The Pros and Cons of Banning Embedded Commissions

embedded life insurance commissions

Morning Star defines embedded sales commissions (also known as trailer fees) “as service commissions paid by the mutual fund company to the sales representative managing your mutual funds. This commission is paid as long as you hold units in the fund. Commissions generally range from 0.25% to 1% and are paid out of the management fund’s expenses.

The trailer fee compensates the advisor for ongoing service. These services can include, answering questions about the performance of your investments and other related matters. Segregated funds offered through Insurance companies carry similar fees.

Embedded commissions are a very hot topic in the insurance industry right now. The big questions right now are whether embedded commissions should be banned altogether, have more rules and regulations attached to them or just left as they are. The Canadian Securities Administrators are taking a serious look into the matter and considering the possibility of banning embedded commissions or trailer fees – a move Britain and Australia have already taken. Industry stakeholders are split almost down the middle on the issue.

One side of the debate believes that there is an immediate need to reform mutual fund fees. In fact, some experts say that banning third-party embedded commissions, including banning trailing commissions on mutual funds sold through discount brokerages and direct from the manufacturer, is long overdue.

“Trailer fees are the least understood topic for investors,” says Pramod Udiaver, chief executive officer at online portfolio manager Invisor Investment Management Inc. of Oakville, Ont. “Most of the time, when we look at our clients assets from other institutions, that is when they become aware they have funds linked to deferred sales charges and trailing commissions. It is completely unbeknownst to them. Everything is embedded and it isn’t clear to them.”

The other side says that embedded commissions are an important part of the business and many clients like the idea of not paying any upfront fees.

Pros of Banning Embedded Commissions

1. With a fee-based system the advisor is clearly working for you and has your best interests in mind.

2. You know how much you are paying. Your advisor may charge a flat fee, a fixed hourly rate or a percentage of the assets under management. In all cases, you are told exactly how much you are paying.

3. Fees paid to advisors may, in certain circumstances, be tax deductible against income. This can result in significant tax savings for higher-income clients.

4. Working with a fee-based advisor could lead to better investment recommendations for many consumers.

5. An embedded commission ban could mean that investments such as individual securities and exchange traded funds will be poised for a boost in popularity. This is what happened in the UK and Australia when similar fee bans were implemented. These investments having a lower cost to the consumer.

6. As a general rule, individual investors assisted by a financial adviser accumulate significantly more financial assets than non-advised investors.

7. All charges are based on specific activities the advisor provides for the client.

8. Typically, fee-based advisors have access to lower cost, institutional share classes.

Cons of Banning Embedded Commissions

1. There are usually limitations to fee-based accounts. Most firms limit the number of trades you can make in a year and charge more if you go over the limit.

2. Greg Pollock, chief executive officer of Advocis, an industry association for financial advisers, says “Banning commissions could do more harm to average Canadian investors than good, leaving many Canadians without affordable access to investment advice.”

3. Many experts believe that a commission ban could force sales people at large firms such as Edward Jones and Investors Group to leave the industry.

4. John DeGoey, portfolio manager at Industrial Alliance Securities Inc. rebuffs the argument that removing commissions – and incentives – for advisors will lead to a higher cost of financial advice for clients.

5. Many investors tend to equate financial advice with financial risk, which scares them to death, so they avoid getting advice. These clients resist paying upfront fees for financial advice because they do not understand what it means to work with a financial advisor.

6. Many investors prefer commission-based advisors because they don’t like to write a monthly cheque to their advisor.

7. A commission-based account is often cheaper for clients that don’t trade too much and don’t need the financial planning services offered by an advisor. The commission ban could increase costs and reduce access to advice for many Canadians, especially those with small to modest-sized accounts.

8. If the option for embedded commissions is removed by the industry, it could lead to far less advice for the average Canadian.

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