Insurtech: Ned Ryerson meets Silicon Valley

   

I’ve always been somewhat of a gadget guy. When 4K TV came out in an 85 inch screen, I had to have it. Got the solar panels on the house and a Tesla in the garage. And like many of you, I’ve got drawers full of old blackberrys, nokias and iphones as I’ve continually upgraded to the newest, fastest and shiniest gadget available. Juxtapose this to the industry I’ve been in for 30+ years, the insurance based retail financial services business. Of all the business models out there, it is arguably the least technology driven. While most other industries have gone Netflix, the insurance industry is still Blockbuster. The basic premise for this is that the products are sold and not bought. It’s a people business and technology will never replace the human touch. It’s the ultimate relationship business. All these premises are historically correct. It is a relationship business…but the relationship is changing. Ned Ryerson…meet Silicon Valley.

As some of you have noticed (Thanks for the congrat notes on Linkedin!), I recently joined a technology firm specializing in an industry sub-sect of Fintech known as Insurtech. Yup…traded in the pin striped suits for more casual attire and I’m developing new lingo like UX, UI and API.  Somewhat ironically, when the HBO series “Silicon Valley” first came out in 2014, I took a pass. It looked like something that would be of more interest to my 20 year old kids than a boomer like me. But recently at the office after hearing the team make multiple references to the show, my wife and I fired it up and plowed through 3 seasons in a matter of days. Very funny. When they quote Reid Hoffman as saying “If you are not embarrassed by the first version of your product, you’ve launched too late”, I can actually relate to it now.

In season 3, Silicon Valley introduces a new character into the show named Jack Barker. Given my perspective having been in the insurance industry and now the tech business, there seemed to me like a bit of symbolism in this. The character actor, Stephen Tobolowsky, who plays Jack Barker in Silicon Valley is the same actor who played the role of Ned Ryerson, the annoying insurance salesman in Groundhog Day twenty years prior. Check out the short video clips of these two scenes and you’ll see the similarities in the characters down to even holding the briefcase in the left hand. Ned Ryerson is often cited as the symbol of the obnoxious insurance salesman and of course Jack Barker is the symbol of a rich tech CEO. This got me thinking, is the insurance industry ready for technological change? Is it time for Ned Ryerson to become more like Jack Barker?

Obviously, I do believe it’s time for the insurance industry to digitize. Why? While it remains a relationship business, increasingly, the preferred customer relationship is going digital. But unlike most digital disruptors, I don’t think it’s going to bypass traditional distribution of the products and services. We see what is happening in the robo-advisor world where the cost of customer acquisition is financially bleeding the tech start-ups to the point where they are forced to sell out to traditional distribution platforms. While this is evidence that digital B2C is a risky financial services business model, it is increasingly more apparent that the traditional distribution platforms that integrate digital technology tools to enable their advisors will be far better positioned to thrive than those who stick with “the good ‘ol days”. Here are a couple trends and thoughts on why I see it this way (and why I’m bullish on Insurtech):

• InsurTech investment is growing faster than FinTech: FinTech ($5.4 Bill investments in Q-1 2016) is large but mature. Most Insurtech investment is going towards the Property & Casualty insurance segment and B2C models. Investment in the Life/Annuity segment is far behind creating a substantial white space opportunity
• The DoL is driving digital solutions: The U.S. DoL fiduciary rule impacts up to 60% of annuity sales and technology solutions are believed to be the predominant tool to comply. This will eventually bleed into other lines of business as it will be difficult to operate a distribution business model that is inconsistent across all product lines
• Insurers are partnering with digital firms:Technology is expected to replace up to 25% of insurance jobs (McKinsey). Life Insurance carriers and distributors do not have the depth of talent nor budgets to build digital platforms and are choosing instead to partner with digital technology firms
• Margins tighten/Scale matters: In a protracted low interest rate environment, the margins for insurance carriers are extremely tight. Overhead currently consumes up to 40% of premium revenues. This is forcing cost cutting efforts, industry consolidation and a desire to find lower costs methods of distribution using digital technology
• The “insurance is sold-not bought” prevailing belief is changing: Historically the industry has been a top down product push model. Shifting demographics and technology are moving that to a bottom up customer centric model. Digital technology is at the root of placing the customer first.
• Demographics are a driver: The vast majority of current sales come from the traditional agent channels. With an average age of 60, the agent/advisor channel is in decline and insurers need to find alternative lines and methods of distribution. Not surprisingly, the Independent Broker-Dealer model is growing sales of insurance products more quickly than the traditional independent agent channel.
• Aligning with trends: Millennials are now the generation in the majority and are driving the shift in consumer preferences to digital. The mobile phone is quickly becoming the main screen
• Augmentation Beats Automation: As revealed by the robo-advisor trending towards enabling rather than replacing the financial advisor, the same can be expected in the insurance industry as “Insurtech” matures
• We have "robo-advisors" but where is the "robo-agent"?: There are multiple digital offerings to manage assets but surprisingly few to protect them in the life/annuity space.  
• Digital has taken root with the customer:Cited by AM Best, 83% of consumers would use the internet to research life insurance before purchasing a policy if they had that option. One in four consumers said that given the option, they would prefer to research and purchase life insurance online. In addition, global mobile data traffic will increase nearly eightfold between 2015 and 2020.
• The current distribution model is not
  
