Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with several big news stories, including the first court decision of the lawsuits against the DoL fiduciary rule (with the ruling against NAFA and entirely in favor of the fiduciary rule!), an announcement that Morningstar is cutting its benchmark fees to zero for investment managers who want to benchmark against them (in an effort to compete more broadly in the world of index benchmarking), and the decision of John Hancock to stop selling traditional long-term care insurance policies to consumers (despite being one of the three biggest companies providing coverage!).
From there, we have several practice management articles, including a glimpse at how broker-dealers are looking to change grid payout systems in 2017 to comply with the recent DoL fiduciary FAQ, the risk of advisory firms acquiring multiple local advisors where the firm gets the cash flow but doesn't truly 'own' the client relationships (a serious problem when the parent firm wants to sell in the future!), and how advisors are increasingly struggling to differentiate themselves in a changing environment (and what they need to do about it).
We also have a few more technical planning articles, including: a fresh look at the tax policy proposals from President-Elect Trump and Speaker Ryan, which provides a glimpse into the kind of tax reform legislation we could see in early 2017; a discussion of how, despite the popular view that we may all live to age 120 and beyond, life expectancy has actually been declining slightly since 2010; and a look at the newly announced Medicare Part B premiums (up just 4% for those eligible for Hold Harmless, but up 10% for higher income individuals who don't qualify!).
We wrap up with three interesting articles: the first is a reminder that differentiating on service is a challenging way to build an advisory firm, given that everyone has a different (and evolving) view of what "good service" even means, and why it's better to build around relationships instead; the second is a look at what's called the "Goal Gradient Hypothesis", and the idea that we tend to work harder on a goal as we approach its end point (which suggests that clients may be more motivated by a series of short-term goals than one giant long-term goal like "retirement"); and the last is a good reminder from Bob Veres that even if the fiduciary rule does see a setback under President Trump and the Republicans, that in the long run the financial planning profession can still emerge victorious by continuing the "ground war" of winning over consumers to the virtues of a fiduciary advisors, one client at a time.
And in honor of Veteran's Day, be certain to check out the video at the end celebrating the delivery of pro bono financial planning for the military (and how it's being supported by the Foundation for Financial Planning)!
Enjoy the "light" reading!
Weekend reading for November 12th/13th:
Federal Court Rejects NAFA Attempt To Kill DOL Fiduciary Rule (Bruce Kelly, Investment News) - Last week, the news broke that a judge has ruled in the first case against the Department of Labor's fiduciary rule (filed by NAFA, the National Association for Fixed Annuities), and the outcome was a resounding win for the DoL, as the court entirely refused NAFA's request to delay the rule and/or set aside some of the fiduciary requirements. Notably, NAFA has already indicated that it plans to appeal the ruling; nonetheless, the fact that Judge Moss' memorandum opinion did not find substance in any of NAFA's broad range of complaints against the fiduciary rule does not bode well for its appeal, or the other five lawsuits that are still outstanding against the DoL fiduciary rule. Of course, with this week's "surprise" presidential election victory for Donald Trump, giving the Republicans a clean sweep of the White House, Senate, and House of Representatives, questions have arisen as to whether the DoL fiduciary rule may simply be rolled back altogether; however, the reality is that rolling the rule back is actually more complex than just an executive order from President Trump at this point, and with more and more large firms stepping up to comply (including this week's announcement that JP Morgan Chase will also eliminate commissions in retirement accounts to become a level fee fiduciary, there may even be industry firms that previously opposed the fiduciary rule but would now call on the President to keep it in place (given the changes they've already made).
Morningstar Cuts Index Benchmarking Fees To Zero (Jeff Benjamin, Investment News) - In order for actively managed funds to benchmark themselves to an index, and market their results relative to that index, they must pay for access to the benchmark data in the first place, which can be a non-trivial cost for those funds that require more specialized benchmarks. To encourage adoption of their solutions, Morningstar announced this month a new Open Indexes Project, which will allow companies access to the Morningstar index benchmarks entirely for free... ostensibly in the hopes that more funds will begin benchmarking to a (relevant but free) Morningstar index (as currently 73% of U.S. mutual fund assets are benchmarked to an index from just one of three firms). Notably, the Open Indexes Project does not give away any licensing agreements to asset managers who want to create an index fund pegged to one of Morningstar's indexes – for that, providers must still pay a licensing fee. Nonetheless, the effort seems to be a clear attempt by Morningstar to raise the profile of its indexes as a competitor to other index benchmark providers like S&P and Russell, where additional competition could reduce prices for index fund providers and ultimately investors... albeit with the caveat that as more funds have a wider range of benchmarks to choose from, the risk increases that funds will selectively hunt for and choose benchmarks that simply happen to make their results look more favorable!
