If you think it’s tough to run a financial planning practice, think about what it’s like to run an AFSL. Licensees face low profits and even less sleep.
Who would buy an AFSL?
LIF starts on 1 January 2018, so the buyer’s commission income falls straight away, by perhaps as much as 40 per cent, depending on the mix between initial and renewal commissions. There is no real way to replace this income other than directly or indirectly increasing adviser or client fees. Good luck there.
New training and education requirements intended to thin out adviser numbers kick in over the five years between 1 January 2019 to 1 January 2024. Watch AFSL income fall as adviser numbers fall. It could be as high as 30 per cent, with replacements deterred by high barriers to entry (i.e. a three-year degree and a professional year).
ASIC is introducing a new supervisory cost recovery fee of perhaps as much as $1,500 per year per adviser. For Dover it’s another $600,000 of annual costs that obviously cannot be passed on to advisers. Pop that one into your valuation model.
Watch this space for significant minimum capital requirements. These are needed to properly comply with ASIC’s rules on adequacy of compensation arrangements.
Professional indemnity insurance premiums are steep, and getting steeper every year. There is no respite. Some say they are $6,500 per adviser per year. But watch what happens if the AFSL make a claim: it will be knocked back or, worse, its next renewal application will be declined or the premiums increased beyond belief. And there is no run off cover. If the insurer decides to not renew the policy the AFSL is from that day on un-insured and possibly un-insurable, and with an unknown future potential claims liability and no realistic statute of limitation.
The naive AFSL buyer can be hung tomorrow for a crime committed by someone else 10 years ago. Imagine being statutorily responsible for advice you have not reviewed provided by an adviser you do not know to a client you never met, for evermore. That’s the liability the AFSL buyer takes on.
The single external dispute resolution service (EDR) is another reason to lose sleep. EDR fees will rise, as will the claims threshold and the EDR’s willingness to find for the client against the AFSL.
The single EDR can ignore the law, cherry-pick the facts and forget about its previous determinations. It can do whatever it wants, and is accountable to no-one. There is nothing the AFSL can do about it. It's defenceless. Young staff with no financial planning experience or qualifications determine damages of hundreds of thousands of dollars against AFSLs. Even the most obvious technical error cannot be corrected: the AFSL cannot appeal. The AFSL is contractually bound to accept the determination, no matter how unfair it is.
The client, of course, can appeal.
AFSL profits are not high. I know small medical practices making more profit than the best AFSLs. Medical practice profits are stable, predictable and virtually guaranteed by the government. AFSL profits are not: one complaint cluster; one thieving adviser; one error of judgement and the AFSL’s annual profit is wiped out, or worse.
The average AFSL balance sheet is an interesting mix of hope and luck. On the assets side there is a strange beast called “intangibles”. On the liabilities side the real liability is usually not there: the latent liability euphemistically called “provision for claims not yet reported”. Every AFSL has some. The future dollar cost of claims against advisers not yet known to the AFSL.
Some are bigger than others.
Does the real balance sheet balance? Or are real liabilities 10 times real assets? Time alone tells.
Borrowing to buy goodwill is dangerous. AFSLs are no exception. Is the goodwill real? Can the debt-burdened AFSL pay the buyer’s interest and principal repayments? Plus pay the buyer’s target ROI? Let’s not pretend there will be no new sales KPIs. Spare me. There will be big increases in the sales KPIs. The buyer has to say something positive quick. Its share price depends on it. The first six months have to be great.
Who will buy that AFSL down the track? What is the exit strategy? The potential purchaser pool is shallow, and one must look hard at any purchaser’s balance sheet or it could be out of frying-pan and into the fire. Under-funded aspirant purchasers are a dime a dozen. Properly funded ones are fewer and further between. AFSL owners must have a good track record: a solvent balance sheet, a long and stable profit history, a strong operating cash flow, an AFSL experienced management, a compliance orientated mind-set and, above all else, a sound moral compass.
Running an efficient and effective AFSL, as section 912A requires, is not about maximising profits. It is about making sure clients get good advice, that is in their best interests, appropriate to their circumstances and prioritises the client over the AFSL. And the AFSL’s owners for that matter.
What of the AFSL’s non-owner stakeholders? The AFSL’s loyal staff? The AFSL’s loyal advisers? How do they feel reading the press release for the sale of their AFSL? They don’t get that cheque, but they do get that new performance KPI. New product directions and new volume quotas will be the order of their day. The vendors’ sale price depends on it.
What sort of management decisions are made under this sort of financial pressure? How do these decisions square with the best interests duty? The appropriateness of advice rule? The obligation to prioritise the client’s interests?
What does an adviser do if the AFSL’s buyer says recommend this product, at this price, in these volumes, no matter what is best for the client?
How can the AFSL hit the new big sales KPI next year if it did not hit it last year?
How does the philosophically-non-aligned-non-institutionally-influenced-adviser respond to these conflicted product expectations? Remember, it is the philosophically-non-aligned-non-institutionally-influenced-adviser who is banned for life and loses everything when something goes wrong. The AFSL just gets bad press. The AFSL buyer, the faceless owners, walk away scot-free.
That’s the way its set up. The advisers take the rap. They don’t sign the sale contract but they pay the price.
Be demanding of who buys your AFSL. Not everyone is up to it.
Terry McMaster is the managing director of Dover Financial Advisers
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