Challenges loom for financial services

This year promises to be interesting year for the entire financial services industry, writes Jim Minto.

First, we must recognise this is an election year and we will all be subjected to the noise that entails. Therefore, it is unlikely we will see radical financial services reforms driven by the government this year unless it is an issue that is popular with the electorate.

Ideas concerning tax and superannuation changes will be floated, but nothing controversial will be endorsed. The Government will not want to give traction to a resurgent opposition by floating issues that may be used negatively.

Here are some of my thoughts about the issues in 2010:

• There will be greater recognition and support from government that advice is of real value to Australians. There should be recognition that more people need access to advice. We will also see more protection of value in superannuation — especially for those who don’t actively control their superannuation portfolios but rely on their fund and trustee.
• I have my fingers crossed that we will see some simplification of advice requirements from people with more moderate needs.
• There will be greater awareness of remuneration choice concerning advice, and there will be improved disclosure as commissions are removed from superannuation. The debate about advice will move away from how people are paid to the value advisers add, and how they can be appropriately remunerated.
• Over the next few years we can expect to see a smaller role for superannuation in the investment portfolios of high net worth individuals. Superannuation will be more focused (in a tax benefits sense) on middle to upper middle Australia. We can already see the emergence of this in the Cooper and Henry announcements to date. This idea will be floated this year, and from 2011 advisers will direct high net worth investors towards non-superannuation investments. There is a real change here from the practice of recent years.
• The competitive battle in superannuation between the industry funds and retail sector has been shaken up by the first Cooper announcements. Not much serious public comment has emerged yet on this aspect, but this foreshadows a more constrained competitive marketing ability for superannuation funds. There will be intensive lobbying behind the scenes about this aspect, since it has major potential competitive effects.
• Consolidation in superannuation will continue, but it won’t be solely driven by the Cooper Review. Logic and member benefits will drive this, as is the case today.
• More wealth management consolidation will come. We can expect fewer platforms, with the economics of smaller platforms being further challenged.
• I expect to see more specialisation in life insurance. Even the major players may decide not to compete in all market segments.
• The definition of the bank-owned versus independent life and wealth management sector will become more pronounced. This goes to the heart of consumer demand. Not all consumers want banks to dominate their offerings, and many advisers will continue to demand more choice in providers and products. Advisers have already seen the effects of bank power over distributors in the mortgage broker sector. Many will still demand choice.
• Major institutions and institutionally owned dealers will try to exert more control over the independent adviser sector. There will be attempts to tighten advice to fewer products offered by dealers and to benefit the product stables of the companies that own those dealers. Consumers will see reduced choice and higher margins paid on their products if this happens.
• Independent dealers will look for the right partners as the market reshapes in a larger way than at any time since financial services reform. They risk being marginalised and advisers need to support them by paying realistic fees and revenue splits for the costs and risks of operating dealerships.
• We can expect greater scrutiny of the end-to-end margins charged by fully integrated businesses to their customers. Debate about commission and fees is a nonsense when fully integrated product manufacturers can embed high margins and returns where consumers have little awareness, understanding or choice. This is now a global regulatory issue in consumer credit insurance, and I believe we will see it emerging in life insurance as well over time.
• I expect the life insurance market to continue to grow strongly, driven by basic consumer needs. But the role of life insurance in superannuation will come under further review based on the first Cooper announcements, with more Cooper announcements due this year.
• We should expect Henry to recommend targeting of tax benefits through superannuation to those who need them most, to recommend simplification of the tax legislation, and to question the continuation of a number of tax deductions and tax effective investments. Pleasingly, stamp duties for general and life insurance are expected to be simplified. The high top marginal rate continues to drive taxpayers towards tax planning and tax effective arrangements. A bigger reform agenda is needed than I believe the review will recommend. The Australian tax system is too complex and should be simplified to a more significant extent than I sense is being contemplated.

Market consolidation

In superannuation, many funds are already closely considering merger options independently of the Cooper review.

While scale is seen to be the attraction in most cases, I know managers and trustees of the larger funds are concerned about value to their members, complexities that flow from mergers and the associated costs. In superannuation funds there are no shareholder interests to consider but only member interests.

There are no capital or investment criteria to drive these mergers, and value to members from being part of a merged fund is the key.

That will tend to mute the growth in merger activity. The expectations of the two parties need to be aligned, and while there is much dialogue I suspect progress will be a little slower than many expect.

The drivers of progress in these mergers will be boards and fund executives who have strategic visions for their funds and are acting in the longer term interests of members.

On the retail financial services side expect more consolidation. Smaller platform players already acknowledge privately they are subscale and have limited options.

They are driven by the need to merge. The financial services sector will see companies become mainstream players or just focus on niche positions.

The big longer-term question in life insurance will be whether the banks really do want to own life insurance manufacturing, when they can capture the value available through their distribution positions.

On the investment platform side banks will want to own manufacturing as it is core to their superannuation strategies, but in life insurance they don’t need to own manufacturing and they don’t automatically want to own it in all other markets.

Generally, they have not been investing in the emerging technologies and change processes to the same extent as non-bank life insurers.

The grab will be on for quality distribution assets, but they must be quality and structured and operated in a manner that can easily deliver value for future owners. Collections of advisers by themselves will not be able to capture commercial value in this way. We should expect more dealer consolidation in 2010.

Cooper Review

The first Cooper announcement deserves particular comment and the next Cooper review announcements are awaited with interest.

This has a bigger potential strategic impact than people in the sector are acknowledging. I suspect various parties are still thinking about it, but the initial commentary has been quite low key.

The first discussion paper really painted a picture of the greatest focus on those people who have not actively engaged an adviser or started a SMSF.

For those people who have already done these things, the first Cooper Review suggests an element of ‘let the buyer beware’.

If people want to make their own investment option choices, choose an adviser, buy additional life insurance or employ an accountant, the review says ‘that is up to you and the risks are with you’.

This is logical, but it also suggests fewer tax benefits to flow in this area in the longer term.

The main focus group, called "Universal" by the first Cooper Review, is those people whose interests will be protected most strongly.

These are people who are passively in superannuation because they are required to be by government policy.

They are generally not actively managing their superannuation. If we did not have compulsory superannuation, many of these people would not save for retirement, as they are required to do today.

So there is a strong public interest in these savings and concerns, including that value should not be lost through excess cost or poor efficiency. Important factors for the Universal group include:

• a focus on simplicity and lower costs;
• no subsidisation out of member funds for advertising or non-member value spending;
• simple investment management options;
• a tighter role for life insurance in super;
• no commissions or fees payable at fund level. Members will have to engage advice and pay for it either personally or from their own balances;
• more fund consolidation;
• high and broad focus on the trustees duties;
• simplification, data agreements, no cross subsidisations with member bases of uneconomic behaviour such as poor contribution processes by employers; and
• a protective Government hand to be played in future years.

The industry funds movement will rethink its strategy about how it can both defend current member bases and win new members in a world where no cross subsidisation of member choice marketing campaigns will be allowed.

On the retail funds side, profit margins in super will be progressively tightened — a good move for consumers — and this again will drive more market consolidation among providers. It is hard to invest shareholder funds when returns look constrained.

In short, there will be challenges for all parts of the market this year. Yes, I am looking forward to the year ahead, and I wish you all every success in 2010.

Jim Minto is managing director at Tower Australia.