As the Smoke Clears...
Written by John M. Lefferts, CFP,CLU,ChFC
5/12/09
This past week, I had the opportunity to speak with some Congressmen and Senators on "The Hill" while in Wash DC for an industry conference. Intuitively, I've always known that politicians will be partisan as is the way with politics. But I was struck by how extremely polarized each side has become leaving little room for compromise. In the spirit of full disclosure, my political views tend to be fiscally conservative and pro-business while being socially moderate. Unfortunately, it seems that politics these days force you into either the camp as being a truck with gun rack driving and bible thumping red neck or a dope smoking, tie dye gown wearing hippie dancing with hands flailing in air. It doesn't seem like those who connect with both sides of the aisle have any representation at all. And it's this "all or none" mentality that causes me to wonder how anything ever gets done in Washington. That brings me to the central theme of this writing... We are in a unique point in time in the financial services industry where there is an opportunity for new regulations to truly re-shape the landscape for the benefit of consumers and the business. Not only is this long overdue, but we have the chance to align regulations closing the gaps that enabled the multiple Ponzi schemes to exist for decades and Credit Default Swaps to go virtually unregulated destroying much of the US economy. But as they say, never underestimate the status quo, which is a threat to getting anything meaningfully done at all. It's my hope that new regulation will be well thought through and eliminate the current patchwork of regulatory silos (SEC, FINRA,State Securities Dept's, State Insurance Departments, CFP board, etc). But then again, the status quo would lend to simply placing a new layer of "systemic" regulation on top of the existing regulatory patchwork not only keeping a bad system in place, but making it worse by having to answer to yet another regulatory body.
I've written before about why now may be the time to anticipate "where the puck is going" and how regulatory and economic changes are potentially reshaping the financial services business and business models for good. The company/individuals who have the foresight to get this right and act on it would be in the driver's seat to take advantage of the growing boomer demographics' financial needs as the economy eventually recovers. Let's not forget that even with the economic downturn, the amount of "money in motion" will reach all time highs in the next several decades as boomers retire and transfer their wealth to the next generation. It may be too early to call from what we know today, but the smoke on this crisis is beginning to clear and the resulting factors effecting the financial services business are starting to take shape. There are 3 primary factors driving change in the business. They are: 1) Updated regulation 2) New economic realities of business with beaten down balance sheets and 3) A shift in consumer attitudes and behavior. So, I'm going to go out on a limb and give it my best shot at what I see evolving...as smoky as it still remains.
Changes in regulation
It's been well chronicled how we got into this financial crisis and I won't rehash it here. But the other day I heard one politician (admission: I was watching the financial porn channel CNBC) proclaim with relative certainty that it was the repeal of the Glass Steagall Act allowing banks, insurers and investment banking walls to fall that caused this crisis. What a bunch of baloney! The repeal of Glass Steagall, which was built in a different era for different reasons, was not the cause of the mess. If you examine it more closely, you'll see that while the silo's between financial intermediaries came down, the regulatory silo's remained in place. It was this misalignment of regulation that caused many bad things (i.e. Madoff, CDS, Hedge Funds, Mortgage excess, etc) to slip through the cracks. What should have happened along with the repeal of Glass Steagall into a new era of financial services was a new era of financial regulation. Talk of a systemic regulator is about a decade too late. Meanwhile every regulatory body is lobbying for their respective relevance and survival while the consumer and those of us in the financial services industry stand by and watch. The quote, "The more things change, the more they remain the same" comes to mind which is why I fear that the ultimate solution of a total regulatory overhaul will give way to the status quo in more of the same.
Nonetheless, there is sufficient demand for at least some change that has momentum to get done in short order. One part I think will happen is that the life insurance industry will finally get differentiation from the Property and Casualty Insurance business and get the federal oversight they so desperately want. This will be a big win for the life companies who have had barriers to competition and are hampered with unnecessary costs as they've been hand-strapped by a mishmash of state insurance regulators. It's also a win for consumers with an opportunity for simplified and less costly products while additionally eliminating the seedy side of the insurance business selling 15% commissioned annuity products to all too trusting seniors. But in the "be careful what you ask for, you may just get it" department, FINRA and SEC Chief Shapiro have been making noise about "harmonizing" the regulations between Investment Advisors, Broker-Dealers and yes, Life Insurance. Further, there has been much talk about these new "harmonized" regulations holding Advisor/Broker/Agent to a Fiduciary standard of care. This is still being duked out in Washington, but think about the ramifications should this come about. And whether or not this happens, at least directionally it is where regulations are headed over time. It's a consumer centric way of looking at it. The customer doesn't know or care which hat an advisor/broker/agent is wearing when they present a financial solution. Much of what is being recommended today resembles professionally managed portfolio of securities in its purest form. But, if it is wrapped as an annuity, the states regulate it. If there a fee for advice is paid, the SEC regulates it (more or less). And if it's wrapped up as a mutual fund, FINRA regulates it. All the while, the consumer has a tough time distinguishing one from the other... they all look the same to them.
So, as a fiduciary, full disclosure is a requisite. That means the advisor/broker/agent will have to disclose all fees and commissions, not to mention the benefits of any alternatives. Think how red-faced that will make insurance agents when they must disclose in writing that close to 100% of the first year premium paid is gone. Without question, this will definitely lead to product design changes and a movement towards fee based products and services across all disciplines of financial services. This will also place the distribution models that are economically built on the sale of commission based proprietary products at a tremendous disadvantage since the financial solution won't always be one dimensional as is often the case today. Fee driven business will be the wave of the future.
Shift in Consumer Attitudes and BehaviorIt's been cited before that the average consumer spends more time planning their vacation than they do their financial futures. I think that changed In April when everyone opened their quarterly account statements and gasped at the balance. They (myself included) have been going through the range of emotions beginning outward with anger to blame to resentment then moving inward to acceptance. I hear people say, "I was too trusting" or, "It's all so complicated" or "I thought everything was taken care of"...Not anymore. As this crisis moves towards recovery, and there are signs that we are beginning that process now, the consumer will take more control of their financial futures. They will demand to understand what they are investing in, how it works, what the costs are and all the potential outcomes. The mystique of hedge funds, Madoff, Stanford and all the other "high brow" schemes will no longer be alluring. Regulation will require and consumers will demand to know what is in the "black box" of financial products. The veil of secrecy that the "Hedgies" enjoyed was the basis for their success. But with the light being shed on their practices, they'll scatter like certain insects (can't bring myself to say it here) do when exposed to daylight.