  working: LIMRA estimated that life insurance sales would increase $9.5 trillion if the 48 million under-insured households bought the amount of life insurance coverage they said they needed. However, a quarter of under-insured households said they were not approached to buy life insurance.

 Insurance carriers and distribution platforms will need to decide whether to continue down the traditional path and hope for different outcomes (i.e. definition of insanity) or transform their approach to customers and products using digital technology. As the Ned Ryersons' of the business age out and go away, the industry needs to adopt digital technology not only to attract a new generation of insurance based advisors, but to meet the standard set by Amazon, Google and Tesla for a digital buying experience. As actor Stephen Tobolowsky has done, it's time for the industry to morph from Ned Ryerson into Jack Barker. There's an app for that!

“The best way to predict the future is to create it”

–Peter Drucker

Life Insurance 2.0 is coming

“Life insurance is a product that is sold and not bought”

This quote has been the mantra of the insurance industry for generations and somewhat an excuse for a lack of innovation. Life insurance is perhaps the most difficult financial product to sell and by far the most painful to buy. It’s also the reason that commissions are extremely rich while those who don’t specialize in it such as Independent Broker-Dealers and RIA’s often don’t even touch it. (so much for giving “Holistic Advice”!). But the financial services business is undergoing transformational change driven by new regulations, digitization of everything and huge demographic shifts.  And the life insurance industry is not exempt from these forces of change. Here are some influences shaping the life insurance business going into the future…kind of a “Life Insurance 2.0”

The purchasing process has to change

The life insurance buying experience is in the dark ages.  The buying experience for most every product is moving digital through social media that is real time and on the mobile phone.  Contrast that to the way life insurance is sold…think Groundhog Day . First, you have to find someone who needs coverage. Anyone want to talk about dying?…not an easy discussion to initiate. Then if you do find someone who will listen, the primary method for helping a prospect find the right coverage is by thumping multiple 20 page+ illustration’s on their desk complete with numbers they won’t understand and legalese they can’t comprehend. At this stage, perhaps after several meetings weeks apart, if they do trust your recommendation you have to fill out a very detailed multi-page application digging into some very personal and private information. Then comes the bleeding and peeing in a cup part scheduled whenever the paramedic can get to the client. Finally after requesting all their doctors information (APS) which can take months to secure, the underwriter mulls over all the information and if the history matches the underwriting guidelines, a policy is approved. It takes up to another month before the actual policy is issued and ready for delivery. All told, the buyer will have endured a 2-3 month process with very little communication along the way. Could we make this any more difficult? It’s the very opposite of how today’s buyer wants to transact…anti-social, the opposite of real time and totally paper driven.

Investment in InsurTech is hot

As noted below where you can see the huge growth in FinTech, the clear laggard is in the insurance industry known as “InsurTech”. But that is changing. While investment in FinTech is beginning to show signs of maturity, InsurTech is just getting started. A highly respected consulting firm in the space estimates that investment in P&C insurance technology lags banking (ie.FinTech) by up to 5 years and Life and Annuity lags by another 5 years. But with the increased investment and new technology players entering the space, that lag time will close. Tell someone you’re in the insurance business and nobody wants to talk to you. Tell them you’re in the InsurTech business and everyone wants to talk with you. Technology makes a relatively staid and boring industry a bit more exciting. The insurance industry is beginning to attract tech talent like never before which will drag the industry into the digital age, albeit kicking and screaming.

Mortality and underwriting meets bio-technology

At this year’s AALU meeting, one of the speakers was Dr. Craig Venter who runs the human genome project in my neck of the woods here in La Jolla, CA.  Dr. Venter has been instrumental in sequencing human DNA and like all things technology, the advances over the past couple years have been astounding.  Sequencing a human genome now costs just $1,345 compared with the $95 million it cost in 2001, according to the US National Human Genome Research Institute. In a few years, you could possibly get your complete DNA for a fraction of today’s cost. Having your DNA tested can give you tons of valuable information that can prevent a health catastrophe. Not only can it help prevent a life threatening disease, but it presents valuable information to an insurer. What if you knew that in 20 years you would have a high likelihood of getting Alzheimer’s disease?  There are measures you can take today to prevent that from happening if you knew it. The same with various cancers and other life threatening diseases. My son recently fought and won a battle with leukemia. If we had his DNA, it would have told us about the translocation of a particular gene that caused the cancer and we could have prevented it from happening in the first place. Armed with this information digitally, an insurance company no longer needs you to bleed and pee. They may no longer need to access volumes of medical information from your doctor. And having this information in advance helps the insurer get to “yes” faster rather than “no” longer. Underwriting for life insurance is about to be changed forever…for the better.

