The Future for Financial Services Distribution Models: Integration
“Our dilemma is that we hate change and love it at the same time; what we want is for things to remain the same, but get better”
–Sydney J Harris
The silos from which the financial services industry have evolved are breaking down, yet the noise we hear from each segment trying to protect their respective turf is louder than ever. The perspectives and arguments from each are becoming old and running thin:
Fee only advisor: Blow up FINRA and force everyone who gives advice to be held to a strict fiduciary standard
Broker: RIA’s serve only the top 1/3rd of households who can afford their fees while holding an unfair advantage escaping oversight and supervision by FINRA
Insurance Agent: How can brokers and RIA’s say they are acting on behalf of their clients best interests when they fail to address the most important financial risks of living too long and dying too soon?
So, in the ongoing debate about the direction of the financial services business, who’s right? My perspective...Separately, none of them but collectively, all of them.
I think the quote above says it best. We’re all for change so long as we personally don’t have to change. Doesn’t that sound like the Albert Einstein’s definition of insanity?- “doing the same thing over and over again and expecting different results”. I’ve been in this business now going on a fourth decade and I’ve observed a fair amount of change during that time. This “wisdom” has taught me a few things over the years:
There are few new ideas, just old one’s updated and repackaged
Compensation drives all perspective and behavior
While it is smart to recognize and learn from the past, you have to let go of it to grow and succeed into the future
Today’s hot button issues are not too different than what we’ve seen before. New ways of distribution threatening traditional methods and shifting regulations have been a common theme since I got into the business. However, what seems different today is the pace of change. The impact of “Moore’s Law” on technology and the massive amount of information and velocity of communication is driving it to a point where no business model can keep doing business as usual. It’s a case of change or be changed. It’s hard to believe that the first launch of the i-Phone was June 29th 2007 and in 2010, Blackberry had a 40% share of the smartphone market. In 2006 when Webster’s Dictionary made “Crackberry” the word of the year, few of us could predict what we have witnessed in the smartphone business landscape. And similarly, as changing marketplace dynamics shape the financial services business of the future, within 5 years there will be some household names that disappear and others not yet launched that will quickly emerge as market leaders.
In my current role as an industry consultant, I'm fascinated by the divergent points of view held by leaders of the various industry business models. I'm reminded of the quote "There are three types of people in this world; Those who make things happen, those who watch things happen and those who wonder what happened" Apple made things happen and Blackberry is still wondering what happened. From my unique perspective, here are some moves I think industry leadership in the camp of making things happen should consider:
Change compensation models
I mentioned above my belief that compensation drives all behavior. The structure of current compensation models are largely inconsistent with the direction of the business. And this includes fee only models. The drift away from commissions and towards fees over the past decade is not a fad. It is estimated that by year end, up to 75% of all industry compensation will have been generated by fees driven largely by the wires and regionals rapid transition away from commissions. And since fees for AUM have been on the increase, the activity of providing financial planning has been on the decrease. Why? When you’re getting paid to capture more AUM, why do the hard labor intensive work of financial planning. But this is changing. As even traditional insurance agents have been evolving towards a fee for AUM model and robo’s gain traction, investment management has become a very crowded marketplace with little differentiation. Not surprisingly, financial planning is seen as a key differentiator. What I expect to see happen will be more firms starting or restarting their financial planning activity (modular and comprehensive) and charging separately for it on a retainer basis while they reduce their % fee for AUM from about 1% to about 50-75bps. This split of investment management and financial planning from bundled to being separate services better recognizes and aligns the activity. Additionally, as there will be a need to diversify revenue models, I believe those who have been marketing themselves as “fee only” will come to realize that advertising one’s compensation model is hardly good for business, not to mention overlooking the huge revenue potential in offering insurance based products. Met Life recently launched a life insurance product that pays 75bps on assets in the policy with a very slight and quickly disappearing surrender charge. This opens a whole new asset class for advisors to add to their practice while truly acting in their clients’ best interest by addressing risk management. I expect other insurers to follow suit as traditional methods of distributing life insurance are on the decline and no longer sufficient for their growth.
2. Integrate platforms
Similar to the merging of compensation models, expect to see the same with business models formerly hatched in their regulatory silo of SEC RIA, FINRA broker and state regulated insurance agent. Whether the regulators/government wise up and eliminate triplicate layers of regulation and harmonize or not (and I have little faith that they will), the business models will harmonize more as a business necessity than a regulatory requirement. Any model that relies solely on commission revenues for sustenance has its days numbered. And the career distribution companies, the majority being tied to a life insurance manufacturer, whose economic reason for being is to distribute commission based proprietary product are in the cross-hairs of this developing movement. I believe the landscape will begin to look like the technology platforms where the largest in the business (i.e. Samsung and Apple) have integrated smartphones, tablets and PC’s/Mac’s each seamlessly talking to each other. Except for our business it’s not integrated devices, but integrated business models of RIA, B/D and Insurance BGA, or what I call the “Tribrid”. And I wouldn’t count out the wires just yet. They have such size and scale that if they made some adjustments, they could easily become a model of choice for a new harmonized marketplace while solo RIA practitioners scream “But I’m fee only!” all the way to irrelevance.