Having said that, as simple and transparent as financial products and services can get, the vast majority of the population will still need the help of a financial professional to assist them in sorting through it all. At the end of the day, American's have neither the time, training nor temperament to get their financial houses in order. While the doors may be closing for the transaction driven product hucksters, it appears to be opening for process driven financial planners. Financial Planning is a relatively new profession still trying to find its footing and gain acceptance on par with CPA's, Attorney's or medical doctors. Wall Street has summarily thumbed its nose at the profession relying more on their investment acumen with charting, timing, and all else that is typically confusing to the investing public. They viewed the planning segment as a whacky touchy-feely underworld that lacked the sophistication of Wall Street. (Yes, the emperor has(d) no clothes) But now, the consumer wants help and no segment of the financial services world is in a better position to give it than a financial planner who can coach, counsel and hand hold while caring less about a sales commission because they receive a fee for their services. While there is much talk about the end of Wall Street, there is little attention being paid to the part of the financial services business best positioned to take over the throne: Fee based or fee only Financial Planners.
New Economic RealityWe've almost become numb to the staggering news that comes at us daily to recognize the magnitude of what has happened in the financial services business over the past year. If we step out of the box and take ourselves back a couple years, who would have believed that the "thundering herd" of Merrill would be subservient to Bank of America, The largest insurance company in the world, AIG, is being sold off in parts to raise money for the government and household names like Bear Stearns, Lehman Brothers, WAMU and Wachovia cease to exist as stand alones. As Will Farrell says in one of his spoof movies, "It's mind-bottling". The shift in the financial powerbase from Wall Street to Main Street has only just begun. Over the past 6 months, most financial firms have been simply positioning for survival and living off TARP money. The damage caused by the subprime mortgages and all the various ways it was packaged is already legendary. But as commodity, equity, debt and residential real estate values have plummeted, it is widely thought that there is one more shoe to drop. That is commercial real estate. As commercial real estate becomes the last bubble to pop, a new wave of firms, many insurance companies, will need access to capital or risk government intervention, which as we know, is not a good thing. The key driver here is leverage which works great going up and is devastating going down. Investment Banks were the worst employing up to 30X in debt to equity. Next have been the commercial banks who were hovering around 20X. Life insurance companies have been relatively safe at 10X, but those with large commercial real estate exposure will have trouble. The least leveraged of the bunch appears to be Property and Casualty companies who have had roughly 5X leverage. Once we get over this period of downsizing and fighting for survival, and I think we're about at that point now, then I think we'll see the consolidation games begin. Once they have cut all that can be cut, the Financial Firms will have no choice but to begin to move from being reactive to more strategic. "Strategic Reviews" such as what ING used to decide to sell their Broker-Dealer business, will be the new phase. What you will see is firms shedding all that is "non-core" as companies retreat to their respective silo's where insurance manufactures insurance products, banks provide banking products and investment companies provide, surprise!...investment products. Then within each respective financial services silo, the consolidation games will begin as the balance sheets and equity values rebound. Mid-sized or regional firms, heretofore under the radar, may emerge as players in the consolidation of the businesses as the giants are still staggering from the blows they have taken and continue to deal with their legacy costs not to mention the requisite in paying back the government first.
As the Smoke ClearsSo the smoke is beginning to clear and we can see the rough shapes taking form. New Regulation will force transparency, full disclosure and a fiduciary standard across all financial disciplines. This forces a move towards fee based lines of business. Consumers will demand simplicity and actually make attempts to get their financial houses in order. This forces a move towards financial planning. Financial institutions will be forced to "stick to their knitting" and do what they do best which is to manufacture products and services in their area of expertise. So I think you can probably guess what my conclusion will be. Financial firms will manufacture products and distribute them through fee based and/or fee only financial planners driven by new regulation, changes in consumer attitudes and the new economic reality caused by the great recession of 2008. Does this mean that stockbrokers and insurance agents and other financial services specialists will become extinct?...of course not! As I mentioned at the start of this piece, I'm suspect of any extreme position and tend towards moderation. But the stage is set for financial planning to play a much larger role in the financial services business as the evolution takes hold. Who, how and when will this happen...I'll save that for another chapter...and as the smoke clears.
Wednesday, May 13, 2009
Thursday, May 7, 2009
Lefferts view on retail financial services today
Skating in Boiling Water
Written by John Lefferts, CFP,CLU,ChFC
"I skate to where the puck is going, not where it is"
-Wayne Gretzky
This often used quote seems to have new meaning to those of us in the retail financial services business as the unprecedented volatility and market declines have shaken what we know as "where the puck is" to wonder "where the puck is going." For years, it has been thought that the current retail financial services models whether they be wirehouse, insurance agency, banks or independents would have to inevitably change as a result of evolving economics and convergence. But there were never any major lasting events to force this to happen. Yes, 9/11 did shake America's psyche and the markets roiled afterwards for a while, but we rebounded shortly after. The depth and spread of this financial crisis is unlike anything we've seen in modern history, yet the retail financial services industry seems to be doing little to respond. It's like the crude, but true description of placing a frog in a boiling vat of water. (please don't try this at home). It's feels the heat and jumps right out. But if you place a frog in a vat of lukewarm water, it swims around like everything is okay. When the heat is turned up, it happily stays. Then, when the heat brings the water to a boil, it continues to stay and boils to death. Frankly, this example, as repulsive as it is, can be applied to the retail financial services industry models we have been operating under for the past several decades where there has been no material structural change. Yes, there has been a drift towards the independent advisory model, but there is no bona fide evidence that this is a panacea either. And the economics of this meltdown and eminent re-regulation of financial services have changed the game for everyone.
