this paper adequately addresses remuneration practices and concerns: 1. Do you think the principles identified are correct? Do you have any specific concerns regarding any of the principles outlined? 2. Should the FPI find-a planner website show the remuneration method of the financial planner? 3. Have we identified all the key charging methods? 4. Is there any advantage or disadvantage to the financial planner moving to a fee only or fee based method? 5. What transitional issues may arise if you had to move to a fee only or fee based remuneration model? 6. Do you think that the South African consumer is ready for a fee only or fee based remuneration environment, if legislation is amended to go this route? 7. What is an acceptable phase-in period to move to a fee only or fee based model? 8. Do you have any other comments in relation to financial planner remuneration? -END- Page 8 of 8