A New Advice and Distribution Paradigm in Financial Services

Increasing consumer legislation and new advice models, coupled with the entry of new digitally enabled propositions into the insurance market, will significantly affect the way pensions, insurance, and investment products are sold and managed in the future. In many ways, these trends are being driven by new technology, which is creating new possibilities – for example, smartphones and tablets are changing the way we access investment information and buy investments and insurance. Equally, new wealth management and automated advice platforms (so called “robo-advice” platforms) are providing greater access and choices for consumers in managing their investment and insurance needs.

Growing consumer regulations – such as the Retail Distribution Review (RDR) in the UK, multiple European initiatives including the Packaged Retail Investment Products (PRIPs), and the changes occurring in the US with the introduction of the Consumer Financial Protection Bureau (CFPB) and MiFID II – are driving increased professionalism and transparency on charges embedded in investments and insurance contracts. This is putting pressure on insurers in particular to reduce margins. New advice models and platforms are also transforming the way advice is provided to both the high net worth and mass market sectors.

The UK is indicative of what is happening in Europe in terms of consumer protection, though the Nordics are also very advanced in this area. Generally, consumer legislation has taken two distinct routes:

1. Consumer protection across the insurance and investment industries: For example, the RDR is looking to improve the professional standards of intermediaries (focusing on new qualification levels) and eliminating provider bias (with the banning of commission).

In the US, the CFPB is currently deciding whether it should help Americans manage retirement savings and regulate savings plans, particularly investment scams that target the retired and elderly. The Affordable Care Act, related to selling health plans directly to consumers, adopted the Employee Retirement Income Security Act-style regulatory model, requiring all plans to have standardized documents, such as a Summary Plan Document, but the marketplace was regulated by the individual insurance commissioners of every state, with some states having multiple regulators (California maintains both a Department of Insurance and a Department of Managed Care).

Individual Retirement Accounts (IRAs) directed to consumers are regulated by the type of custodian (the FDIC regulates bank custodians, the IRS regulates non-bank custodians). Annuities, life insurance, and disability insurance purchased directly by consumers are regulated by individual state insurance commissioners.

2. Greater freedom/choice: In April 2015, the UK government’s “Pensions Freedom” legislation introduced pension flexibility, with people having the option to take their entire direct contribution pension benefits as cash (subject to taxation), and the abolition of compulsory annuity purchase. There has been significant market commentary on the “advice gap” for those people who do not want to pay advice but are likely to require guidance in relation to the options available to them. The government has looked to plug this gap by offering free guidance through its Pension-Wise Portal; however, the array of options and complexity of client requirements signify there is a major opportunity for direct-to-consumer technology solutions (D2C).

Then, there is MiFID II, which relates to investment activities under which advisors have to state whether their advice is independent or not. It also prohibits independent advisors from receiving or giving third-party fees, commissions, or other monetary benefits.

These regulatory pressures have led to lower margins, simpler products, a cap on initial charges, and potentially a cap on exit charges (which together would reduce the embedded value of existing business). Regulatory compliance is also challenging the business models of traditional financial providers, advisors and wealth managers. Profitability, too, is challenged by regulations like RDR. The pressure on existing business models and need for automation will continue to increase.

In recent years, we have seen the emergence of platforms, which look to automate the investment and financial advice processes for customers. Some of these operate on a D2C basis; others are dedicated to employers giving their employees online access to pension and investment information on so-called “retail” platforms. These platforms are offered by advisory firms such as Hargreaves Lansdowne, Nutmeg, and Money on Toast in the UK and Charles Schwab, Wealthfront, Vanguard, and RebalanceIRA in the US.

Earlier this year, Vanguard in the US introduced its Personal Advisor Services, which combines aspects of web-based advice and investment-modeling algorithms with traditional human contact. There is speculation that it is ready to be rolled out to clients in the UK. Schwab’s Intelligent Portfolios to retail investors and independent investment advisors will create portfolios of exchange-traded funds (ETFs) managed by Schwab and other providers. In foregoing management and transaction fees, Schwab intends the initiative to be "disruptive" to competitors. Most automated investment programs charge about 0.25 percent of the money that clients invest. Schwab clients can open robo-accounts with a minimum of $5,000. Investments are allocated by a sophisticated algorithm to around 20 asset classes, ranging from US stocks and bonds to commodities and emerging markets securities.

Equally, a number of insurers in the UK have also set up advice platforms – Standard Life, AON (who recently launched their Big Blue Retirement proposition), and Liverpool Victoria (who have taken a majority shareholding in Wealth Wizards, which powers its defined contribution and defined benefits workplace engagement propositions).

Figure 1 illustrates the basic advice process relating to insurance and investment products. Today, much of the process is manually oriented, based on questionnaires (with up to 200 questions) and expert advice. For wealthier segments of the market, human financial and investment advisors charging fees are still predominant. But some advisors use portal technology to give their clients easier access to wealth management information and portfolio modeling services.

