Much has been written about the value of financial advice. There are many people who believe that financial planners offer little value for the fees charged while there are others who believe that the value financial planners add is very significant.
Research by Morningstar has revealed that the value of advice (they call it “gamma”) can be as much as 3% (of the client’s portfolio) per annum. This is, among other things, a result of managing investor behaviour and greater tax efficiency for the advised client.
We have more than a few clients who prefer to manage their own funds with no on-going advice fees and who will then consult with us from time to time when they think it necessary. And while this may seem to save them an “annual advice fee”, in my experience, it has almost always cost them significantly more than the fee that they would have paid as an “advised” client. Consider the following example from our practice.
The client retired a few years back and transferred his funds to a living annuity – he met with us around the income draw, asset allocation and resulting fund selection and has been looking after it on his own since then. He has been drawing the minimum income (as a result of some consulting that he was doing) until the anniversary earlier this year when the consulting stopped and he needed to increase the annuity. Which he did – without consulting us and without any thought to the tax consequences.
He did not consider that he had a discretionary pot of money from which he could effectively draw (close to) tax-free income. The result is that he is now paying at least R100k in tax that he need not be paying. This is R100k that we would have saved him if he had been an advised client (or if he had at very least sought advice before making the change). The R100k is certainly many times the quantum of the annual fee that we would have been paying. And he is currently staring at an estate duty problem because of the choice to increase the annuity income draw and leave the discretionary assets in his estate.
Add to this the fact that he recently switched funds – “the funds had done nothing for the past few years” and so he made the change. The move was at exactly the wrong time and his asset allocation is now also out of kilter (way too much offshore exposure for a living annuity with a 5% draw). The annual fund fees that he is paying is also way too high – he had “no idea that was an issue”.
Clearly in this case, the value of advice would have been way less than the cost to his portfolio. But then, perhaps we have ourselves to blame. If all clients think we do is choose funds then why would you pay (a significant) ongoing fee for that?
We need to make sure that clients fully understand that asset allocation is but one part of the value-add from a professional financial planning service. There is so much more to the financial planning service, but they wont know that if we don’t tell them and more importantly, if we don’t demonstrate it.
About 5-6 years ago the Life Offices Association (now ASISA) made the claim that up to 35% of the cost of new business was due to the commission paid on the products (http://www.busrep.co.za/index.php?fArticleId=2627965&fSectionId=552&nld=2005-07-18&t=html&f=d) and that was one of the reasons life insurance products were “expensive” and heavy penalties were levied when these were cancelled before maturity.
As a fee-based financial planner it has always amazed me then that when we dont take commission on life insurance products we never see a 35% reduction in the cost of the cover. There is a reduction but it is nowhere near 35% and not all companies are equal either. So where is the commission going to?
Consider the following case:
R4million life cover for a male age 35 would cost ±R506 per month and the commission that the advisor would earn would be almost R7000. If the commission is removed from the policy (yes it can be done) the premium would reduce to ±R372 pm – that’s a saving of R134 per month (26%) for the duration of the policy. Over 5 years that means you would save at least R8040 in premiums. The question I have is why is it only 26% – where is the “other” 9%?
So I did a bit of comparing and it turns out that 26% is a really good reduction and that most of the insurance companies are only reducing the cost of the cover by 15-20% (see table below – these figures are based on quotes for life and disability cover on my own life):
||R 1 153
From the table above it is pretty clear that none of the companies is giving the full 35% reduction that the LOA spoke about and many of the companies also appear to be “holding back” some of the commission that would have been paid (I can only guess where it is going).
In my experience, Altrisk, which has a 26% reduction, is consistently the best company when it comes to reducing the cost of the cover when the commission is removed (they also have a really simple but highly rated product).
So where to from here?
My advice to you is the next time you consider taking out some life insurance, ask your advisor what the premium would be if there was no commission on the policy and then ask him/her what fee they would charge you to do the business – you could end up saving quite a bit of money if you are prepared to pay a fee for the work that is done (typically we would charge between 2 and 3 hours for the implementation of a life policy). So on the above R4million example, you would pay a (maximum) fee of 3*R750 = R2250 to us (we allow our clients to pay this off over a few months if necessary) and you would have the lower premium for the life of the policy – this way you can also be satisfied that if the advisor recommends any additional benefits (such as disability or dread disease cover) they are not doing it to increase the premium and thus increase their commission – they are doing it because it is in your best interest. Under the commission model, the greater the premium, the greater the commission paid – whereas the premium has no bearing on the advisor’s earnings under a fee model.