It ain’t over yet. Round 6 of the Financial Services Royal Commission, set for September, is going to focus on insurance. An investment in the Forager Australian Shares Fund, Freedom Insurance (FIG), has been called to appear. The revelations are likely to be ugly.

But we don’t need round 6 to tell us something needs to change. We have already seen enough—this is an industry rife with conflicts of interest and woeful consumer outcomes.

The question now is how to fix it? As the year draws to an end, that’s the question to which Commissioner Kenneth Hayne will be turning his mind. And it’s one I haven’t seen many sensible answers to.

There are two key problems from where I sit.

Why aren’t people in jail?

Firstly, why haven’t these companies and the people behind them been punished for breaking the law?

I attended a compliance course recently that went right back to basics. As an AFSL holder, your obligations are pretty clear. This is Part 1 of Section 912A of the Corporations Act:

(1)  A financial services licensee must:

(a)  do all things necessary to ensure that the financial services covered by the licence are provided efficiently, honestly and fairly;

Efficiently, honestly and fairly. How does any of what we have seen meet that criteria? And this is not some regulatory guide or compliance statement. It is the law.

The natural reaction to what we have seen is going to be more regulation and red tape, but I can’t see what is wrong with the law that currently exists. I can tell you from personal experience that smothering the industry in expensive compliance obligations only entrenches the large established participants.

We need stricter penalties. And an ability or willingness to enforce the law. Extreme behaviour needs to be criminal. What is the point of fining the company or their insurers if the executives responsible get to retire with their bonuses?

The default needs to change

The second big issue is that the customers of these financial institutions are letting them get away with it. Here is a table from AMP’s half year results showing their market share in various parts of our asset management industry:

AMP’s market share in retail superannuation fell 0.4 of one percent on a year ago. You couldn’t script a worse quarter of public relations, and the company loses less than half a percent of market share. In fact, if you go into the details, the company matched its outflows with inflows.

It is tempting to think that people don’t care. There is certainly a part of the population — frustratingly for me — that see their super as too far into the future and don’t give it any attention. But the public outrage to the Royal Commission suggests the problem is far more nuanced than that. A lot of people do care. But they still don’t do anything about it.

One reason is that what to do with your savings is a big and difficult decision. And the more difficult a decision, the more likely we are to stay with the status quo.

Psychologist Dan Ariely talks about this using organ donation rates as an example. Trying to explain the high level of variability of organ donation rates between similar countries, researchers discovered that the main cause of difference was whether people were asked to opt in or opt out:

“It turns out that it is the design of the form … In countries where the form is set as “opt-in” (check this box if you want to participate in the organ donation program) people do not check the box and as a consequence they do not become a part of the program. In countries where the form is set as “opt-out” (check this box if you don’t want to participate in the organ donation program) people also do not check the box and are automatically enrolled in the program. In both cases large proportions of people simply adopt the default option.

You might think that people do this because they don’t care. That the decision about donating their organs is so trivial that they can’t be bothered to lift up the pencil and check the box. But in fact the opposite is true. This is a hard emotional decision about what will happen to our bodies after we die and what effect it will have on our those close to us. It is because of the difficulty and the emotionality of these decisions that they just don’t know what to do so they adopt the default option (by the way this also happens to physicians making medical decisions, and also to people making investment and retirement decisions).”

Sound familiar? Faced with a complicated decision, people choose the default. And that is something Australia’s financial institutions have made billions of dollars out of.

If I were to make one change to the system it would be to make the default choice one that is good for consumers. If you want to do some research, tick a box and go with a different option, that is completely up to you. And if you lose your money or get bad advice, then tough. Most of this cohort are pretty good at looking after themselves.

But if you do nothing, it should not be possible for you to end up with AMP. I know MySuper is a step in this direction. But I would take a significant step further. Australia has a well run sovereign wealth fund, the Future Fund. Why not make it the default manager for Australians’ superannuation?

Beware the unintended consequences

Sadly, I can’t say much of what I have heard at the Royal Commission has surprised me. I have worked in the industry for 20 years and built a business on the back of the small percentage of the population who worked out what was going on long ago. But that’s precisely why this Royal Commission needed to happen. Much of the behaviour had become culturally ingrained. And it wasn’t going to change without a public inquisition.

But now we enter the risky phase. History is littered with unintended consequences of well meaning responses to public outrage. Getting the response right is going to be the most difficult step.

