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Analyst: Brace yourself for a BIG, post-DOL rule revenue dip

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A new report from the global management consulting firm A.T. Kearney makes a jaw-dropping forecast: a precipitous, $20 billion dip in industry revenue resulting from the pending phase-in of the Department of Labor’s fiduciary rule.

The study, “Why investing will never be the same,” contains other provocative data points. Among them:

    • advisor-switching is accelerating, rising to 13 percent in 2015 from 4 percent after the 2007-2009 recession;

    • about 9 in 10 investors below age 45 say they would “change their advisory models” to pay less for advice. Among all age groups, nearly 3 in 4 (72 percent) would do so; and

    • 30 percent of older, “fully delegated” advised investors might opt for “lightly managed,” less costly advice.

The bottom line for retirement advisors: big changes are afoot.

To learn more about what agents and brokers can expect under a DOL regime, LifeHealthPro interviewed Uday Singh, partner of the Americas, at A.T. Kearney’s Financial Institutions Practice. The following are excerpts.

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LHP: Did the report’s findings align with your expectations or were there surprises?

Singh: The level of revenue erosion we forecast resulting from the rule will be more significant than we originally anticipated. The fact that $20 billion in revenue will be disappearing is a big deal. So the magnitude of the loss was a surprise. 

LHP: How do you account for such a steep decline? 

Singh: Several factors are at play. The main one is the expected decline in commissions as advisors drop low-balance retirement accounts that will no longer be profitable to serve. Other factors include the slowdown in IRA rollovers and a consumer shift to ETFs [exchange traded funds].

In respect to compensation, there will be, as the DOL rule requires, a levelizing of commissions for comparable products. But in addition to this compression, we foresee an overall drop in revenue, as advisors migrating to fees will not — at least in the early going — be able to make up for the lost commissionable revenue. This revenue loss will inevitably squeeze people out of the market.

By the way, the $20 billion dip doesn’t factor in an uptick in expenses due to compliance costs and potential litigation, both of which will affect profitability. It’s difficult to say at this point how much the additional compliance costs will be. But we know that it’s a massive focus now for every advisory firm and financial institution.

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The industry will have to plan for a fiduciary regime, whatever its final, court-approved form, says A.T. Kearney’s Singh. (Photo:Thinkstock)

LHP: Given the decline in commission sales, what will be the favored compensation model going forward for advisors: commissions plus fees or fee-only? 

Singh (pictured): There will be a gravitation to a fee-only model, if only because it’s easier to comply with and manage. The compliance requirements and increased litigation risk for not having a fee-only model are quite onerous under the rule. As the industry migrates to fee-only, many broker-dealers will either leave the market or become registered investment advisors.

LHP: Some independent marketing organizations I’ve spoken with say they’re applying with the DOL to become financial institutions not only to serve their own advisors, but also other IMOs that may be unprepared to make the significant investments needed to become DOL-compliant. To what extent do you foresee such partnering, as opposed to mergers among IMOs?

Singh: How industry intermediaries come together, whether through alliances or mergers, will be worked out over the next 12 to 18 months. Right now, they’re narrowly focused on how to comply with the rule.

LHP: Your report foresees the fiduciary rule becoming permanent, despite the fact that several lawsuits are underway against the DOL over the new regulations. So you expect the department to prevail in court?

Singh: Yes. The reality is that consumer sentiment is very much against the financial institutions, and in favor of greater transparency. We’ll see how the lawsuits go, and what additional regulation may be forthcoming, but the wind of change is blowing in one direction: requiring that advisors act in their clients’ best interests. The industry will therefore have to plan for a fiduciary regime, whatever its final, court-approved form. 

LHP: After the U.K. implemented its Retail Distribution Review regulations in 2013, about a quarter of Britain’s advisors left the field, in part because of the RDR’s outright ban on commissions. Do you expect a similar exodus of U.S. advisors after the DOL fiduciary rule is phased in?

Singh: This remains a possibility. Certainly there will be some reduction in the advisor field force, but there will also be substitutions. To fill the advice gap, automated digital solutions — robo advisors — will increasingly service smaller accounts. At asset levels above, say, $1 million, human advisors will play a central role.