Digitization of everything

Blockbuster has given way to Netflix, K-Mart/Sears have yielded to Amazon and Tower Records was beaten down by iTunes. Everything is moving to digital and the insurance industry is not an exception. While the insurance industry has been slow to adopt new technology  there are signs that this is beginning to change. By using data integration, cloud technology and new digital formats, technology today allows insurers to digitize the purchasing experience without having to change their legacy systems (which will continue to be a drag on progress). Imagine a digital lead nurturing program that, through analytics, targets customers based on specific demographic information along with life events that trigger the needs for life insurance. Perhaps through Facebook or other social media, a client clicks on a message that seems personalized to them and their particular situation taking them to a landing page educating them on the features and benefits.(Side note: when you explain the features and benefits of permanent life insurance without first saying it’s life insurance, the product sounds amazing. Of course, compliance folks don’t let you do that...nor should they). Once the prospect has been educated online through various mediums such as video, storyboards or a Khan academy styled explanation, they then fill out some personal information online which begins to populate an illustration and application. If they chose to do so, they can talk to an agent or advisor unless they prefer to continue on their own (most will likely choose an agent/advisor). With the data input about name, age, face amount and premium, multiple illustrations can be simultaneously run and rendered on a simplified policy comparison chart (like above) with visual graphs viewable on any device of their choice (with the compliance approved illustrations attached via pdf should they want to review them). Once a product is selected, an electronic application is filled out and electronically signed, medical underwriting is streamlined by using online DNA information and a policy is issued almost immediately. Technology today can tackle the two most difficult things in the business which is finding a qualified prospect under a favorable circumstance and making the purchasing process less time consuming and confusing. 

Non-traditional channels will be compelled to address life insurance needs

The big story lately in financial media has been the margin compression in the wealth management space. The DoL and the advent of robo’s are moving the dial on that even quicker. With the AUM fees expected to be cut from today’s standard of 1% to about 25 basis points, and commissions fading away, RIA’s and Independent Broker-Dealers will need to find revenues from somewhere else. There is a general belief that fees for comprehensive financial planning (as opposed to investment management) is one place to go whether it’s a flat fee, hourly charge or baked into a higher % of AUM. But one of the tenets of financial planning if memory of my CFP training is correct, is life insurance. How can an advisor meet their fiduciary requisite and not address their client’s life insurance needs? I don’t think they can. But why don’t advisors address it today? …you guessed it…it’s freaking complicated! And it makes the advisor look stupid if they don’t have it mastered. But what if the process to address it is digitized and made seamless? That’s where I see the advisor stepping up and making life insurance part of their value proposition. At the same time, life carriers are actively looking for alternative lines of distribution since the traditional agent with an average age of over 60 is a dying breed. Look to see new forms of permanent life insurance priced for the advisory marketplace so the conflict of interest over commissions are taken away. And technology will enable the RIA and Independent Broker-Dealer to address the needs in a far more consumer friendly way.

Robo-advisor as a proxy for robo-insurance

Not surprisingly, the majority of FinTech investments early on went towards B2C direct models trying to disrupt the space through what we know as the "Robo-Advisor". Now that we’ve seen a couple of them crash and burn, there seems to be a reorientation towards using technology to enable rather than replace the advisor. In InsurTech, we’re likely going to see the same. The majority of InsurTech investment is currently going towards B2C models attempting to go around the current distribution channels following the theme of “disruption”. But following the FinTech trend, I think within a couple years just as we’ve seen the robo-advisor shift, we’ll see the same with InsurTech. Technology in insurance will reset from attempting to bypass the traditional channels to enabling them. (that is…until all the agents age out of the business!)

There is no other industry as ripe for a technology overhaul than the life insurance industry. Paper driven legacy systems have been like a ball and chain on technology progress. However, the dynamics impacting the industry are creating opportunities to change that. The painful process of finding a prospect and the multi-month purchasing process is on the cusp of changing through new technology. It will be the carrier or distribution firm who finds a way to change the buyer experience through new technology that will win in the future. However, as life firms have been in cost containment mode the past several years, the talent to create a digital platform is slim. I see carriers and distributors more likely to partner with InsurTech firms to create the future platform while using their current resources to keep the lights on with legacy systems. Imagine if we could flip the old quote around and say, "life insurance is a product that is bought and not sold" ...Life-Insurance 2.0 is almost here. 

