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Understanding super & money
The ongoing Royal Commission has focused the interest of the Australian public and policy makers on financial advice and how it operates - in reality and theory. We welcome this as increased awareness and scrutiny will ultimately benefit the financial advice industry, and in time, elevate advisers to a level of transparency and accountability that equals or surpasses the professional standards in other trusted professions in our society. Overtime, I am confident the industry will rebalance this narrative, extending our ability to help all Australians achieve their goals.
Presently, public commentary has a decided tilt towards the failures, or potential failures, embedded in our advice system, with very little acknowledgement of the many financial and psychological benefits advisers give to their clients.
As the public now expects more value and transparency from financial advisers, product providers also need to ensure they are lifting their standards to support the responsibilities associated with financial advice.
At the end of June, the Australian Prudential Regulation Authority (APRA) noted its concerns about cash accounts in super. It had two specific concerns - that some cash accounts are not ‘true-to-label’ because they contain assets that wouldn’t be considered ‘cash’ by the majority of consumers and that interest rates were too low on some cash accounts.
To address these concerns, it’s clear that more needs to be done to ensure both advisers and clients are clear on the cost and value equation – thereby eliminating long-standing, self-serving, cross-subsidies.
There is a place for cross-subsidisation in financial services, but only when it serves the needs of clients. For example, it can easily be argued the life insurance industry operates based on cross-subsidisation. In an insurance pool all clients pay premiums yet very few of them will ultimately claim the insurance – but overall this system benefits clients and our broader society.
What is not acceptable is when the value chain is opaque and only serves the needs of wealth management product providers. A good example of opacity in the cost and value equation is when wrap platforms use clients’ super cash accounts to generate profit for themselves at the expense of client returns. This profit is achieved by paying a low rate of return on the member’s cash account so they can use that gain to subsidise administration fees and other costs.
This source of excess profit gives them a competitive advantage which is gained at the expense of returns to clients. In our experience, this situation is not understood by clients and is rarely factored in as an important consideration in the provision of advice. If we then overlay trustees’ obligations in relation to super, we find it challenging to understand how using the cash accounts of clients to subsidise other parts of the value chain or to generate excess profits can continue.
The table below contains the rate on cash accounts for seven of the major platform providers and for IOOF’s Pursuit platform.
1 Indicative net interest rates based on latest publicly sourced online data or from a provider. Effective dates may differ. 2 IOOF net interest rate at 30 June 2018.
While it can be argued that because only a small portion of members’ funds need to be held in cash accounts for cashflow purposes, this has an insignificant effect on overall client returns. Our analysis shows that this argument misses the important point that across all wrap account providers there is about $50 million per year in excess profits being generated from cash accounts that are paying rates below the Reserve Bank of Australia (RBA) cash rate – currently 1.5 per cent per year. During a typical 40-year lifetime of accumulated savings, this equates to up to an estimated $1 billion in value being extracted from the cash returns of client cash accounts. If interest rates rise from their current, abnormally low, levels then this amount will be considerably greater.
Wrap providers may argue that if they were forced to pay at least the RBA cash rate on working cash accounts, they would have to increase fees elsewhere – and this may well be true. The issue here is not about the cost to the client – it’s about ensuring the wealth management industry is supporting a transparent value chain that clients understand.
We will continue to strive for pricing structures that are equitable, transparent and easy to understand. Despite the challenges of an increasingly complex advice landscape, IOOF’s advice-led positioning will assist in the journey towards financial advice becoming a trusted profession. We welcome your feedback in relation to this issue and ask for your support as we continue to help clients turn their life goals into reality.