Figure 1. Basic advice process for insurance and investment products)

Source: Moody's Analytics

Deloitte refers to a so called “advisory gap,” where only the wealthiest customers value face-to-face advice and are therefore more willing to pay professional fees. There has been a trend within the mass affluent market for consumers to look for do-it-yourself propositions, and D2C platforms such as Hargreaves Lansdown have continued to grow in both the number of clients and assets under management. However, due to the complexity of retirement decisions and mass market consumers’ resistance to paying professionals fees for advice, there is a significant opportunity for technology-enabled propositions.

Artificial intelligence is another area that could become a central component in the future of financial advice, wealth management, and related services. Financial providers, insurers, and related advisors are now beginning to use artificial intelligence, machine learning, cognitive computing, and evolutionary algorithms. In the banking industry, however, the use of algorithms is nothing new – algorithmic trading has already made a huge impact on the stock markets, and credit and risk scoring algorithms have been at the core of banking for some time now. As algorithms become more sophisticated, their potential applications are shifting from statistical analysis of historical data to a wide variety of potential applications, such as robo-advice.

Figure 2. Robo-advice replacing personal financial advisors

Source: Shutterstock

The United States, though, is probably the most advanced in the provision of what is termed robo-advice services. Robo-advice is already a two-year-old trend in the US, where market leader Wealthfront has attracted $1.8 billion without ever seeing or speaking to any of its customers.

The Wealthfront model relies on customers first entering basic information about their income, life stage, appetite for investment risk, and amount they have to invest, albeit through a much slicker interface than a typical electronic form.

Its engine then combs algorithmically through the 4,000-odd ETFs available in the US, allocating the customer’s money to a combination of products matching their profile. Wealthfront’s robo-advisor then periodically checks with the customers for changes in their situation, and automatically adjusts their portfolio accordingly – the engines can now even assign individual stocks. Organizations such as Charles Schwab, Wealthfront, and RebalanceIRA have developed platforms that provide clients with access to low-cost retirement solutions with financial education support and, in some instances, access to a telephone-based client manager.

The evidence from the US suggests that portfolios constructed automatically perform as well as those put together by human advisors, at a fraction of the cost. The Australian start-up closest to this “pure” robo-advice model is StockSpot. Recognizing the poor reputation of human financial planners in the wake of the Commonwealth Bank and Macquarie Bank scandals, StockSpot’s homepage makes much of the fact it is not incentivized to recommend any particular product. It will work with a customer who has as little as $2,000, and charges fees that would be impossible to sustain were a human involved in the process.

As an example of the growing demand for robo-advice, Yellow Brick Road’s new portal will include both general and life insurance products in its “robotic” financial modeling. The technology, called Guru, calculates clients’ financial needs and the actions they should take to meet them. It can also provide projections for five, 10, or 30 years into the future, assessing decisions made today and their impact on later life events. Guru generates a roadmap for each client, outlining his or her full financial situation.

It is perhaps, in the pensions arena that robo-advice can make the greatest impact. Pensions often involve complex legislation and choices, resulting in a wide range of options for consumers to consider. There is, therefore, a need for guidance and, in many cases, active advice. However, many of the people now taking out pensions are only investing small amounts of money and cannot afford human advice. Consequently, low-cost automated robo-advice for pensions is growing fast, and is already advanced in the US, the Nordics, and Australia.

Mutual fund companies, such as Fidelity and Vanguard, have gained a huge share of the investment dollars in 401(k) retirement plans in the US, and relatively recently they were allowed to offer some investment direction to plan participants. The creation of target-date retirement funds as a "safe harbor" made portfolio decisions easy for those who did not want to study the market and/or adjust (rebalance) portfolios along the way. Financial planners and mutual fund companies already offer individualized Monte Carlo modeling strategies for retirement withdrawals – but can that advice be applied broadly and robotically, or will it always need a personal touch?

Some experts predict that personal financial advisors will be replaced by robots in financial services and banking, and in this scenario the future is now! UBS predicts direct advice and simplified advice’s share of UK retail savings inflows will rise from 21% to 29% by 2025 – although it does not break out how much of this figure will be accounted for by roboadvice. Given that very few people have the time or inclination to tackle the challenge of investment planning on their own, robo-advice is becoming a buzz-word. It is scalable yet individualized – and it lowers the cost of advice so it can be made available to those who might otherwise be intimidated.

It is workplace pensions advice that will grow more sharply, according to banks’ forecasts: up from a current level of 19% to 31% by 2025. This equates to a compound annual growth rate of 10%, compared with 8% for the direct/automated advice space.

However, a recent Wells Fargo/Gallup Investor and Retirement Optimism Index survey found the following:

• Majority of clients still prefer traditional face-to-face financial advice when preparing for retirement or planning investments
• Around 44% preferred the traditional model of advice, compared with 20% who would seek out online alternatives.