"The secret of change is to focus all your energy not on fighting the old, but on buillding the new" -Socrates

Demographics and the Emergence of Robo-surance

 Ever since I entered the financial services business back in the 80’s, the Baby Boomer demographic has been the overwhelming driver of consumer behavior and how companies marketed their products and services. While it remains true that the majority of investable assets remain with the Boomer generation due to a lifetime of accumulation, what seems to be changing is their influence on purchasing behavior and decision making.  Why? After multiple decades of demographic dominance, it is estimated that as of last year, there were about 75.4 million Millennials, outnumbering the approximately 74.9 million Baby Boomers. The Boomer has been overtaken in sheer size for the first time in over six decades. Pew Research Article  

So far, 20% of Baby Boomers have retired. By 2020, it is estimated that 44% of boomers will have retired. While the Boomer is definitely where the assets are currently, guess who is going to inherit all that money in the coming decades? You guessed it…Millennials. And just as the size of the Boomer generation impacted how we marketed to them, Millennials are today shaping the business models for the future. To be successful for this segment, it comes down to one key word: Digitization. That’s why we’ve seen an explosion in FinTech investment for the financial services industry. It seems everything is going digital whether it’s going direct to the consumer over the web or enabling intermediaries to be more efficient and tech forward in marketing to the shifting demographic. As noted below where you can see the huge growth in FinTech, the clear laggard is in the insurance industry known as “InsureTech”. But that is changing. In this article titled  "The Insurance Tech Moment is Coming" , it states, “Insurance is the next FinTech” growing faster in the past couple years than FinTech itself, which includes the “Robo Advisor”. It appears that InsureTech lags the FinTech investment by about 2 years…but it's catching up.

Combine this phenomenon of industry digitization with all all the other drivers of change such as regulations (DoL today and likely the SEC soon), Advisor/Agent demographics on the decline and the demand for financial services products and advice on the increase, and you’ve got an atmosphere ripe for disruption. But not the kind of disruption where the robo will replace the advisor. As we in the business know, people do not make impulse purchases on complex products and services or as we often say, they're sold and not bought. That’s why we’ve seen multiple slick robo offerings struggle with gaining traction only to be bought out by well capitalized human advisor firms. But there will be some direct models that can replace the advisor/agent. Financial services and insurance products that are more straight forward and simple such as simple asset allocation, home/auto insurance, term insurance and health insurance will be easier to buy online in the future through B2C direct models. However, Comprehensive Financial Planning, Permanent Life Insurance and Annuities are more likely to be digitized through a financial professional rather than around them due to the complexities.

Not surprisingly, the majority of FinTech investments early on went towards B2C direct models trying to disrupt the space. Now that we’ve seen a couple of them crash and burn, we’re seeing a reorientation towards using technology to enable rather than replace the advisor. In InsureTech, we’re likely going to see the same. The majority of InsureTech investment is currently going towards B2C models but following the FinTech trend, I think within a couple years just as we’ve seen the robo-advisor shift, we’ll see the same with robo-surance. (Note: Insurance is so tech backward, there isn't even a "robo-advisor" like-kind term, so I made up "robo-surance")

Another emerging trend in insurance is the need to find alternative forms of distribution. With the average agent age at 60 and regulations causing manufacturers to drop their proprietary distribution models (as Met did recently), insurance carriers and BGA's have to find a way to open up sales to grow or else they’ll die a slow death. Coincidentally, the RIA and Independent B/D's are seeing their margins compressed like never before and similar to the insurers, need to find alternative lines of revenue or they'll also die a slow death. With the benefit of technology being able to simplify an otherwise complicated product and service (think Turbo-Tax), there are some technology companies entering the financial planning and insurance space to do the same. By taking a consumer focused approach which is leaning towards digital and reshaping the complexities of insurance products, not only will the traditional channels be more effective, but those who have typically referred this piece of business away such as RIA's may be inclined to keep it in house, particularly if the carriers reprice their products (from commission to asset based) which is the current trend. 

One company I've been advising in this space is Assurance. The firm is taking the Intuit Turbo-Tax technology and applying it to the complex life insurance business to format illustrations that not only help the financial professional comply with new regulations, but renders the proposals digitally in a graphic, easy to understand way, viewable on any device (computer, tablet, cell phone) rather than thump down multiple confusing 20 page illustrations on the desk. 