So, I pose the questions, will the retail financial services distribution models continue in their present forms while the environment around them is essentially boiling?... Are they adept enough to see that if they stay in their current structures, they will potentially die a slow and agonizing death?... Or will they figure out that now, unlike ever before, it is time and perhaps even a unique opportunity to make long overdue structural changes for future survival? Answering these questions are not as simple as saying, "just get out of the boiling water!" We know that the current environment is forcing a change, but then, what to? Where is the puck going? In this paper, I'll explore what I see evolving from my vantage point.
The Opportunity
For the longest time, the careers of financial advisor and financial planner have been ranked as the leading professions to enter based upon a growing need for quality financial advice given the complexities of products and the economy. But more so, it is the "pig in a python" baby boomer demographic that is evolving and aging needing help like never before. In their early years, it was easy... Get a job, buy a house, save for college education and hopefully have enough left for retirement. So for this huge segment of the population, financial planning was relatively easy...just save money. The focus was on accumulation of assets which is how the mutual fund industry exploded over the past several decades. But now the kids are out of the home and educated, the house can no longer be viewed as the nest egg it once was and the 401(k), once joked to be a 201(k) is now more like the 101(k)...not very funny. Folks need advice more on how to protect what they have, how not to outlive their assets and if they're lucky enough to have anything left over, how to efficiently transfer it to the next generation. It's a sad irony that now and for the next decade, there has never been a greater need for quality financial advice and advisors at a time when the industry is least prepared to provide it.
The rules for retail financial services distribution models have been re-written as a result of the confluence of events ignited by the bursting of the real estate bubble and resulting fallout, the aging boomer demographic and an actual decline in the supply of advisors to meet the increasing need for advice. Add to that an expectation of widespread financial regulatory overhauls, a shrinking universe of players (Where's Bear, AIG, Lehman, etc?), tax law changes and the expectation of convergence/consolidation in financial services gaining momentum, it can be a "head hurter" to try to figure it all out. But in change there is always opportunity for those adroit at reading the tea leaves, or being able to "skate where the puck is going." And if the size of this economic crisis is any indicator, the opportunity has never been greater.
The Current State of Affairs
To decode this coming opportunity, it seems logical to me to lay out what we know so far. The best way I can break it down is identifying and sorting out the two key components of the business; supply (financial services providers) and demand (the financial services consumer). With their faith in the financial system rocked by Madoff, Stanford and their account statements at values less than over a decade ago, the average consumer is paralyzed with their financial matters. They're highly dissatisfied with where they are, but are confused and afraid about where else to go. And there really are few places to go. But time heals, and when the smoke begins to clear in the financial markets and with customer loyalty being at all time lows, you can bet there will be more money in motion than ever before. It will take some time, but it will happen. Every piece of research tells us that with the exception of a small segment of "do it your-selfers", most consumers don't have the time, desire or aptitude to shop for financial products. They simply want to look a competent, reputable and honest financial advisor in the eye to tell them what to do. And further, they don't want the inconvenience of having multiple financial services providers, multiple account statements and multiple tax reports. They want one place where they can confidently trust that it's all taken care of. And it's been estimated that at least 50% of the financial services clientele is up for grabs. Big change-big opportunity.
How about the supply to meet this coming demand? That is a great deal more complex. With the deregulation and modernization of what was formerly Glass-Steagall in the late 90's, it was thought that the walls between banks, insurance and investment companies would come down and a new model of a financial services supermarket would evolve. Citigroup was thought to be the model of the future with the banking entity coming together with Travelers Insurance and Smith Barney Investments. But the horizontal integration didn't ever materialize as planned since the cultures between each entity never blended together. The brokers remained transaction driven, the insurers process driven and the banks service driven. Today, the Citi model appears to be going down in flames. Despite the politicians trying to blame deregulation for the current economic crisis, it wasn't the removal of the outdated separation of banks, insurers and investment firms enabling this mess so much as it was the continued misaligned web of regulation that missed the oversight of complex leveraged financial products...products that Warren Buffet described as "financial weapons of mass destruction". How can an insurance company regulated by a state insurance department, issue complex investment products like Credit Default Swaps and get away with it? ...misaligned regulation. Between state insurance departments, state securities departments, FINRA, SEC, FDIC and virtually no regulation of the mortgage business, the rocket scientists of the financial services product development business found an opening that fell between the cracks of the outdated and over-politicized regulatory bodies. Repeal of Glass-Steagall changed the game for financial intermediaries to enter a modern era in financial services, but regulations remained unchanged and stuck in the past. It's unfortunate that we needed a crisis to realize it's time to align the business models with the proper regulations.
Let's take a closer look at where each silo'd model within retail financial services is currently positioned...
Insurance
As the water continues to boil, the insurance companies will be forced to stick to their knitting and manufacture insurance products. For those with their own sales force, they will have to reach a decision on the sustainability of maintaining their owned distribution that makes its profits only if it sells the products it manufactures, something that flies in the face of today's market reality. If an insurer can find a way to make profit margins from non-proprietary lines of business, it has a shot at sustainability with its owned distribution. But the dynamics of the marketplace today appear to be dictating that insurance manufacturing needs to be separate and distinct from insurance distribution much like the commercial insurance brokerage distribution firms have done. Additionally, the high-low commission structure of the insurance business will undoubtedly come under scrutiny as regulations force disclosure of compensation. If the economics of the products force a flattening of the insurance product commission structure, it will have dramatic implications for the Insurance based B/D. Mutual insurance companies can temporarily hide under their dated "black box" structures but will be challenged to compete in a consolidating and converging marketplace lacking the currency of equity to participate once the games begin.
Wirehouse
The wirehouses, having lost the consumer trust and throwing good money after bad by giving huge upfront signing bonuses to has-been brokers, will potentially fade away over time since they've stemmed the recruiting of new blood and the vets retire or leave after their deals are up. Top producers will no longer be willing to stay with the wires giving up compensation and payouts for the privilege of using a tarnished brand. Much like the proprietary insurance distribution models, the stockbroker who once peddled proprietary stocks from its parent company market-making investment banking arm no longer exists with the recent demise of investment banks as we know them. And with their compensation models publically exposed and the shift of power from Wall Street to main street, we may have just witnessed the end of an era. Greed, as it turns out, was not so good.
