Rita is aged 38 and Tom is aged 42. Rita is a stay-at home mum whilst Tom runs his own marketing business from an inner suburban office, and they have two sons, aged 5 and 8, Rita and Tom recently visited Jerry Drake, a financial planner, to help sort out their financial affairs. Both Rita and Tom are quite conservative in nature and because of their lack of investment sophistication and requirement to preserve their capital, they are reluctant to consider anything too risky. After 2 short interviews, one being online, Jerry Drake sent them a 5-page financial plan. Rita and Tom received no other documentation from Jerry nor did they complete any forms.
Tom’s business produces an average annual net profit of $150,000 before tax, also they own their own house worth $950,000, which is subject to a mortgage of $375,000. They also have an outstanding credit card debt of $6,000. Both Rita and Tom own their own cars. The couple’s living expenses total $84,000 p.a. including payment of a $27,600 p.a. annual mortgage payment. They expect their two sons to remain dependant until age 21 at which time the living expenses will decrease by $13,000 p.a. for each child when they leave home. The couple would like to send the
children to a private school from years 9 – 12 which is expected to cost $160,000 in total. In event of death of either Rita or Tom, they estimate death and medical expenses to cost around $12,000. Tom currently has life cover of $150,000 in his superannuation fund (his current superannuation fund balance is $225,000) whilst Rita has no life cover (but she does have a superannuation fund with a balance of $125,000), also they have no other personal insurances. The couple’s superannuation accounts are invested in a growth fund with the following allocations: Cash 5%; Fixed interest 25%; Australian shares 35%, Property 10%; and International shares 25%.
Tom’s father passed away recently at age 67 as a result of heart disease, which seems to be a historical problem in Tom’s family. They have $40,000 invested in a savings account which came from Tom’s father’s estate which they have set aside for emergency expenses and to help with the education of their children. Jerry has recommended that they take out a margin lending facility totalling $200,000 and together with their $40,000 savings account, acquire units in an international share fund for an amount of $240,000. Jerry has argued that he relied on the yield curve as a leading indicator of economic activity.
Tom and Rita say they are uncomfortable with some of the recommendations and do not understand a number of the strategies. The financial plan contained no information as to risks or insurances. When they asked about the fees, Jerry replied that the plan was absolutely free and there was no charge to them.
Tom and Rita say that they don’t understand what a margin loan is and they are not sure whether investing in an international share fund is suitable for them. One of their friends told them that the fund has performed poorly over the past 5 years and has a very high fee structure.
Read the above case study and answer the following:
1) List the potential risks faced by the couple in terms of their assets and income.
2)What type of insurance policies would you recommend for Rita and Tom to protect their personal risks? List the three most important and explain.
3)Calculate how much additional life insurance might be recommended for Tom? Assume that coverage is required through to current life expectancy (85 for females, 81 for males) and do not allow for the adoption of the recommended margin lending strategy.
4) How appropriate do you think a margin lending strategy is for Rita and Tom? Discuss.
5) Jerry advised that the plan was absolutely free and there was no charge to them.
i.Describe the various methods of remuneration available to financial planners?
ii. From a client point of view, discuss the benefits and limitations of each method remuneration identified.
ii.What are your views on the recommendations put forward by The Financial Adviser Standards and Ethics Authority (FASEA) in relation to remuneration?
6) Suppose the product disclosure statement of the international share fund indicates that the fund’s ICR is 2.1% p.a. In addition, the margin lender would pay the planner a fee of 1.5% of the amount borrowed upon commencement of the lending facility. Prepare a table to indicate what fees Jerry Drake should have disclosed in the financial plan given to Rita and Tom.
7) It is obvious that the financial planner has breached several ethical, professional and legal obligations. Discuss the major areas of non-compliance by the financial planner.
8)Discuss some of the ways in which financial planners can seek to limit their exposure to possible litigation and breaches of their ethical, professional and legal obligations.