John Hancock Ceases Sales Of Traditional Long-Term-Care Insurance Policies (Greg Iacurci, Investment News) - Yesterday, John Hancock announced that it is leaving the individual long-term care insurance marketplace in 2017, and will no longer issue new policies after February (with applications due by December 2nd to make the issuance deadline). The shake-up is a major one, as John Hancock was one of the top three in market share for traditional long-term care insurance, but the company stated that the combination of stagnant consumer demand for traditional products (even after their recent launch of the experimental Performance LTC product), combined with distribution challenges and significant capital requirements, led to their decision to walk away. Notably, all in-force policies from John Hancock will continue to be serviced (with benefits paid), and the company will also continue to offer so-called "hybrid" or asset-based long-term care insurance products (using an accelerated benefit rider on top of a life insurance policy chassis). John Hancock's effective shift from traditional coverage to a hybrid policy isn't entirely surprising, as overall Americans purchased just 105,000 new stand-alone LTC policies in 2015, but purchased 220,000 hybrid policies; in other words, the marketplace already appears to be shifting, and John Hancock has simply decided to move along with it. Notably, this isn't the only recent shake-up in the LTC marketplace, as last month Genworth was purchased by China Oceanwide Holdings for $2.7B, with a promise to shore up Genworth's capital as the company continues to suffer from ongoing losses on its existing coverage.
Brokers Gird for Grid Changes Under Shadow of Fiduciary Rule (Jed Horowitz, AdvisorHub) - As the DoL fiduciary rule and its recent FAQ statements about how the "grid" payout system for brokers must be adjusted to limit inappropriate incentives, broker-dealers are still trying to decide how exactly to structure their grids for 2017. Some companies are looking at structuring grids based on 12-month performance (rather than monthly or quarterly adjustments) to at least eliminate intra-year sales incentives; others are looking at calculating payouts based on a rolling average of 6, 12, or even 24 months of production, to further reduce incentives to clear payout hurdle thresholds; and some are even looking at two-tiered payout systems that provide distinct grids for retirement versus regular accounts. Either way, grids that previously gave "retroactive" payouts for reaching thresholds will unquestionably be eliminated, as will grids that have "penalty boxes" that decrease payouts if recent production falls below certain levels. Ultimately, broker-dealers claim that they are trying to figure out how to restructure grid payouts that keep total compensation to brokers roughly the same overall, though clearly for any individual broker, there will be both winners and losers under the new fiduciary-compliant grid structures.
All Of The Liability And None Of The Value (Matt Brinker, Wealth Management) - While industry pundits have talked a great deal about the prospects of "roll-up" firms (mega RIAs that buy other RIAs to try to sell the larger whole for more than the sum of the parts), Brinker notes that the roll-up trend has been underway at a "smaller" scale amongst mid-sized firms as well. For example, he recently saw one firm that had $400M of AUM, but over the span of two years, bought four other smaller firms at $50M - $100M each, emerging at the other end with $800M of AUM (and $3M of personally guaranteed debt for all the acquisitions). The idea was that the larger $800M business would be worth more than in total thanks to economies of scale driving greater profits, but in reality it wasn't playing out that way. Because the advisor had simply "rolled up" the existing advisors and their firms, but left the advisors themselves in place to manage and service the clients, the real power and control remained with the acquired advisors... who, knowing they still had the real power in the relationship, stated that if the roll-up firm sold that they wanted retention deals to stick around with "their" clients! In other words, the acquiring advisor did get the client revenue and 'legal' title of the acquired businesses, but couldn't really harness the value of the acquisition, despite being on the hook for all the liability. The key point is that merely acquiring advisory firms, if they're not truly integrated into a central core, are really just a conglomeration of independent advisors, and in the end there's a real limit to how much value a parent company can exert (and how much value can be extracted) with independent advisors who still control their own client relationships!