Independent B/D's
As prior mentioned, Independent B/D's have been steadily increasing in size over the past decade at the expense of the wirehouse and Insurance B/D models. But a shift occurred last year that hadn't happened before...more were leaving the Indy model than entering. It comes down to 3 things, or the 3 "C"'s. Compliance: Indy's have a need to increase their expenses to prepare for the coming increase in regulation, something that will place a strain on their already thin profit margins. Cost: With increased need for technology platforms and the general cost of doing business on the rise, Indy's lack the scale to spread these fixed expenses around. Camaraderie: Many advisors who left the larger firms with their traditions and culture find themselves lonely, particularly in this economic crisis. The increasing trend in teaming has placed a strain on the lone independent producer model. However, the greatest threat to the independent B/D model is the classification of their advisors as independent contractors. It is believed that the Obama administration favors a tightening of the classification of independent contractor towards employees. If this happens, it would be the death knell to the Indy's as the costs of maintaining employees would be too great to survive. Bills have already been submitted on this and it will be interesting to see how it plays out.
Banks
Then commercial retail banks, who have neither the depth of talent (paying for performance is counter to the culture) nor the know-how of insurance and investment products, have "missed the ball since the kick-off". They have had the greatest opportunity of all, but lack the leadership to execute on a fully integrated financial services strategy favoring a passive self-service strategy. Unlike famed bank robber Willie Sutton who figured out that banks are the place to go because "that's where all the money is", bankers haven't realized they're sitting on a financial services goldmine seemingly because they're unwilling to pay for the skill that knows how to get it. As the more exotic lines of business become regulated away, perhaps banks will wake up to their tremendous opportunity held within their existing clientele...stay tuned.
De-Reg to Re-Reg
Needless to say, re-regulation is coming, and it will serve as a primary driver in the evolution of the retail financial services industry... where the puck is going. The need for a super-regulator that oversees all financial intermediaries, including the mortgage business, has never been greater and all indications are that this will happen soon. And the angle for FINRA brokers to give up their licenses to enter the more thinly regulated financial advisory business,...the end to that strategy will be coming as well...thanks, Bernie!
The politicians and several regulators would love to go back to silo's as banks separate from insurance companies separate from investment companies turning the clock back to the era of Glass-Steagall. It's what they know, understand and frankly can point at to assign blame for the crisis. However, we cannot effectively undo what has already been done without creating more calamity in the markets. The best option is to have a single regulator that cuts across all financial intermediaries aligned in the modern era of a global economy. This would eliminate the inefficiencies, redundancies and holes in the current web of overlapping and misaligned regulations that let credit default swaps happen and Bernie Madoff exist. For those who are currently overregulated such as insurance companies with state insurance and multiple securities regulators to answer to in every state in which they do business, updated regulation will be welcome. But for those who have been flying under the radar, such as investment advisory firms, or hedge funds, you are now in the cross hairs of the feds and their coffers are being filled to launch warfare. This regulatory leveling of the playing field is something to pay attention to as we try to anticipate the future.
Suitability versus Fiduciary Responsibility
Once the regulators have financial products distributors "on the same page" the next question is, what page will that be? With what seems like a new Ponzi scheme uncovered each day, the government will be focused more than ever on protecting the consumer. And the consumer has no idea what regulations their advisor/planner/agent/broker/financial professional, etc are being held to. To the general public, they all look the same, but nothing could be further from the truth. There appears to be momentum in correcting this confusion with former FINRA head Mary Shapiro now leading the SEC. Her view that all financial product distributors should be held to the higher standard of fiduciary responsibility could drive towards uniform regulations for all providers. Just as the definition change of independent contractor to employee would be devastating to the Independent model, a move towards fiduciary standards could likewise impact the product driven distribution models that are economically built on selling "proprietary" products and services.
Business Economics
In addition to sweeping new regulations, another factor influencing the future of retail financial services are the economics of the current business models. With a cost of around $200,000 per trainee only to lose 80% of them after 4 years, it's no wonder most financial firms have dropped their recruiting of new blood for in favor of essentially buying veteran talent. Add to that the likelihood that the 20% who do survive will likely be recruited away for the "greener pasture" someday, and it doesn't take a brain surgeon to figure out that the model of grow your own is seriously fractured in its current form. I personally believe that under a new and updated model, a grow your own strategy can be successful, but changes in training, compensation and recognition are a pre-requisite. Additionally, eliminating new advisor recruiting in favor of experienced producers can be a suckers bet. Seldom do they meet the requirements that their "signing bonuses" were predicated upon and in the net, they simply roll existing customers from firm to firm rather than create new ones which creates a huge compliance liability. So, if the large national firms are flawed, one might surmise that the independent model would be the natural wave of the future. But with the coming increase in regulation, the increasing costs of doing business, their lack of scale combined with increasingly thin margins are the greatest challenges to the survival of the independent producer. And as prior mentioned, the classification of independent contractor to employee is looming out there over the head of the Indy's.
Will anyone survive?
So here we are. Trying to anticipate the inevitable re-regulation of the financial services business while lacking a current business model that appears to be economically sustainable. Where is future for retail financial services and who will be successful? When I ask myself that question, the raspy voice of my linebacker coach comes to mind as he yelled "shoot the gap!" In a environment where silo's no longer need to exist between banks, insurance and investment, combined with rationalized and broad regulatory oversight, cutting a new path down the middle, a space currently open for the taking, screams out to me as a potential solution. By evolving and improving on the poorly executed concept of CitiGroup, but integrating it into a single culture with scale, absent the product driven underpinnings of insurers or wirehouses, there is a light at the end of the tunnel. That is by taking the best aspects from independents, investment, insurance and banking models into a fully integrated, scalable organization. I think Citi had the concept right, but was simply too large and silo'd to pull it off. The chassis of this evolved model could have its roots in the wirehouse, bank, insurance or independent models. It will be the entity that can organize in anticipation of the coming regulatory, legal and tax law changes while meeting the greater share of a customers' needs that will have an opportunity to become the breakaway model for the future. Most leaders in the business I've spoken to generally acknowledge that change has been forced upon the industry and there is no turning back to an era gone past. With the forces of the economics and sweeping new regulation, now may be the opportune time.