We are at the intersection of demographic change (Boomer to Millennial) and regulatory disruption where the natural solution is new technology. Just as it has been said that if you google yourself and nothing comes up, you really don't exist, likewise, if you are a financial services or insurance firm and don't have a digital consumer offering, the firm doesn't exist. It's time that the insurance industry play catch-up with a digital strategy. Assurance is one of a handful of firms that can show them how to do it. 

"A horse never runs so fast as when he has other horses to catch up and outpace"

-Ovid

Sun-Moon-Stars Align for Retail Financial Services Platforms

It’s not often that from a business perspective, the sun, moon and stars align to create both tremendous opportunity and incredible change. What we are witnessing now in the financial services business is that exact phenomenon. But in this business, it’s not the sun, moon and stars, but instead, shifting consumer preferences, technological advancements and regulatory change. The alignment of these key components is creating a game changing environment that will further delineate winners from losers while being unforgiving to those prone to maintaining the status quo. The release of the DoL rule last week was the final piece to fall into alignment setting everything in motion that had prior been somewhat paralyzed.  Now that we have some clarity, it’s finally time to press forward…game on! Here are some observations about this unique point in time…

Consumer preferences: It’s no mystery that everything is moving towards a digital platform for most anything we need and want. Whether it’s entertainment through Netflix, shopping with Amazon or updating features on the Tesla, it’s no longer an option to opt out of the digital revolution. Brick and mortar stalwart Nordstrom had 8% of their sales online in 2010. It is expected to soon be up to 30% and that’s a store most folks like to physically shop. What about the one’s that aren’t as consumer friendly?  I suppose now that my 83 year old mother prefers to shop through her Amazon Prime account, it’s a sure sign to me that the way folks prefer to purchase products and services is profoundly changing.

Technological advancements: It’s been said that if a customer googles your company or name and nothing comes up, you really don’t exist. In today’s world, particularly with the rising millennials, you now have to be seen on tablets and most importantly, smartphones. With the average age of a financial advisor at 55 and the insurance agent pushing 60, there is a strong tendency to do things the way we’ve always done them. When I started in the business we used to carry around “rate books” for insurance products. That gave way to computer illustrations. Now that we’re at the intersection of new technology and changing regulations, you no doubt will see the next evolution of ways to engage and communicate complex products to consumers through the device of their choice, not ours. In the future it is going to be benchmarking data analytics comparing product recommendations and disclosures through graphics seamlessly viewable on any device you prefer.  

Changing Regulations: If consumer preferences are the moon and technological advancements are the stars, then the sun (the big one!) is the seismic change in regulations taking place. There is much yet to digest about the 1,000+ page DoL rule, but whether it gets through or not, it is likely the catalyst to get long anticipated industry change moving. Some first impressions:

• The DoL was smart to acquiesce on some of the initial language. Yes, the insurance and B/D industry will continue to push back, but how can you argue against doing what is in your client’s best interests? It was a challenge for them to keep it from happening and now it has happened, it will be a greater challenge to stop it from moving forward.
• Sales illustrations have long been a tool used to recommend certain products. But in a best interest environment, that won’t be enough. It has been said that without the advent of new technology such as the robo-advisor, this rule would not be possible. Likewise, it’s going to require new technology to meet the DoL requirements. Benchmarking alternatives, providing the necessary disclosures and listing every potential conflict of interest goes way beyond the current illustration of today. Advisors/ Brokers/Agents are going to need a tool to demonstrate that they have met all the requirements of the best interest contract (BIC) to play in this space going forward.
• With the DoL “genie out of the bottle” , I don’t think there is any going back. Firms that choose to take a wait and see approach as many have done thus far will find themselves at a severe disadvantage whether the rule moves forward or not. While the large IBD’s such as LPL and the wires don’t like it, they’re not gambling on the rule being overturned and are already moving forward on plans and infrastructure to comply. And with a more “friendly” version of the rule having come out than previously thought, it is more likely that the SEC will fall in line for all non-retirement products as well.
• Just as the DoL pulled indexed annuities from the
  insurance exemption and under the BIC due to their complexity, I think a “harmonized” SEC best interests rule will pull in complex life insurance as well. If an indexed annuity and variable annuity are “complex” enough to be overseen by the DoL then it stands that Indexed Universal Life and Variable Universal Life will likely be pulled into the fiduciary complex.
• In that the DoL has essentially harmonized the regulations for a huge piece of business, it is natural that business models will follow suit. This lends to the Tribrid model of B/D, RIA and BGA under the same roof for ease of meeting regulatory requirements while reducing liability and risk.
• It is quite likely that insurance companies will reprice their life and annuity products not only to meet the “reasonable” compensation thresholds of the DoL but also to open up a new line of distribution through RIA’s. If distribution expenses are stripped out of the life/annuity products and they get repriced like an AUM model, RIA’s who routinely refer this line of business out may be inclined to keep it in house.
• It is estimated that the DoL covers up to 60% of investable assets. This is the first regulation that universally covers state insurance agents, FINRA brokers and SEC investment advisors cutting across the outdated and cumbersome product silos. It will materially change distribution business models to fall in line with the new regulations. Either business models comply or they impracticably decide not to play in this space from where up to 60% of their business is coming from. I don’t really think there is an option.