Growing an Advisory Business in a Rapidly Changing Industry (Angie Herbers, Investment Advisor) - One of the notable trends that began to emerge in the 2014 industry benchmarking studies was that organic growth rates (i.e., growth from client referrals, center-of-influence referrals, etc.) were starting to slow. The response from most advisory firms was to re-double their efforts on marketing, and bring their message to even more prospects... only to find that the numbers just continued to fall in 2015, with profit margins starting to take a hit as well. Herbers suggests that this is an indicator that real change is underway in the advisory industry... and it's change that most firm owners are not correctly identifying and responding to. As a result, the popular 'solutions' aren't really solving the problem, from firms adopting a widening range of revenue and compensation models (which may just be confusing investors more than actually differentiating advisors), to independent firms that are getting so large they're finding economies of scale but struggling with new challenges and conflicts in the business, the changing regulatory standards (which may be a good thing in the long run, but in the near term may just be confusing prospects even more), and the introduction of various forms of "digital advice" (and while robo-advisors may not be attracting many clients, they do raise fresh questions in the minds of prospects about whether a human advisor will provide real value, either). In other words, the growing range of advisory choices for consumers may be confusing them and slowing their decision-making process, rather than attracting them to a wider range of potential solutions! So what's the solution? Herbers suggests that the key is focus; being the signal that cuts through the noise (at least for your particular target niche or clientele), allowing the first to "pitch" and differentiate itself to a specific clientele... and then once the pitch is perfected, teach everyone in the firm to say it, then teach your clients, and get the organic growth engine underway again, by growing more rapidly in a more focused way.
Your Taxes Are About to Change—Perhaps Not the Way You Think (Laura Saunders, Wall Street Journal) - With this week's Republican sweep of both the White House and Congress, it's increasingly looking like major tax reform is coming in 2017, given that President-Elect Trump has pledged tax reform efforts in his first 100 days, and there were actually post-inauguration tax changes for Presidents Reagan, Clinton, George W. Bush, and Obama in their first terms. While it's not entirely clear exactly what the details of tax reform will turn out to be, between GOP proposals through Speaker Paul Ryan, President-Elect Trump's own Proposals, and the 2014 proposals from House Ways and Means Chairman Dave Camp, some likely changes are fairly clear, including: consolidation of individual income tax rates into just 3 brackets (12%, 25%, and 33%) with the top rate kicking in at $225,000 of taxable income (for married couples); a significant increase in the standard deduction, reducing the relevance and impact of most deductions (except at very high levels of income and deductions), and further capping deductions (e.g., at $100,000 for individuals and $200,000 for couples) or just eliminating most of them altogether (perhaps just keeping mortgage interest and charitable deductions); keeping capital gains and qualified dividend rates in place (at the 0%, 15%, and 20% levels), but eliminating the 3.8% surtax on net investment income; eliminating the AMT (by simply wrapping most of its tax rate structure and limitations on deductions into the regular tax system); and potentially the total elimination of estate and gift taxes, with the possibility that it might be partially replaced by eliminating step-up in basis at death (at least for ultra-large estates).
U.S. Life Expectancy Now 6 Months Shorter (Ben Steverman, Financial Advisor) - After years and years of improving life expectancy, last year the numbers actually took a surprising downturn; while the average 65-year-old will live to age 86 (males) or 88 (females), those numbers are actually down six months from last year's actuarial studies, and the downshift in life expectancy appears to be happening for younger individuals as well (as the life expectancy of a 25-year-old woman fell from age 90 to 89 1/2 last year). The shift appears to be driven by a wide range of issues, from drug overdoses and alcohol poisoning, to suicide and liver disease, and is part of a life expectancy downturn that appears to have actually begun back in 2010. Of course, it's still possible (and expected by most actuaries) that future medical improvements will turn the improvements in life expectancy around again. Nonetheless, the point remains that even as a growing number of retirement planners and companies are suggesting that today's young people may live to 120 or 150 and beyond, the actual progress on life expectancy doesn't appear to be moving most people's lifespan beyond the typical age 80 or 90, and at best is just doing a better job of getting us to our typical maximum age.
Low Social Security Cost-Of-Living Adjustment Keeps Medicare Premiums Lower For Most (Christine Izdelis, Investment News) - This week, the Centers for Medicare and Medicaid Services announced that the standard monthly premium for Medicare Part B will rise 4% to $109/month, thanks in part to the "Hold Harmless" rules that limit Medicare Part B premiums from rising any more than the Social Security COLA amount. However, the Hold Harmless rules do not apply to those "higher income" individuals who are subject to the income-related monthly adjustment amount (IRMAA) surcharges, which kick in at an AGI of $85,000 for individuals (and $170,000 for married couples); for those people, and also those new to Medicare this year (roughly 30% of all those eligible for Medicare), the standard Medicare Part B monthly premium will rise 10% to $134/month. Of course, for those who are higher income, the IRMAA surcharge itself can add another $294.60/month, bringing total premiums as high as $428.60 per month for anyone receiving Medicare Part B! Notably, though, for those whose income is down significantly this year (2016) due to a material change in circumstances (e.g., retirement or another life-changing event), it is possible to apply for a reconsideration of the IRMAA rules using Form SSA-44, as the calculation by default will be based on the prior 2015 tax year.