Change=Opportunity
It is still somewhat unclear as to how all the change will shakeout the retail financial services industry. New broad based regulations, new tax law, employee status changes, and the continuing erosion in the economics of the business will be key factors in shaping the future. While certain retail financial services models will die in the boiling water environment because they are either paralyzed and don't know what to do or simply choose not to make any changes because change is uncomfortable, there is an opportunity like never before for a new model to emerge in the direction of where the "puck is going". And whoever gets this right, will be the victor to the riches of the coming economic recovery and demographic evolution of the baby boom generation. It will take vision, leadership and the ability to execute on a plan to make it happen, something that at the moment is difficult to find in the financial services industry. It will be interesting to watch this evolve and witness who survives and thrives as the new realities of the marketplace create the opportunity for better, more evolved retail financial services models as we "skate to where the puck is going" and out of this boiling water market. e to make changes rather than have changes forced upon us.
If you have any comments on this article, please send them to John Lefferts at his e-mail address: jmlsr1@gmail.com
Written by John Lefferts, CFP,CLU,ChFC
"I skate to where the puck is going, not where it is"
-Wayne Gretzky
This often used quote seems to have new meaning to those of us in the retail financial services business as the unprecedented volatility and market declines have shaken what we know as "where the puck is" to wonder "where the puck is going." For years, it has been thought that the current retail financial services models whether they be wirehouse, insurance agency, banks or independents would have to inevitably change as a result of evolving economics and convergence. But there were never any major lasting events to force this to happen. Yes, 9/11 did shake America's psyche and the markets roiled afterwards for a while, but we rebounded shortly after. The depth and spread of this financial crisis is unlike anything we've seen in modern history, yet the retail financial services industry seems to be doing little to respond. It's like the crude, but true description of placing a frog in a boiling vat of water. (please don't try this at home). It's feels the heat and jumps right out. But if you place a frog in a vat of lukewarm water, it swims around like everything is okay. When the heat is turned up, it happily stays. Then, when the heat brings the water to a boil, it continues to stay and boils to death. Frankly, this example, as repulsive as it is, can be applied to the retail financial services industry models we have been operating under for the past several decades where there has been no material structural change. Yes, there has been a drift towards the independent advisory model, but there is no bona fide evidence that this is a panacea either. And the economics of this meltdown and eminent re-regulation of financial services have changed the game for everyone.
So, I pose the questions, will the retail financial services distribution models continue in their present forms while the environment around them is essentially boiling?... Are they adept enough to see that if they stay in their current structures, they will potentially die a slow and agonizing death?... Or will they figure out that now, unlike ever before, it is time and perhaps even a unique opportunity to make long overdue structural changes for future survival? Answering these questions are not as simple as saying, "just get out of the boiling water!" We know that the current environment is forcing a change, but then, what to? Where is the puck going? In this paper, I'll explore what I see evolving from my vantage point.
The Opportunity
For the longest time, the careers of financial advisor and financial planner have been ranked as the leading professions to enter based upon a growing need for quality financial advice given the complexities of products and the economy. But more so, it is the "pig in a python" baby boomer demographic that is evolving and aging needing help like never before. In their early years, it was easy... Get a job, buy a house, save for college education and hopefully have enough left for retirement. So for this huge segment of the population, financial planning was relatively easy...just save money. The focus was on accumulation of assets which is how the mutual fund industry exploded over the past several decades. But now the kids are out of the home and educated, the house can no longer be viewed as the nest egg it once was and the 401(k), once joked to be a 201(k) is now more like the 101(k)...not very funny. Folks need advice more on how to protect what they have, how not to outlive their assets and if they're lucky enough to have anything left over, how to efficiently transfer it to the next generation. It's a sad irony that now and for the next decade, there has never been a greater need for quality financial advice and advisors at a time when the industry is least prepared to provide it.
The rules for retail financial services distribution models have been re-written as a result of the confluence of events ignited by the bursting of the real estate bubble and resulting fallout, the aging boomer demographic and an actual decline in the supply of advisors to meet the increasing need for advice. Add to that an expectation of widespread financial regulatory overhauls, a shrinking universe of players (Where's Bear, AIG, Lehman, etc?), tax law changes and the expectation of convergence/consolidation in financial services gaining momentum, it can be a "head hurter" to try to figure it all out. But in change there is always opportunity for those adroit at reading the tea leaves, or being able to "skate where the puck is going." And if the size of this economic crisis is any indicator, the opportunity has never been greater.
The Current State of Affairs
To decode this coming opportunity, it seems logical to me to lay out what we know so far. The best way I can break it down is identifying and sorting out the two key components of the business; supply (financial services providers) and demand (the financial services consumer). With their faith in the financial system rocked by Madoff, Stanford and their account statements at values less than over a decade ago, the average consumer is paralyzed with their financial matters. They're highly dissatisfied with where they are, but are confused and afraid about where else to go. And there really are few places to go. But time heals, and when the smoke begins to clear in the financial markets and with customer loyalty being at all time lows, you can bet there will be more money in motion than ever before. It will take some time, but it will happen. Every piece of research tells us that with the exception of a small segment of "do it your-selfers", most consumers don't have the time, desire or aptitude to shop for financial products. They simply want to look a competent, reputable and honest financial advisor in the eye to tell them what to do. And further, they don't want the inconvenience of having multiple financial services providers, multiple account statements and multiple tax reports. They want one place where they can confidently trust that it's all taken care of. And it's been estimated that at least 50% of the financial services clientele is up for grabs. Big change-big opportunity.