“The [survey] shows that the great majority of investors feel they need expert advice to help them invest in the stock market, and the desire for professional input would likely be greater when advice needed for other types of financial matters (such as planning for retirement, college expenses and healthcare) is factored in,” said Gallup Poll senior editor Lydia Saad, in a statement reflecting on the survey results.

In the UK, the “retirement freedoms” have led to a major increase in client interest in pensions. At present, however, a lack of clarity in relation to the provision of guidance without advice is hampering the development of new age robo-advice propositions. Technology companies continue to work with product providers to develop their strategies for the new pensions world. In addition, the Financial Conduct Authority has committed to review pensions communications, simplified advice, and robo-advice.

In the meantime, both providers and advisors have also supported hundreds of thousands of employers through the new process of auto enrollment of their employees into designated pensions schemes, while at the same time negotiating fee agreements to pay for their services. This has led to employers looking to work directly with providers to reduce their advice costs, and providers developing business-to-business relationships without advice.

Financial services has always been a conservative marketplace dominated by banks, insurance companies, and traditional advisors. But the public perception of these organizations is generally quite poor, particularly with the younger generation. The next generation is much more loyal and has a better customer experience with firms such as Google, Apple, eBay, and Amazon. Interestingly, all these companies have expressed an interest in the financial services marketplace. And while there are barriers to entry, their significant client base, brand awareness, and strong customer experience would make them formidable competitors to traditional insurance and investment providers.

As an example, the insurance markets are highly regulated, capital intense, low margin, and commoditized to a degree. In direct contrast, the business models of Amazon, Google, and Walmart are built around a high volume of transactions, where regulation is not a major problem. Amazon and others excel in selling commoditized products, which is not a particular strength of insurers.

Some insurance products are obviously easier to sell than others – for example, most people have the compelling need for home, automobile, and term life insurance. Insurance products such as these have moved toward a comparison site/dial-a-quote model and could be easily sold or offered by Amazon or Google. However, more complex life and investment products require a more sophisticated approach, usually involving a professional advisor (or possibly in the future an automated advice portal).

Figure 3. Technology firms may disrupt the financial services industry

Source: Moody's Analytics

For the mass market, there is the need for simplified products, advice, and low costs, which are areas where the likes of Google and Amazon could prove to be winners. They would, however, face significant challenges, such as obtaining authorization to trade by the relevant industry regulators, capital management, as well as the need to fundamentally change their operating models and support clients with call centers. It could be argued that this would essentially be departing from what has made these companies successful in the first place. Therefore, another option could be for these organizations to partner (or even acquire) with companies who are established in the financial services market.

Google is a good example. In terms of collecting and organizing data, Google is unparalleled – with six billion daily unique searches and more than 50 billion web pages (2013) indexed.

In a recent report published jointly with BCG India, Google concluded that insurance is among the top five product categories in which the web is the dominant purchasing channel, along with travel, digital media, ticket purchases, and books/magazines. In the other four product categories, traditional sales channels have long been redundant as a result of digital disruption. The same report predicts that 75% of all insurance purchases will be online by 2020. If these predictions are accurate, it will give Google a dominant position as the primary sales channel for the insurance industry. Is this the next industry where technology, with Google as a key player, disrupts the existing value chain?

Google made its first move toward the insurance industry back in 2012 with the acquisition of BeatThatQuote, the price comparison service for car insurance, for £37 million. According to the numbers, Google charges up to $54 per click for insurance quote searches. Perhaps the question is not whether Google is going to take a position in the future value chain for the insurance industry, but which position Google wants to take and how this will affect incumbents.

Apple is another interesting example. Apple Pay is Apple’s first venture into the financial arena. Apple Pay is a virtual wallet installed on your iPhone or Apple Watch that uses near-field communication technology. When paying for something, you swipe your iPhone 6 or Apple Watch – the only devices currently supporting the software – at a contactless payment reader, and the funds are withdrawn from your account. You can also use Apple Pay online for a seamless digital shopping experience, meaning that it will be easier than ever to spend money, and pay for insurance and investments!

There will undoubtedly be changes to the way insurance and investment products are distributed and managed in the future. There will, of course, be winners and losers. The winners will be those companies that can make financial products and advice accessible through intuitive customer journeys that are delivered at a low cost using the latest technology. A key metric of success would be which company dominates consumer screen time.

Pensions can also benefit from the new paradigm. Consequently, there is an opportunity for new entrants who understand the retail market and already have experience with managing data to provide products aligned with client behavior. Making the complex world of pensions accessible through intuitive customer journeys can only be delivered at a low cost by technology, and those organizations that focus on a digital proposition to control the client experience should have a competitive edge.

Advisors have established themselves as experts and have proven to be more appealing to high net worth clients who value their services. Advisor and platform providers, however, continue to review their strategies and are looking to develop robo-advice propositions that complement their existing wealth management propositions.