Maybe Professionals Should Stop Selling "Service" (Tony Vidler) - At the most basic level, professionals sell their time (which is valuable because of their expert knowledge), and consumers pay to receive those expert services. Of course, the caveat is that no client knows what the service will be, until they've actually received it, and the challenge of trying to sell an 'invisible' intangible service is that we must make promises of good service up front. Yet Vidler points out that consumer expectations about the speed and quality of service are shifting so quickly, that now we risk overpromising on service expectations relative to what we can deliver (and what other industries provide), which means even if we do provide "good" service, clients whose even-higher expectations aren't met will still be unhappy and disappointed. And of course, unless you've defined what "great service" means in your business (e.g., with a Client Service Standard), there's an even-greater risk of a mismatch between your promised service and what clients expect in order to be satisfied. So what's the alternative? Vidler suggests that going forward, "service" is simply not a viable and sustainable differentiator for advisory firms, and that instead our business is really about relationships, and that is what we should be "selling". After all, "relationships are what gets held onto" and what drives retention. Notably, this doesn't simply mean trying to turn your financial planning fees into a "friendship fee", as clients realistically aren't going to pay that much just for a friend, but the key point is that it's the combination of professional and social relationships that create some of the stickiest and strongest client relationships.
Moving the Finish Line: The Goal Gradient Hypothesis (Shane Parrish, Farnam Street) - One of the interesting things observed in athletics is that when runners get to the "home stretch" of a race, even if they're already fatiguing or completely exhausted, they somehow manage to muster a newfound source of energy to accelerate into the finish. This phenomenon has been dubbed in the research as the "Goal Gradient Hypothesis" - the idea that as a goal gets nearer, we seem to increase our energy and focus to get to the finish line. And it's not just a matter of running races; the effect has been observed in everything from our tendency to accelerate coffee purchases as we progress towards earning a free coffee, to the fact that when we have shorter consecutive goals we can be encouraged to push towards goals repeatedly. The implications for both employees of financial planning firms, and the clients we work with, are profound. It suggests first and foremost that distant incentives and far-away rewards are really not nearly as motivating as near-term ones; in other words, a chance for a $1,000/month bonus is probably more motivating month after month than a $12,000 year-end bonus (even if the dollar amount is the same). And from the financial planning context, the idea that setting a series of small goals is better than a single large goal implies that just saving for retirement in the aggregate may not be nearly as effective as helping clients identify interim nearer-term goals they can try to achieve along the way.
Pushing The Wind Out Of Our Faces (Bob Veres, Inside Information) - With the Republican sweep of Congress and the White House, there are growing concerns that the DoL fiduciary rule will be unwound entirely in the first few months of 2017, or at least substantively "de-fanged" of its fiduciary enforcement potential. And the next President will get to appoint a new SEC chairperson as well... which, given historical Republican positions on the fiduciary standard, isn't likely to favor a stringent increase in professional standards for financial advisors. Which means one way or another, improving the professionalism of the financial planning world faces a severe setback in the coming years. Notwithstanding these likely setbacks, though, Veres notes that the reality is the advancement of a fiduciary standard for professionals is really more of a "ground war" than a pure regulatory battle; it's about winning over consumers, one at a time, to the virtues of a fiduciary advisor, until eventually is has already become the de facto standard anyway. Which means even if progress on a true fiduciary standard for all advisors is slowed in the near term, that simply means it's necessary for us as true professionals to continue to explain to consumers how to distinguish advisors from salespeople, and that even if the Department of Labor doesn't bind you to be a fiduciary, you can still bind yourself, and proudly proclaim it to all your clients and potential clients. That's how you play the long game for building a profession.
I hope you enjoy the reading! Please let me know what you think in the comments below, and if there are any articles you think I missed that I should highlight in a future column!
In the meantime, please check out this video below from the Foundation for Financial Planning, celebrating the pro bono financial planning for the military that the organization has supported in recent years! Be certain to check out the Foundation for Financial Planning website as well, to learn more about how the organization supports pro bono financial planning!