How about the supply to meet this coming demand? That is a great deal more complex. With the deregulation and modernization of what was formerly Glass-Steagall in the late 90's, it was thought that the walls between banks, insurance and investment companies would come down and a new model of a financial services supermarket would evolve. Citigroup was thought to be the model of the future with the banking entity coming together with Travelers Insurance and Smith Barney Investments. But the horizontal integration didn't ever materialize as planned since the cultures between each entity never blended together. The brokers remained transaction driven, the insurers process driven and the banks service driven. Today, the Citi model appears to be going down in flames. Despite the politicians trying to blame deregulation for the current economic crisis, it wasn't the removal of the outdated separation of banks, insurers and investment firms enabling this mess so much as it was the continued misaligned web of regulation that missed the oversight of complex leveraged financial products...products that Warren Buffet described as "financial weapons of mass destruction". How can an insurance company regulated by a state insurance department, issue complex investment products like Credit Default Swaps and get away with it? ...misaligned regulation. Between state insurance departments, state securities departments, FINRA, SEC, FDIC and virtually no regulation of the mortgage business, the rocket scientists of the financial services product development business found an opening that fell between the cracks of the outdated and over-politicized regulatory bodies. Repeal of Glass-Steagall changed the game for financial intermediaries to enter a modern era in financial services, but regulations remained unchanged and stuck in the past. It's unfortunate that we needed a crisis to realize it's time to align the business models with the proper regulations.
Let's take a closer look at where each silo'd model within retail financial services is currently positioned...
Insurance
As the water continues to boil, the insurance companies will be forced to stick to their knitting and manufacture insurance products. For those with their own sales force, they will have to reach a decision on the sustainability of maintaining their owned distribution that makes its profits only if it sells the products it manufactures, something that flies in the face of today's market reality. If an insurer can find a way to make profit margins from non-proprietary lines of business, it has a shot at sustainability with its owned distribution. But the dynamics of the marketplace today appear to be dictating that insurance manufacturing needs to be separate and distinct from insurance distribution much like the commercial insurance brokerage distribution firms have done. Additionally, the high-low commission structure of the insurance business will undoubtedly come under scrutiny as regulations force disclosure of compensation. If the economics of the products force a flattening of the insurance product commission structure, it will have dramatic implications for the Insurance based B/D. Mutual insurance companies can temporarily hide under their dated "black box" structures but will be challenged to compete in a consolidating and converging marketplace lacking the currency of equity to participate once the games begin.
Wirehouse
The wirehouses, having lost the consumer trust and throwing good money after bad by giving huge upfront signing bonuses to has-been brokers, will potentially fade away over time since they've stemmed the recruiting of new blood and the vets retire or leave after their deals are up. Top producers will no longer be willing to stay with the wires giving up compensation and payouts for the privilege of using a tarnished brand. Much like the proprietary insurance distribution models, the stockbroker who once peddled proprietary stocks from its parent company market-making investment banking arm no longer exists with the recent demise of investment banks as we know them. And with their compensation models publically exposed and the shift of power from Wall Street to main street, we may have just witnessed the end of an era. Greed, as it turns out, was not so good.
Independent B/D's
As prior mentioned, Independent B/D's have been steadily increasing in size over the past decade at the expense of the wirehouse and Insurance B/D models. But a shift occurred last year that hadn't happened before...more were leaving the Indy model than entering. It comes down to 3 things, or the 3 "C"'s. Compliance: Indy's have a need to increase their expenses to prepare for the coming increase in regulation, something that will place a strain on their already thin profit margins. Cost: With increased need for technology platforms and the general cost of doing business on the rise, Indy's lack the scale to spread these fixed expenses around. Camaraderie: Many advisors who left the larger firms with their traditions and culture find themselves lonely, particularly in this economic crisis. The increasing trend in teaming has placed a strain on the lone independent producer model. However, the greatest threat to the independent B/D model is the classification of their advisors as independent contractors. It is believed that the Obama administration favors a tightening of the classification of independent contractor towards employees. If this happens, it would be the death knell to the Indy's as the costs of maintaining employees would be too great to survive. Bills have already been submitted on this and it will be interesting to see how it plays out.
Banks
Then commercial retail banks, who have neither the depth of talent (paying for performance is counter to the culture) nor the know-how of insurance and investment products, have "missed the ball since the kick-off". They have had the greatest opportunity of all, but lack the leadership to execute on a fully integrated financial services strategy favoring a passive self-service strategy. Unlike famed bank robber Willie Sutton who figured out that banks are the place to go because "that's where all the money is", bankers haven't realized they're sitting on a financial services goldmine seemingly because they're unwilling to pay for the skill that knows how to get it. As the more exotic lines of business become regulated away, perhaps banks will wake up to their tremendous opportunity held within their existing clientele...stay tuned.
De-Reg to Re-Reg
Needless to say, re-regulation is coming, and it will serve as a primary driver in the evolution of the retail financial services industry... where the puck is going. The need for a super-regulator that oversees all financial intermediaries, including the mortgage business, has never been greater and all indications are that this will happen soon. And the angle for FINRA brokers to give up their licenses to enter the more thinly regulated financial advisory business,...the end to that strategy will be coming as well...thanks, Bernie!
The politicians and several regulators would love to go back to silo's as banks separate from insurance companies separate from investment companies turning the clock back to the era of Glass-Steagall. It's what they know, understand and frankly can point at to assign blame for the crisis. However, we cannot effectively undo what has already been done without creating more calamity in the markets. The best option is to have a single regulator that cuts across all financial intermediaries aligned in the modern era of a global economy. This would eliminate the inefficiencies, redundancies and holes in the current web of overlapping and misaligned regulations that let credit default swaps happen and Bernie Madoff exist. For those who are currently overregulated such as insurance companies with state insurance and multiple securities regulators to answer to in every state in which they do business, updated regulation will be welcome. But for those who have been flying under the radar, such as investment advisory firms, or hedge funds, you are now in the cross hairs of the feds and their coffers are being filled to launch warfare. This regulatory leveling of the playing field is something to pay attention to as we try to anticipate the future.
Suitability versus Fiduciary Responsibility
Once the regulators have financial products distributors "on the same page" the next question is, what page will that be? With what seems like a new Ponzi scheme uncovered each day, the government will be focused more than ever on protecting the consumer. And the consumer has no idea what regulations their advisor/planner/agent/broker/financial professional, etc are being held to. To the general public, they all look the same, but nothing could be further from the truth. There appears to be momentum in correcting this confusion with former FINRA head Mary Shapiro now leading the SEC. Her view that all financial product distributors should be held to the higher standard of fiduciary responsibility could drive towards uniform regulations for all providers. Just as the definition change of independent contractor to employee would be devastating to the Independent model, a move towards fiduciary standards could likewise impact the product driven distribution models that are economically built on selling "proprietary" products and services.