But advice won’t necessarily be provided only through one or another channel. I foresee a hybrid model arising, where at higher asset levels, human interaction will be the primary channel, and digital advice secondary. At lower asset bands, the order will be reversed. Such a hybrid model is increasingly how consumers are being serviced across all sectors of the economy today, not just the retirement planning space.

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Over the next 3 to 5 years, many players will have to make substantial investments in business processes, software and systems. (Photo: Thinkstock)

LHP: Do you expect that market incumbents will retain the lion’s share of new retirement accounts or do you expect new players entering this space?

Singh: We expect that most retirement investments will stay with the traditional players, many of whom will simply offer robo advice as part of a portfolio of solutions.

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LHP: Given the range of choices available to retirement investors, why do you anticipate, as the study notes, a slowdown in plan rollovers?

Singh: Because a lot of potential rollover money is invested in small, employer-sponsored retirement accounts, fewer advisors will be marketing to this space. So I expect a good portion of these assets to stay put. That’s not necessarily a bad thing.

LHP: A number of states have set up state-sponsored retirement plans for small businesses that, the DOL has indicated, would not be subject to ERISA law or the new fiduciary rule. Do you see these plans as a viable market niche for those advisors looking to continue to serve the retirement space while escaping the DOL’s jurisdiction?

Singh: It doesn’t appear that these plans have a lot of assets in them yet, so I’m not sure what role advisors would play in this space. But there’s no reason to believe these plans would not also be subject to requirements similar to the DOL’s.

If state agencies are regulating these plans, then I imagine they’ll implement regulations aligning with the DOL’s best interest standard. The fiduciary rule will be the model for other regulators, whether at the federal or state level.

LHP: How significant an investment in business processes and technologies will industry stakeholders have to make to become DOL-compliant? Do you have a thumbnail estimate?

Singh: I don’t have a specific number to give, but certainly it will be significant. Even while suffering a decline in revenue, market players will need to remain profitable. That will require them to rethink their operating business models.

Over the next 3 to 5 years, many will have to make substantial investments in business processes, software and systems — among them solutions for managing advisor compensation, product recommendations, best interest contract disclosures and client servicing — to protect their bottom line.

LHP: A software executive I earlier interviewed suggested that existing practice management technologies will need to evolve to align with the DOL’s new compliance requirements. Do you agree?

Singh: Much is now in place to comply with the DOL rule, at least at the robo level. If you look at the digital advice landscape, the fact that there are already multiple products that simplify investing, comply with the best interest standard, have efficient asset allocation algorithms — and do all this in a frictionless, emotionally engaging way — is evidence that the technology exists today to do the job. But it remains to be seen how quickly assets will navigate to the digital model and which aspects of robo will become part of a hybrid, digital/advisor solution.

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Advisors will have to know how to do comprehensive financial planning, and not just have expertise on certain products. (Photo: Thinkstock)

LHP: How do expect the market will look in 3 to 5 years? Will there still be a place for broker-dealers? Will some consumers be left without an affordable advisor, given the shift to fees?

Singh: The DOL rule points to a world in which fee-based advice is the default model for the industry. Clearly, fee-based compensation will be dominant if, as we expect, the SEC unveils its own harmonized fiduciary standard, which won’t apply only to retirement assets, but all securities.

Related: Broker-dealers on DOL fiduciary rule: Expect advisors to walk

In this scenario, a lot fewer brokers will continue to sell on commission, given the increased compliance demands and litigation risk. At the same time, people with smaller accounts will still have access to advice using the digital solutions we talked about.

LHP: Do you also expect that advisors will need to upgrade their skills and pursue advanced designations to operate effectively on a fee-basis?

Singh: There will certainly be a rush among agents and brokers to get the licensing needed to transition to fee-based compensation. The skills upgrading will also be driven by a larger shift: investors wanting more holistic retirement solutions.

Millennials especially are sophisticated consumers and very suspicious of being marketed to. As they gain more market power, agents and brokers will need to change how they approach them. Advisors will have to know how to do comprehensive financial planning, and not just have expertise on certain products.


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