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Oliver Cay

So what are Forager doing with their shareholding in FIG? If the revaluations are ugly, it would be hypocritical to continue to hold the shares and criticise the consumer.

Mike Brown

Jail for the directors will stop bad culture, incentives and behaviour. Also, they should never be allowed to act as a director again. This threat - if real - would fix things quickly. The directors are supposed to make sure the company is acting properly. If they don't do this, then they are either corrupt or incompetent. Either way, they should not be directors. Companies should not be fined. The shareholders should not be punished for the misdeeds of the people in public companies. These people should not be allowed to hide. The shareholders cannot know what is being done, especially if the directors are hiding it. Punish the perpetrators, not the innocent bystanders. Some people may claim that they had to defraud customers to keep their jobs. This is no excuse for breaking the law. It just makes them professional thieves, without a working moral compass. Financial advisers who gave advice that put their own interests ahead of their clients are either corrupt or incompetent. Either way, they have committed fraud. Jail them if corrupt, and don't let any of them give financial advice ever again. The advice obviously hasn't been really good anyway. Everyone who has done the wrong thing should be punished. Name them and shame them so that their friends, families and communities know what type of people they are. Remember: they wouldn't have hesitated to defraud or steal from members of your family to benefit themselves.

Justin Baiocchi

"Australia has a well run sovereign wealth fund, the Future Fund. Why not make it the default manager for Australians’ superannuation?" This has been discussed at length and is no solution to the problem. The FF is not set up to be a superannuation fund. It doesn't have the administrative capacity to manage millions of customers with millions of accounts and constant withdrawals and contributions. Also, if somebody points out how great the returns are, well, show me another investor that has $100 billion to invest with no liquidity restrictions and need not provide for withdrawals until a date ten years in the future. It's simply not realistic.

jack Upton

The core of the problem as I see it is the pathetic attitude of the funds who keep voting their large holdings for the directors' remuneration every year. The directors then encourage the sort of activity that is happening so that next year's profit is larger - and the directors are then voted even larger remuneration. V-I-C-I-O-U-S circles in the extreme. And then, of course, is the lazy attitude of the financial policemen - close your eyes and it will go away.

Andrew Peters

The problem goes back to the FOFA rules which were meant to make everything transparent and increase advice. But of course what we got was a disclosure mess, grandfathering, Fee Disclosure Statements, that don't need to count commissions or grandfathered income ......or any insurance commissions. Quite simply , if the legislators had made it mandatory for all Financial Institutions to print on the top right of your annual statement : - who your adviser and Licencee is - what they or the licencee receive as direct and indirect fees -any links of ownership between the insto and the product The at least the consumer would know exactly what the effect on them was - what we have today is a mess Time to start again

Steve Johnson

Hi @Justin. Outsourcing the administration is straight forward. Link already performs that role for most of the industry funds.

Aart Hofman

This country needs to copy the Singapore Central Provident Fund model. This would eliminate all the shonks and shysters and we'd be blessed with an honest and fair to all system. If anyone thinks this Royal Commission will clear out the rot, think again! There'll be a flurry of activity for a while and the whole lot will gather again and revert to type. Vested interests will see to that. Aart Hofman

William Hanna

While your example of AMP implies that little has changed in superannuation capital allocation, it has already been shown that $1B in both July and August this year has seen money flow out of retail-superannuation funds to industry-superannuation funds such as AustralianSuper and Cbus. In this case, I don't think default bias should be given as much weight as you might apportion - rather, I think the general financial illiteracy of not knowing the difference between retail and industry super is far less appreciated as an explanation for the very slow movement to industry super.

Jason Smith

At the heart of the problem is conflicted remuneration structures. When the advice or service providers interests are in conflict with the clients, the advice/service providers interests will prevail and the client will lose out. It's human nature and the RC is highlighting it. As you say Steve, everyone in the financial services industry knows this is how it works and most have no desire to change a thing because its in their interests not to. Sadly, the problems are so structural and ingrained many within financial services can't even see the problem. "That's how we do it. That's how its always been done." Eliminate the conflicted sources of income, such as commissions on all products/services (with no exceptions) and behaviour will change. Regulation is a band aid solutions that will not solve the problem. Penalties can have some impact but won't stop you being ripped off legally and plenty of that goes on.