Business Economics
In addition to sweeping new regulations, another factor influencing the future of retail financial services are the economics of the current business models. With a cost of around $200,000 per trainee only to lose 80% of them after 4 years, it's no wonder most financial firms have dropped their recruiting of new blood for in favor of essentially buying veteran talent. Add to that the likelihood that the 20% who do survive will likely be recruited away for the "greener pasture" someday, and it doesn't take a brain surgeon to figure out that the model of grow your own is seriously fractured in its current form. I personally believe that under a new and updated model, a grow your own strategy can be successful, but changes in training, compensation and recognition are a pre-requisite. Additionally, eliminating new advisor recruiting in favor of experienced producers can be a suckers bet. Seldom do they meet the requirements that their "signing bonuses" were predicated upon and in the net, they simply roll existing customers from firm to firm rather than create new ones which creates a huge compliance liability. So, if the large national firms are flawed, one might surmise that the independent model would be the natural wave of the future. But with the coming increase in regulation, the increasing costs of doing business, their lack of scale combined with increasingly thin margins are the greatest challenges to the survival of the independent producer. And as prior mentioned, the classification of independent contractor to employee is looming out there over the head of the Indy's.
Will anyone survive?
So here we are. Trying to anticipate the inevitable re-regulation of the financial services business while lacking a current business model that appears to be economically sustainable. Where is future for retail financial services and who will be successful? When I ask myself that question, the raspy voice of my linebacker coach comes to mind as he yelled "shoot the gap!" In a environment where silo's no longer need to exist between banks, insurance and investment, combined with rationalized and broad regulatory oversight, cutting a new path down the middle, a space currently open for the taking, screams out to me as a potential solution. By evolving and improving on the poorly executed concept of CitiGroup, but integrating it into a single culture with scale, absent the product driven underpinnings of insurers or wirehouses, there is a light at the end of the tunnel. That is by taking the best aspects from independents, investment, insurance and banking models into a fully integrated, scalable organization. I think Citi had the concept right, but was simply too large and silo'd to pull it off. The chassis of this evolved model could have its roots in the wirehouse, bank, insurance or independent models. It will be the entity that can organize in anticipation of the coming regulatory, legal and tax law changes while meeting the greater share of a customers' needs that will have an opportunity to become the breakaway model for the future. Most leaders in the business I've spoken to generally acknowledge that change has been forced upon the industry and there is no turning back to an era gone past. With the forces of the economics and sweeping new regulation, now may be the opportune time.
Change=Opportunity
It is still somewhat unclear as to how all the change will shakeout the retail financial services industry. New broad based regulations, new tax law, employee status changes, and the continuing erosion in the economics of the business will be key factors in shaping the future. While certain retail financial services models will die in the boiling water environment because they are either paralyzed and don't know what to do or simply choose not to make any changes because change is uncomfortable, there is an opportunity like never before for a new model to emerge in the direction of where the "puck is going". And whoever gets this right, will be the victor to the riches of the coming economic recovery and demographic evolution of the baby boom generation. It will take vision, leadership and the ability to execute on a plan to make it happen, something that at the moment is difficult to find in the financial services industry. It will be interesting to watch this evolve and witness who survives and thrives as the new realities of the marketplace create the opportunity for better, more evolved retail financial services models as we "skate to where the puck is going" and out of this boiling water market. e to make changes rather than have changes forced upon us.
If you have any comments on this article, please send them to John Lefferts at his e-mail address: jmlsr1@gmail.com
Saturday, May 2, 2009
Lefferts Professional Beliefs
Lefferts 10 Core
Professional Beliefs
1. As a Financial
Professional, it is incumbent on me to be a student of the financial world and
to stay current on product, industry and economic trends in order to provide
added value to my client and professional relationships.
2. Financial Planning is not
so much about investment returns and the product of the day as it is about shaping,
directing and coaching investor/client behavior.
3. Financial Success will
not be achieved by the temptation of purchasing last year’s number one ranked
product, but through adherence to a plan/strategy and being invested in the
proper asset classes fitting to one’s goals and risk tolerance, over long
periods of time.
4. Over the long run, a
diversified and professionally managed common stock portfolio has outperformed
any other asset class. This understanding and belief is core to our philosophy
in not falling prey to “get rich quick” schemes, but to grow wealth slowly
through proper asset allocation.
5. The greatest cost in an
investment is not a sales load, expense charge or management fee. The greatest
cost is taxation and lost opportunity by investing too conservatively, too
risky or not investing at all.
6. A client is best served
by a team of financial advisors who are “interdependent” using a holistic and
comprehensive approach towards asset and risk management with total
independence from any one product manufacturer or provider. The client is not
well served by a broker/agent/advisor who is tied to and supported by a single
product manufacturer beholden to the highest fee and/or commissioned product du
jour under the guise of objectivity.
7. Over time, the firm/advisor
from which one buys an investment product, insurance policy, annuity or mutual
fund is relatively meaningless if first a well thought out financial plan with
a qualified independent financial professional is not in place.
8. Most customers do not
have the training, temperament or time to shop for or learn the necessary
details about financial products and services. They simply want to look a
competent professional in the eye and know that they can trust him/her to give advice
that is in their best interests and guide them towards making the most
appropriate decision.
9. Counter to conventional
wisdom, Financial Planning is more than investments. At its foundation is a
proper risk management plan with adequate life insurance and up to 1 year of liquid
emergency reserves on hand. Having these core strategies in place first gives
one the foundation on which to build a balanced and appropriate financial plan.
10. One’s finances and/or
career are rewarded by hard work, persistence and the repetitive act of
performing the basics with self-discipline to stay the course, despite the
temptations to do otherwise.
Friday, May 1, 2009
Lefferts Top 10 Truths about Business
Lefferts Top Ten Overlooked Truths In Our Business
(ie-Observations I’ve had in my career)
1. If you commit first, it commits back to you. You must make a leap of faith and close the back door once you enter this or any entrepreneurial business. If you wait for good things to happen before you mentally, emotionally, and physically commit, it’ll be a long wait. The happiest people are those who commit to the situation they are in and make the best of it while unhappy people are continually looking to external factors for their success or to blame for their failure. Take 100% responsibility, commit and enjoy the results, but you have to make the first and continuing move. Don’t be in the backyard looking for four leafed clovers while opportunity is knocking on the front door.
