Sunday, April 8, 2012

Will fee-based financial advisory model lead to more financial literacy?

Recently, an insurance agent called me in my office. He was very polite, so I did not want to cut him off too quickly. He started off recommending whole-life insurance products. I was not interested. Then, he went on talking about savings and endowment plans. I still was not interested. Finally, I told him to email me the information so that I could end the conversation. Before hanging up, I told him I am interested only in insurance plans that offer purely protection and have absolutely no interest in savings-related or investment-linked insurance products. After all, insurance is all about protection. Savings and investment should be secondary considerations. This insurance agent never contacted me again.

Several years ago, an insurance agent came over to my home because I wanted to buy H&S (Hospital and Surgery) plans for my whole family. He spent the first half hour talking about critical illnesses and endowment plans which I have never express interest in. I listened patiently and politely since the agent took the effort to travel down to my home. I refused to buy any of the plans that the agent recommended because I prefer term plans which are cheaper. Before he left, I guess he could not hide his irritation and told me that the commission he earns from my H&S plans can at most pay for the transport he took to come to my place. I am not sure if this is an exaggeration. At least I know now that agents are paid a pittance for selling term-plans. So, in future, if I should need to buy products that an agent seems uninterested to sell, I will go to his office myself.

For the past decades, insurance sales is driven by commission. Commission-driven insurance agents plus financially ignorant or lazy consumers has resulted in Singaporeans overpaying for insurance protection and yet, remain under protected. How can Singaporeans have adequate insurance protection if the salesmen's main priority is to recommend savings or investment-linked products or expensive whole-life plans that cover death and 30 critical illnesses rather than hospitalization which is much likelier to happen? There is nothing evil in their actions because I will do the same thing in their shoes. If I were an insurance agent, I too will focus on selling products that pay me the most commission instead of selling the most appropriate product to the client. Client analysis means selling the highest-paying commission product that he can afford and probably likes, not necesarily the best product for his financial future. Hey, my own financial future comes first before my clients, right? Let us not be hypocritical. We are all like that.

Ravi Mellon(Managing Director, Monetary Authority of Singapore) made a dreaded speech on 26 March 2012 to the Life Insurance Association. Ironically, this much dreaded speech addressed to the financial advisory community is entitled "Putting the Customer First". Why should a speech from a regulator that puts customers first be received with such dismay? This really highlights the serious conflicts of interests between customers and financial advisers.

Some interesting nuggets from this speech that reveals why that insurance agent started off recommending whole-life insurance plans first;
MAS will move more commission-based financial advisory activities to become fee-based. Already, the obvious losers are making noise. Fee-based advice is objective and the adviser undertakes client analysis to recommend products based on what he thinks is best for the client's financial future as opposed to commission-based advice in which client analysis leads the adviser to recommend the highest-paying commission product that he has the best chance of selling.

Unfortunately, fee-based financial advice does not come cheap. These advisers charge by the hour and the average fee comes to around $3000 on average, $2000 at least (correct me if I am wrong). If a person has savings of around $10k-$30k, it does not make sense to go for fee-based advice because the fees are too significant as a percentage of the money being managed. This cuts off the lower-income and youngsters who still have not accumulate a meaningful sum of savings. This is still better than the present commission-driven model because no advice is still better than bad advice. Bad advice is unavoidable when there is a serious conflict of interest between advisers and clients.

I think fee-based financial advisory business will evolve to serve mainly the rich because that is the profitable way to go. What does it leave for the rest? When consumers want something but cannot afford or do not want to pay for advice, they will have to educate themselves. Perhaps the best thing to come out of the move towards fee-based financial advice is that more people will become financially literate in insurance matters.

By the way, do not expect members of the financial services community to educate you. They actually have an interest in keeping their clients ignorant. Ignorant customers are the easiest to do a rip off. There are knowledgeable people around who are generous in sharing their knowledge on financial forums. Below are some links that may be useful;

http://www.valuebuddies.com/thread-389.html

http://forums.hardwarezone.com.sg/money-mind-210/newbie-guide-how-find-good-agent-investment-insurance-2818607.html

37 comments:

  1. Hi, I happened to stumble across your blog, and while it is informative, there are some things I feel are biased.

    Let me clarify myself. I'm a financial planner myself, and yes, while there ARE agents out there who only care about their commissions, this shouldn't be generalised. I for one sell more term and hospitalisation plans, and rarely do I sell whole-life plans, UNLESS the client himself specifically requests for it. Afterall, my position is as an advisor, not a product-pusher. I will not force anyone to buy a term if he doesn't want it.