I started in this business during the 80’s and have witnessed the evolution through the years. But I have never seen such dramatic change that threatens the very existence of multiple business models as they are structured today. RIA’s and certain forward thinking broker-dealers have been working under a best interests scenario enabled with technology for some time and will only need to make a few adjustments to comply. But the insurance industry has been caught flat-footed on this one. Not only does this change the entire revenue model of high commissions, but the insurance industry has been notoriously slow to adopt new technology. We see a proliferation of robo-advisors, some going direct to the consumer and others enabling the advisor.  But where is robo-surance? I suspect that insurance industry executives are thinking long and hard about that right now. Fintech and the robo-advisor have been dominating industry headlines the past several years. The coming trend? Insuretech and robo-surance…stay tuned

"If you change the way you look at things, the things you look at change"

If A Tree Falls In The Forest, Will A Regulator Hear It?

    "If a tree falls in a forest and no one is around to hear it, does it make a sound?" …or put another way, if a client is ripped off by his/her advisor and a regulator does not know about it, was the client really harmed? After a career in the financial services business as an advisor, supervisor and senior executive, I can’t believe I’m about to stand up for the entity that has caused me so much frustration and consternation over the years; FINRA. You may have noticed quite a bit of industry media and opinion leaders piling on the study released last week titled "The Market for Adviser Misconduct" . The wide distribution of that study which concluded that 7% of “financial advisers” have records of misconduct and of that, 44% of those “advisers” are re-employed in the industry within a year, has prompted headlines like "beware of your financial advisor"  and  "It just got harder to trust financial advisers". As a former Pres/CEO of a 7,000 advisor B/D and more recently having launched an RIA and B/D from scratch through a start-up, I’ve seen the good, bad and ugly from regulation and a lack thereof. Yes, there are some bad actors in the B/D business and unfortunately they too often resurface only to continue their bad acting. Even 1% is a number too high. But to focus on the somewhat flawed study of 7% and 44% is very misleading. This not to mention the suspect timing of the release just weeks before the expected DoL proposal is to be made public. I won’t argue the numbers and methods they used to come to their conclusions. They may even be accurate. What is concerning though is the media spin on it.

After the study and resulting media coverage hit the streets, Elizabeth Warren came out in a Senate Banking subcommittee hearing criticizing FINRA for not doing its job. My initial impression was, Wow!...if she is all over FINRA who closely supervises their member firms, she must be clueless about how inept the SEC and state insurance departments are at policing their constituents. Here’s why I had that reaction:

Companies live in fear of FINRA: No matter what level of the business you’re in, if you’re registered, FINRA is ever-present.  If a tree falls in their woods, they will definitely hear it. No one individual is more important than the broker-dealer firm and any supervisor turning his/her head on misconduct will likely lose their career for “failure to supervise”. Any deviation from “company policy” is typically met with some form of discipline and is made as part of the broker/advisors record. This at times leads to some fairly minor infractions to be reported as misconduct as most B/D’s now exercise a zero tolerance policy.

Routine activities for RIA’s are often cited as misconduct for brokers:I’ve had to discipline (and report to FINRA) for actions that fall into the category of “Failure to comply with company policy”. An advisor was once preparing for an annual review and since the B/D at the time did not have a means to show a snapshot of all the client holdings, the advisor created his own Excel spreadsheet and showed the values. While it was accurate and did not misstate the holdings, the spreadsheet was found in the client file during a routine compliance review and the advisor was then terminated for “Failure to comply with company policy”.  Refer a client to an insurance agent who then sells your client a policy? In some circumstances that could get a registered rep fired for “selling away”. There are many routine activities in the SEC RIA world that would get one fired in the FINRA world.

Certain alleged misconduct, despite being inaccurate, is reported as misconduct anyway: An advisor in a smaller town had an arch rival at a competing firm who was targeting his clients. A tactic that the competing broker used was to write complaint letters for his prospects (the advisors clients) claiming misrepresentation so the firm would waive surrender charges and return the original investment even though there was no basis for it. Of course, each event was reported as a client complaint as required by FINRA. The weight of too many of these complaints forced the B/D to terminate the honest advisor since the risk of  remaining affiliated was too great despite the false nature of the complaints.