2. Simply showing up is half the formula to success. Exercising self -discipline in your time management is vital. You cannot maintain bankers hours and expect entrepreneurial pay (and we all know what bankers earn). Show up whether you have something to do or not. You will create your own opportunities by being “in play”.
3. Be your first and best client. The power you have by owning the products you sell is beyond description. Not only will it be one of the best financial moves you can make, but you will use it as your most vital sales tool for years to come.
4. Effort, at times, defeats itself. If you maintain a consistent, steady pace of doing first things first and last things not at all, then you are on a path to success. By forcing everything, you can come across as desperate. Keep the pace, let it flow, be patient, and success will follow.
5. It really is a numbers game. As much as we want to believe that there is such a thing as “working smart”, the fact remains that successful associates simply make more calls and see more people. Don’t let your mind trick you into believing it’s otherwise. There is no substitute for hard work.
6. “Fatigue makes cowards of us all”. This quote says it all. If you are not well rested, are ill or lack energy due to little or no exercise, take care of it. Prospects buy strength and push away weakness. You need to be in top shape and good health to convey a positive and impacting impression. Get adequate rest and put yourself on a routinized exercise schedule.
7. You are being judged by first impressions. The saying “You can’t judge a book by it’s cover” does not apply to us. Prospects are judging us the moment we meet them. Dress impeccably, drive a clean, well maintained car and be sure your props (pens, presentations, etc. ) are first class. A common theme I have is, “Do it first class or don’t do it at all”
8. Believe, even when you don’t want to. Much of your success in anything will be predicated on your ability to maintain a positive mental attitude. Believe in your industry, believe in your company, believe in your products, believe in your branch, believe in your district and believe in yourself. You can choose to believe or not to believe (being indifferent is not believing). Believing, even when it’s difficult, will open doors and attract the opportunities you want where not believing closes the doors. Besides, given the choice, it’s a lot more fun.
9. It’s not what you say, but how you say it. Many of us spend agonizing time trying to figure out the catch phrase or line that will sell our products. Worse yet, many write letters thinking that they’re selling. It’s not entirely what you write or what you say, but the confidence in how you present yourself that will win over the prospects. This is a proven fact that is counter-intuitive and must be worked on by all of us.
10. You become and get what you consistently think about. Any thought you carry repetitively, will become your reality. The picture in your minds eye of how you look, your level of success and your lifestyle, will eventually become reality if it isn’t already. If you want to make $500,000 per year, then wipe out any thoughts in your mind with other figures. Think the unthinkable, dwell on it daily and your belief will create it’s own talents to get you there. Only you control this. Is your mind disciplined enough to hold the pictures of what you want to become rather than what you don’t want to be? All successful people know this universal key to success and practice it continually through prayer, meditation and visualization.
(ie-Observations I’ve had in my career)
1. If you commit first, it commits back to you. You must make a leap of faith and close the back door once you enter this or any entrepreneurial business. If you wait for good things to happen before you mentally, emotionally, and physically commit, it’ll be a long wait. The happiest people are those who commit to the situation they are in and make the best of it while unhappy people are continually looking to external factors for their success or to blame for their failure. Take 100% responsibility, commit and enjoy the results, but you have to make the first and continuing move. Don’t be in the backyard looking for four leafed clovers while opportunity is knocking on the front door.
2. Simply showing up is half the formula to success. Exercising self -discipline in your time management is vital. You cannot maintain bankers hours and expect entrepreneurial pay (and we all know what bankers earn). Show up whether you have something to do or not. You will create your own opportunities by being “in play”.
3. Be your first and best client. The power you have by owning the products you sell is beyond description. Not only will it be one of the best financial moves you can make, but you will use it as your most vital sales tool for years to come.
4. Effort, at times, defeats itself. If you maintain a consistent, steady pace of doing first things first and last things not at all, then you are on a path to success. By forcing everything, you can come across as desperate. Keep the pace, let it flow, be patient, and success will follow.
5. It really is a numbers game. As much as we want to believe that there is such a thing as “working smart”, the fact remains that successful associates simply make more calls and see more people. Don’t let your mind trick you into believing it’s otherwise. There is no substitute for hard work.
6. “Fatigue makes cowards of us all”. This quote says it all. If you are not well rested, are ill or lack energy due to little or no exercise, take care of it. Prospects buy strength and push away weakness. You need to be in top shape and good health to convey a positive and impacting impression. Get adequate rest and put yourself on a routinized exercise schedule.
7. You are being judged by first impressions. The saying “You can’t judge a book by it’s cover” does not apply to us. Prospects are judging us the moment we meet them. Dress impeccably, drive a clean, well maintained car and be sure your props (pens, presentations, etc. ) are first class. A common theme I have is, “Do it first class or don’t do it at all”
8. Believe, even when you don’t want to. Much of your success in anything will be predicated on your ability to maintain a positive mental attitude. Believe in your industry, believe in your company, believe in your products, believe in your branch, believe in your district and believe in yourself. You can choose to believe or not to believe (being indifferent is not believing). Believing, even when it’s difficult, will open doors and attract the opportunities you want where not believing closes the doors. Besides, given the choice, it’s a lot more fun.
9. It’s not what you say, but how you say it. Many of us spend agonizing time trying to figure out the catch phrase or line that will sell our products. Worse yet, many write letters thinking that they’re selling. It’s not entirely what you write or what you say, but the confidence in how you present yourself that will win over the prospects. This is a proven fact that is counter-intuitive and must be worked on by all of us.
10. You become and get what you consistently think about. Any thought you carry repetitively, will become your reality. The picture in your minds eye of how you look, your level of success and your lifestyle, will eventually become reality if it isn’t already. If you want to make $500,000 per year, then wipe out any thoughts in your mind with other figures. Think the unthinkable, dwell on it daily and your belief will create it’s own talents to get you there. Only you control this. Is your mind disciplined enough to hold the pictures of what you want to become rather than what you don’t want to be? All successful people know this universal key to success and practice it continually through prayer, meditation and visualization.
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