    Perhaps it's because I'm doing this as a sideline job which is why I'm not all out to sell only the high-commission products, which yes are the whole-life, endowment (aka saving plans) as well as investment-linked policies (ILPs). It depends on the client's choice and financial literacy as well. For example, for a person who is active in the stock market, I will not recommend he buy an ILP, as he probably can get higher returns from buying stocks. However, this is certainly not to say that ILP's are bad. ILPs and unit trusts are similar in a way to ETF's, which are now getting more popular with investors. However, some people would rather buy a unit trust or ILP rather than an ETF as they would not want to constantly have to monitor the fund performance. If these products were so horrible, certainly the MAS would have removed them by now instead of letting them remain in the market for so many decades.

    And by the way, H&S policies are not that horrible in terms of commissions for agents.. Haha that fella is exaggerating to the moon. It's certainly not a great earner though. In a nutshell, the lower the commission for the agent, the better the plan. Of course, this is not always the case. There are exceptions.

    And yes, I'm fully for the new fee-based system. Although I suppose its essential that the companies now pay a decent fixed salary, since we would then not be self-employed anymore, but rather as employees to the company.

    I'd certainly like to continue this interesting conversation with you :) Hope it stirs up your mind. God bless!

    ReplyDelete
  2. Hi Terence,

    Thanks for dropping by with a well thought-out reply. I am sure I am biased :) I have not the luck to meet financial planners like you:) The bias was shaped by negative experiences with insurance agents whom I do not really blame for their bad behavior. I blame the insurance companies which shaped the agents' incentive structure in such a way that only agents who behave badly to their clients can prosper. This is the problem with today's commission-drive insurance payment scheme. The insurance companies wanted to shift risk away to their sales people by paying them zero salary and relying on commission 100%. What do we expect the agents to behave? Put the clients first and starve? The insurance companies will certainly resist these changes because they have to take on more financial risk now by paying a fixed salary to their sales force with the fee-based model.

    Much of the insurance sector's wealth was built on the ignorance of their clients plus the serious conflict of interest with their clients. In fact, this statement applies for much of the financial services industry from fund management to audit/consultancy businesses.

    Fee-based financial advisory model removes this conflict of interest. The main benefiaries are ordinary Singaporeans and perhaps some financial planners who prefer to get some guilt off their shoulders. The main losers are insurance companies like AIA.

    http://business.asiaone.com/Business/News/Story/A1Story20120407-338202.html

    ReplyDelete
  3. Hello again, well it would certainly be my pleasure if I could meet you in real life! :) Yes I agree that you have a valid point. However, even if there was a salary involved (talking about banks here, and the various relationship managers), the same thing would still happen. This is because even bankers get commissions out of the policies, albeit lesser than the agents from insurance companies. Even worse for them is the quota that they would have to hit. Thus high levels of churning is hence not uncommon.

    Haha I like the way you phrase the 'financial planners who prefer to get some guilt off their shoulders'. I assume AIA is not your favourite company then ;) then again, not mine either. Had a personal encounter with one of my clients of how unethical some of their financial consultants can be. Pretty shocking story.

    ReplyDelete
    Replies
    1. Hi Terence,

      I just went to your blog and noticed that you are a student. Maybe one advantage to clients of having young students as insurance agent is that they can afford to be ethical:) I think after you graduate, it is much harder to stick to your principles because of the pressure to pay your own bills and feed your family. It is almost impossible to do this if an insurance agent is paid 100% from commission. It is more manageable if he is paid a fixed salary.

      Delete
  4. hyom,

    Fee based, commission based. A sheep will still get fleeced or worst, slaughtered, if clueless.

    I like the way you highlight H&S versus Critical Illnesses plans. Is this the agent's responsibility or the client's to find out which is best for us?

    At the end of the day, it's either we make a "buy" ourselves, or we trust a stranger will have our best interest by being "sold" to.