3. Diversify revenue sources
It is now recognized that the robo-advisor is redefining the value and pricing of investment management. This will continue to force margin compression on firms/practices that rely on the AUM only model of revenues. It places a higher value on those products and services that are more complex and require a human advisor to implement. For RIA’s and Independent B/D’s, this will likely be additional fees for financial planning (not just investment management) and insurance products and services. Similarly, insurance based platforms will continue to see a trend towards levelized and lower front end commissions, and will need to diversify into fees for AUM and financial planning as well.
4. Embrace technology as an enabler versus a threat
I find it interesting that the financial media is so locked on the thought that robo-advisors will replace the human advisor. I suppose it makes for a good story, but it’s simply not true. However, the robo’s will expose those who do not use new technology to enhance the client experience and they will also drive down the going rate for investment management. As more and more robo technology platforms come to market, we’ll see them getting snapped up by the large scaled platforms as we’ve seen recently since they have created smart platforms, but lack the client acquisition skills to remain as stand alone entities. They are not a threat unless you don't integrate them into your practice and business model.
5. Create a career path for “newbies”
The demographics in the business are quickly going from bad to disastrous. The average age for advisors is over 50 with a full 1/3rd expecting to retire in the next decade (according to Cerulli). The insurance industry is worse with the average age at 59 and 1/4th expected to retire by the end of 2018 (according to McKinsey). Heretofore, the primary source for “newbies” (young inexperienced entering the business) has been the career life insurance companies and wires. However, as the economics for proprietary based platforms continue to get squeezed (or potentially eliminated), that source of new blood will soon dry up. This places the responsibility for the future of the business back onto the independent platforms of which none has been successful in executing on a strategy. LPL made an attempt with NestWise a few years back but it failed miserably in execution running it as a stand-alone rather than integrating it with the greater whole. But I have a strategy in mind that solves two big industry challenges. Cerulli did a study on financial planning and found that of those firms that self-identify as members of a financial planning practice, only 38% were actually doing financial planning. Further, the number of those who do actual financial planning has been on the decrease in recent years as they’ve been focused on asset accumulation (AUM) instead. Coaxing established advisors back into financial planning is a tough sale since it’s labor intense and not as profitable as a focused AUM practice. But guess who will do financial planning?…newbies. Recruiting, inducting, training and developing young inexperienced talent into a financial planning career track is proven to be the most successful way to get them into the business. The solution to the financial planning and succession planning challenges facing the industry lies in a strategy giving a career track for “newbies”.
6. Enable modular and comprehensive financial planning at the enterprise level
As mentioned above, financial planning has been on the decline while the greatest need to provide value added services going forward is in fact…financial planning. Many who have strayed away from offering planning services cite the complexity, time commitment and relative ease in focusing on asset accumulation for more revenues instead. But today's tools for financial planning make it far easier to provide the service than just a few years ago. I’ve written before about having built a $30 mill centralized financial planning center for AXA Advisors about 15 years ago. That was painful. Today, the same service can be built for a fraction of the cost providing a virtual paraplanner to each team of advisors. Michael Kitces wrote about the concept of a Turnkey Financial Planning Program (TFPP) in his blog. Providing this service on an enterprise level will be an important value added service for advisors going into the future.
7. Favor ensemble firms over solo practitioners
For generations, the retail distribution firms had a focus on the solo practitioner with individual rep codes. Today, the ensemble team is taking hold yet many B/D’s/RIA’s/Ins platforms continue to identify on individual rep codes rather than aggregating as a team. And naturally as ensemble firms continue to increase their influence, it forces business models to integrate all product lines and services (hence the Tribrid) in order to serve the various roles and specialties of team members.
"We live in a time of paradox, contradiction, opportunity and above all, change. To the fearful, change is threatening because they worry that things may get worse. To the hopeful, change is encouraging because they feel things may get better. To those who have confidence in themselves, change is a stimulus because they believe one person can make a difference and influence what goes on around them. These people are the doers and motivators" -Buck Rogers
Holding onto the familiar is a natural response to the rapid change impacting our industry. But as Socrates is quoted, “The secret of change is to focus all of your energy, not on fighting the old, but on building the new”. Blackberry grew up as a force in a closed system. It’s what gained them rapid growth but at the same time, sticking to it is what has caused their downfall. I think our business is much the same. Financial Services retail distribution grew up on closed platforms (siloes) of RIA, B/D and Insurance BGA. But much like Blackberry, sticking to these soon to be dated platforms could lead to their demise. The future of the business is through the integration of platforms, compensation models and product and service offerings. It will be interesting to see which firms have the foresight to remain relevant into the future and which will fight change to the death.