Middle market at risk of 'abandonment dynamic'
As regulators in Canada’s insurance space propose tighter rules around fees related to seg funds, one North American provider of insurance, investment, and financial services is calling for a broader conversation to consider the possible impact on consumers and advisors in the middle market.
“We're a middle market company. So we're constantly working with regulators to make sure the regulations that are proposed or implemented are ones that consider the entire marketplace,” Glenn Williams, CEO of Primerica, told Wealth Professional. “Often they're focused on upper income [customers], because that's where most of the business in our industry is done.”
Williams says industry groups and regulators have plenty of common ground in the regulation conversation, specifically when it comes to the need for effective consumer protection and the appropriate disclosure of compensation. What should be debated, he says, is how to protect consumers effectively without unintended adverse consequences to middle-market consumers whose business comes through small transactions.
Striking a balance for the middle market
A research paper commissioned by Primerica, which was unveiled last week, laid out some important considerations. It highlighted the ramifications of banning all embedded compensation, a move that is “viewed as a barrier to serving Canadians with modest incomes.
“Embedded compensation helps a client get invested without losing the value of their initial investable assets or having to pay an out-of-pocket fee for the financial advice and service they receive,” it said.
With respect to segregated funds, the Canadian Council of Insurance Regulators (CCIR) and the Canadian Insurance Services Regulatory Organizations (CISRO) have recommended issuers stop using deferred sales charges (DSCs) in sales of new seg funds starting June 2022 until an anticipated phaseout next month. There’s also a raft of proposals out relating to compensation on segregated funds, ranging from additional disclosures on fund fees to prospective investors, to banning all embedded fees and chargebacks on advisors.
“Middle-income consumers generally have fairly small amounts of money to invest that they invest regularly rather than in lump sums,” Williams says. “It’s not really the amount of compensation [that’s an issue]. … Advisors have to be able to make enough money to be able to stay in business and provide the advice.”
Eliminating all compensation options wholesale, Williams suggests, could result in middle-market advisors not getting enough compensation, or not getting it soon enough in a client relationship to continue their business. The question and the challenge, then, is how to create a compensation regime where it makes financial sense for financial product manufacturers, distributors, and clients alike to come together and execute a transaction.
A gaping gap across the pond
Some other countries have failed to achieve that balance. The Primerica-commissioned research outlined a bevy of regulatory changes implemented by the UK’s Financial Conduct Authority (FCA) as well as its predecessor, the Financial Services Authority (FSA).
Those changes include policies around independent advisor transparency, advisor credentials, and a total ban on payments made to advisors for recommendations on retail investment products, which were introduced between 2010 and 2013; and the Markets in Financial Instruments Regulation (MiFIR) II rules that took effect in 2018, which include rules around cost disclosure and suitability.
According to the research paper, fees in the UK have gone up among firms that use an AUM model as well as those focused on financial advice only. There’s also been greater consolidation of services, a precipitous drop in the number of advisors, and a rise in compliance costs. Given high costs of onboarding new clients, UK firms have increased the required minimum portfolio size for new clients, and minimum asset balance requirements for clients overall have risen.
“Advisors have to be able to make enough money to be able to stay in business and provide the advice,” Williams says. “Otherwise, they either get out of the out of the business entirely, or they move upscale and leave the middle market behind. … There's an abandonment dynamic that we want to avoid, as we consider these new regulations in access to financial advice.”
Robos can’t fill the void
The FCA has recognized the current advice gap in the UK as an unfortunate outcome of overregulation, suggesting that low- and moderate-wealth consumers could turn to robo-advisors as an alternative. While Williams acknowledges middle-market households typically don’t need overly complex financial products, that doesn’t mean they don’t have complex financial situations, especially when it comes to the demands on their limited income.
“There is a consumer base that will support some level of robo advisors in our industry, both in Canada and in the US,” Williams says. “The difficulty comes in personalizing financial information, identifying the specific needs of a client, and their specific budget constraints, time horizons, and risk tolerances … Thant’s often very difficult to obtain through a series of questions and an algorithm.”
Most importantly, he argues that robo-advisors have limited success when it comes to relationship-focused aspects such as motivating clients to take action on advice, and answering questions they may have after buying a certain financial product. All the firm’s surveys, he said, point to the same conclusion: clients want relationships – and that’s something only advisors can deliver.
“It's not good to ignore [regulations] and not protect the consumer the way they should be protected,” Williams says. “But it's also not good to implement regulations without full understanding and full communication, and then have to go back and revise them because of the unintended consequences. Or even worse, just live with the unintended consequences that reduce access and reduce choice.
“What we would recommend is that [regulators and the industry] work together better than we have in the past. … the industry and all of its members, including us have a responsibility to deliver on that area and of that communication as well.”