Conflicts still spell trouble in financial services industry
Financial services regulators are doing a decent job of creating better transparency for consumers, and of trying to minimize conflicts of interest. There is, however, a lot of work still to be done.
As part of that movement in the right direction, I offer them and you two significant conflicts of interest that still exist today and that can prevent consumers from receiving the best advice.
The first is from the investment industry, and unlike the many conflicts that are hidden from consumers, it is right out in the open.
( In t he non- f i nancial world, I wonder about this kind of obvious conflict every time I see competing gas stations moving their prices in lockstep — and broadcasting the changes the night before.)
The conflict involves investment advisers, who will often get paid more money to put their clients in more volatile investments and less money to put them in less volatile investments.
As an example, at random I picked a large dividend fund. It is a big one, with over $1 billion in assets. That fund charges 2.50 per cent in annual fees in its ‘A’ class, paying most advisers who sell it one per cent a year.
If instead a client owns the same company’s Canadian bond fund, the fund charges about 1.7 per cent in annual fees in its ‘ A’ class, paying most advisers who sell it 0.50 per cent a year.
If I sold this company’s funds to my clients, would I prefer they put $ 1 into a fund that pays me one per cent or one that pays me 0.5 per cent? All things being equal, I would prefer the one per cent choice.
The conflict is quite simple — why am I getting paid double to put a client into a global dividend investment as opposed to a Canadian bond investment? As a client looking for advice on what investments are best for me, shouldn’t I be able to receive advice that is in my best interests and not because someone gets paid more for investment A vs. B?
What if you said to your advisor that you were worried about the investment market and thought you should be in cash or bonds?
You would hope that your adviser’s advice wouldn’t be based on how much they are paid, but rather on what is in your best interest. What if this conversation happened in the summer of 2008 just before the crash? What if the advice was to stay in stocks? What if that advice was based on how they were paid?
While mutual funds have a clear payment structure that pays more for higher risk investments, there are many advisers who get paid through a fee-based account, meaning that there is a fee based on total assets and not what kind of assets. In other cases, there are fee- based accounts that have a different fee for stocks and bonds. While I understand t he rationale for these different fees based on the type of investment, I believe that they also represent an out-in-theopen conflict of interest that I wouldn’t be comfortable with.
If you t ruly want unbiased advice on your investments, you should expect that your advisor is paid the same regardless of whether the advice is to get more aggressive, less aggressive, move into cash or buy a particular fund.
How someone is paid is a proven, significant influencer on their behaviour. It may not affect everyone, but it certainly affects many. Why put yourself in a situation where you need to find that diamond in the rough to avoid a conflict?
Better to avoid that significant conflict of interest altogether, and if you are going to work with an advisor, work with one who gets paid the same regardless of the risk level of the portfolio.
The second conflict that I would flag to regulators is a hidden one, and comes from the Insurance industry.
Have you ever applied for life insurance ( or other health related insurance) and been told that you can move forward, but that you are being rated? This means that for a variety of reasons, you will have to pay more per year to get the same dollar amount of coverage. As a consumer, this is not ideal, but it becomes part of the overall decision- making process. From the insurance company perspective, they believe you won’t live as long so you have to pay a higher rate for fewer years in exchange for an earlier payout or a higher risk of a payout.
What you probably don’t know is that your insurance broker would get paid more for the same coverage if you are rated than if you are not. To make matters worse, sometimes you are rated for health reasons, but the decision can be overturned with some effort. If you and your broker are successful in lowering the rating, the broker will have money “clawed back.”
Sometimes when an applicant is rated, people work out an insurance budget. If they get rated, they simply take out less insurance but pay the same. Because the insurance broker gets paid based on the cost of the insurance, as opposed to the amount, if your total cost is the same, the broker’s commission will essentially be the same.
Again — this does not make i nsurance brokers bad. In fact, a broker that works with you to try to get a rating reduced, is definitely one that you want to hold on to, because they are working for you even though they will get paid less if you are successful. The question is, why would the industry and compensation system be structured in such a way that there is a clear conflict of interest between the broker and the client?
As the various parts of the financial services industry work to minimize conflicts of interest, these are two major ones that every consumer should be aware of, and I believe regulators should focus on.