The majority of FINRA regulated brokers are also investment advisors: I find it interesting that the financial media and several in the fee-only community continue to run with the narrative that it’s the commission hungry broker allowed to sell bad products versus the fee only RIA who always acts in their clients best interests. It’s been widely reported that 88% of B/D registered reps are also registered as investment advisor representatives (part of the corporate RIA).  And the largest Indy B/D, LPL was reported to have 62% of their 2014 gross sales in advisory business and trending heavily towards going 100% to fees. This is happening at all B/D’s in the business. The narrative of RIA good guys versus broker bad guys is running thin and based on an era gone by.  

Registered insurance agents and brokers drop FINRA to escape supervision: I know many brokers and agents who dropped their FINRA registration to simplify their lives. Many of them are now born again fee only’s. While there are some advisors who have been fee only from the inception of their practice, most started out as brokers and simply could not deal with FINRA all up in their stuff. Some did it in a sincere interest to change their business model to be on the same side of the table as their clients. But as many did it to get out from under FINRA’s thumb.

FINRA members are dramatically shrinking while RIA ranks are the fastest growing. Just a few years ago, the number of B/D’s was around 5,500. This year that number will dip below 4,000 and the expected reduction will likely quicken after the DoL rule crushes the small IBD model.  One wonders, with FINRA being over-resourced inspecting brokers who are trending towards investment advisory and the SEC under-resourced…

The ease in opening an RIA versus a B/D is somewhat disconcerting:Starting any business from scratch is always a tough task, but launching a new B/D is flat out painful. Huge business plans, pro-formas, multiple interviews, background checks, names of potential brokers to submit and vet, setting up net capital requirements, clearing arrangements, etc.  It was an agonizing year of to and fro with FINRA to get approved. For the RIA it was pulling together an ADV, some various forms and filing in each state. A done deal after 2 months. It’s almost scary how easy it was to set up the RIA compared to the B/D. It’s equally scary how absent the SEC is in overseeing RIA business compared to FINRA.

 So, where’s the report on RIA’s? There is no way to do a study on non-FINRA registered RIA’s because the data does not exist. And even if there was a “BrokerCheck” database for RIA’s, it would be highly suspect since nobody is looking except on average an audit every 10 years. If a tree falls in the SEC forest, they most likely will not hear it!  This Investment News article states, “According to the SEC's annual report, 80% of exams by the SEC or self-regulatory organizations identify deficiencies; 35% find “significant deficiencies,” which might damage investors. But only 13% of those are referred to enforcement for action.” 35% have significant deficiencies? And that’s of the 9% RIA population they take the time to examine. Where's the media narrative on that? It’s no wonder why RIA’s staunchly oppose FINRA taking over the job!

 There is no question that there continues to be bad apples affiliated with B/D’s, RIA’s and state insurance departments just as there are bad doctors, lawyers and CPA’s.  While the popular study alleges that 7% of B/D brokers are bad apples, there are indications that the number in the non-FINRA regulated constituencies could be far greater simply because nobody is looking.  As a proponent for a harmonized fiduciary standard, I hope we are all required to act in our clients best interests. I also believe that the incentives for selling certain products in the form of excessive commissions, exotic trips, etc. need to be taken out of the system. But as I started this article, "If a tree falls in a forest and no one is around to hear it, does it make a sound?" I can’t see how you can argue that FINRA should not and cannot inspect RIA’s when the majority of FINRA brokers are essentially conducting much of their business in the same way. And after the DoL proposal gets implemented, the lines will blur even further. Of all the entities in our business that we have to be held accountable to whether it’s the SEC, DoL, state insurance departments and state securities departments, FINRA is the only one that is actually getting the job done (geez, I can’t believe I’m saying that!). It seems like a waste of time and resources to have so many duplicate regulatory entities each with their own set of rules and procedures overseeing what is essentially the same activity of giving personalized investment advice. Unfortunately, I don’t see that changing any time soon. But reading all the vitriol about FINRA is almost laughable. It’s masking the real problem in the lack of accountability and inspection by state insurance departments over their agents and the SEC over their RIA’s. And now we’ve got the DoL stepping in to make things even more complicated. Like in politics, the industry voices are loudest at the extremes while the more level headed are somewhere in the middle. Our business is harmonizing and it’s my belief that the regulators should do so as well. Stoking the narrative that brokers are uniformly ripping their clients off while RIA’s are pure is not helping solve the problem of overlapping regulations and regulators. We have too many regulatory forests and various definitions of what constitutes a tree falling much less hearing it fall. Will anyone write about that?

Who Moved My Cheese?...Is It Top Down or Bottom Up?