    By the way, once the Fee based model is implemented, the days of the part-timers will be numbered. (Would you pay $2,000 to a part-timer?)

    I do feel a tinge of sadness as insurance is one of the meritocratic professions where someone with 4 O levels can make a great SALES career as an agent... (A rose by any name is still a rose)

    Financial advisory is bigger than just "insurance". Salesmen can't compete with CFAs (the direction we are moving) when charging $2,000... Unless the client is clueless again!

    Death of a salesman.

    ReplyDelete
    Replies
    1. Hi Jared,

      Actually, I think Sales is a wonderful career option for anyone with 4 'O' levels. It is one job in which his competitors with better paper qualifications gain no extra advantage because the yardstick for performance is the amount of revenue he generates.

      In fact, if I were an employer, hiring a poorer educated person for Sales does have an advantage. That person will probably be hungrier and more motivated to work hard to beat the better educated ones because all his life, society has always thought that they will never amount to much without good paper qualifications. Being in Sales gives him a better chance to show the world that everyone is wrong about him.

      Delete
    2. You are spot-on hyom!

      "We" are indeed hungrier, have less to lose, and have an axe to grind... To prove we are as good as anyone else!

      Career-minded women executives face similar challenges in a male-dominated world.

      Sometimes it's better to psych ourselves as the "underdog" ;)

      Delete
    3. I am immediately impressed with successful individuals if they are from a minority-race or with poor paper qualifications or simply a woman. This is because these people often have to face unfair discrimination/stereotyping while climbing their way up. They have to be way better than average to overcome the extra obstacles simply because they happen to belong to an unfortunate group.

      By the way, there seems to be something wrong with Blogger's spam algorithm. Of all comments, I wonder why they put your comment into my spam inbox. I had to manually unspam it.

      Delete
    4. hyom,

      It happens from time to time. I too have to "rescue" comments from genuine sources once in a while.

      Today I think Goggle suspect someone was trying to hack into my blog and lock-out my blog. I had to send an email to Google to have it unlock.

      Perhaps that was the reason.

      Delete
  5. The fundamental of finance has hardly changed since moving away from gold standard. The only changes, which is also very rapid changes, is the derivatives such as stocks, options, forex etc.

    I believe that to be a prudent man needs to know the fundamental. He should be financially all right if he follows the fundamental and starts from there.

    Therefore, I think from whether it will be a fee or commission based financial advisory will not improve the financial literacy of an individual. The only way to improve one's financial literacy is to go back to school to learn the fundamental.

    As with any profession, their jobs is to maximise their own self worth. Others' will come second.

    ReplyDelete
    Replies
    1. You made a few fine points there. I did a search on the matter and found most people will go along with with your blog.

      Refinancing

      Delete
  6. I remembered in one of your older posts, you said you were retrenched. In this post, you said an insurance agent called you in your office. So, you found a job?

    ReplyDelete
    Replies
    1. Hi Michael,

      Yes, I had an incredible stroke of luck and is surrounded by wonderful bosses and colleagues for a few months already :)

      Delete
  7. Try to use insurance to your advantage. Never ever let the agent to sell to you by scaring you. They usually told you some financial disaster stories to get your money.

    What I found out, after studying a few insurance policies (not in Singapore. But perhaps it is similar), that most insurance policy is only good for protecting your finance short term, such as sudden death or costly medical bills. After a long term, it is no use to have an insurance policy as the cost of holding it and inflation will be more than if you buy real assets (such as properties, stocks or invest in your own business).

    My advise, buy some insurance then concentrate on building real assets.

    ReplyDelete
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  11. Haha I like the way you phrase the 'financial planners who prefer to get some guilt off their shoulders'. I assume AIA is not your favourite company then ;) then again, not mine either. Had a personal encounter with one of my clients of how unethical some of their financial consultants can be. Pretty shocking story.

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  20. Fee-based advice can be available to everyone, not only the rich. To give an example, a regular client can just pay $50 per month ($75 for a couple) for a yearly review covering all aspects of financial planning all inclusive. This subscription cost less than a gym membership, medical checkup, utility bill, phone bill, etc. If an adviser has just 200 clients on such a program, the adviser would earn a decent $10,000 per month focusing on providing education & value to his clients.

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