I’ve been a follower of Ken Blanchard and Spencer Johnson's books and teachings since the One Minute Manager came out in 1982 (hard to believe it’s that old!). They always have a common sense message for the business community told through stories. With all that is going on in retail financial services, it has caused me to re-look another of their popular books “Who Moved My Cheese”. You may recall it was about change in one's work and life and four reactions (fear, shock, anger and grief) to those changes by two mice and two "little people," during their hunt for cheese. They live in a maze, a representation of one's environment, and look for cheese, representative of happiness and success. One day they went to the spot in the maze that always had cheese and it was gone (hence the title “Who moved my Cheese”). One of them went on to look for cheese elsewhere while the other, with fear of the unknown, does nothing. The brave one, hoping his friend would change his mind and go out to look for new cheese, left a trail of writings on the walls of the maze (ie “Handwriting on the wall”).  The writings are meant to be lessons:

• Change Happens
  • They Keep Moving The Cheese
• Anticipate Change
  • Get Ready For The Cheese To Move
• Monitor Change
  • Smell The Cheese Often So You Know When It Is Getting Old
• Adapt To Change Quickly
  • The Quicker You Let Go Of Old Cheese, The Sooner You Can Enjoy New Cheese
• Change
  • Move With The Cheese
• Enjoy Change!
  • Savor The Adventure And Enjoy The Taste Of New Cheese!
• Be Ready To Change Quickly And Enjoy It Again
  • They Keep Moving The Cheese.

 Given what we are witnessing today in the financial services business I honestly believe this is our “Who Moved My Cheese” moment. It is becoming eminently more clear that we’re about to see a dramatic shift in business models and their source of revenues. I’m not talking about an evolution over a period of years, but swift “turn on its head” kind of change happening as you read this. For the longest time, financial services has prospered under a product driven top down model. Financial product manufacturers made products and priced them with a “Gross Dealer Concession” or “distribution allowance” pushed down through B-D’s or agencies to sell them. The GDC/Dist. Allowance was ultimately paid for by the client in the form of commissions and/or surrender charges. But this is quickly changing from product driven top down to a market driven bottom-up model. Rather than the flow of money starting at the product manufacturer level in the form of GDC moving down the chain, it now is shifting to begin at the client level in the form of fees moving up the chain. The cheese has moved!  If/when the DOL proposal becomes the law of the land, it quickens this shift from top-down to bottom-up. And what does this mean for the traditional distribution platforms of independent and insurance based broker-dealers? It flips the value proposition on its head. Rather than the B/D or distribution entity holding the purse strings dictating the terms of the advisor relationship (What have you done for me lately?) it shifts the power to the client and advisor (This is what we need from you to support our clients). The vast majority of distribution platforms are either unwilling or unable to make changes to survive, setting up what I believe will be a business version of musical chairs as it morphs and consolidates.

“Sometimes, Hem, things change and they are never the same again. This looks like one of those times. That’s life! Life moves on. And so should we.” ― Spencer Johnson, M.D.

We’ve seen a number of companies anticipating change and adapting to it following the “handwriting on the wall” lessons above. They’re primarily product manufacturers coming to the realization that owning distribution is no longer a viable model without substantial structural changes and investment. That was true with AIG selling off their Advisor Group Indy B/D and more recently with Met unloading their career life insurance agency force they’ve held for about 150 years. And Met practically gave it away for $300 mill while saving $250 mill per year by doing so. Can you say “hot potato?” What did Met and AIG see? The current top down model is fractured and neither was willing to make the structural change and investment to fix it. And they won’t be the last to punt.

So, does this all mean that the entire business is transitioning towards the RIA business model and we can all dump our B/D? Wow, you mean we won’t have to be supervised by the terms of FINRA and be subject to their harsh discipline? Not so fast. I think the business model of the future looks more like a law firm where the focus is on client billings driven by partners in various disciplines of financial planning. But I don’t think FINRA goes away. They simply adjust to the new environment and supervise RIA’s as well by shifting resources from overseeing the shrinking universe of B/D models. Yes, FINRA’s cheese has been moved as well.

I think many business models are past the stage of fear and perhaps even shock. But too many are taking a wait and see attitude to the issue of making changes for future survival and that is deadly. Remember, the quicker you give up the old cheese, the sooner you can enjoy the new cheese. You can do this by selling out as did AIG and Met, or making changes and investments for future growth as are firms like United Capital and Dynasty Financial. They have realized that the cheese has moved from top down to bottoms up. It will be interesting to see how advisors, brokers and the various business models face this existential crisis. 

“He knew sometimes some fear can be good. When you are afraid things are going to get worse if you don't do something, it can prompt you into action. But it is not good when you are afraid that it keeps you from doing anything.” 

―Spencer Johnson M.D.