Some years ago my home was burgled. Two crack cocaine addicts, who each had a £500 a day habit, were eventually caught, received long custodial sentences and my insurers made good on my financial losses. The police informed me that they were responsible for at least 30 burglaries over a twelve-month period in my neighbourhood alone. Obviously the need to earn money at whatever cost to society, be it emotional or financial, determined these addicts’ actions and understandably drug rehabilitation was a condition of their release.
In the world of retail financial services many advisory firms both large and small, have for many years, been addicted to what could be termed ‘crack commission’. Otherwise known as indemnity or ‘up front’ commissions it is paid, in the main, by insurance companies or other financial product manufacturers, when one of their products is bought by a client, or sold to a client depending on your point of view. Often after financial advice is given recommending that product. Many of these advisory firms have a business model that relies on large upfront payments to survive and they have been doing so for decades – therefore it may prove a difficult habit to break for some firms.
There has long been an argument, supported by numerous large-scale mis-selling scandals, that it is the commission bias which drives the advice given, which may not be suitable for the client. An example of this is the 2011 case of the Norwich and Peterborough Building Society which earned £2.7m in commissions over a 43 month period mis-selling high-risk investment products to some 3,200 of their customers who actually had a low-risk attitude to investing. The Society was fined £1.4m and faced a £51m compensation bill. Not quite jail and rehab, but you get the point.
Commission payment is something the Financial Services Authority (FSA) and the new Prudential Regulatory Authority (PRA) will ban from 2013 when the proposals contained in the Retail Distribution Review (RDR) come into force. In essence, one of the key RDR principles is to seek to take away any bias of commission on the advice given to clients.
In place of the current system there will be two classes of advisors. The first is those who will be able to offer ‘independent advice’ generally on a broad range of products. The other type of advisors will give ‘restricted advice’ either from a limited number of providers or certain types of products.
Irrespective of whether a firm is ‘independent’ or ‘restricted’, the firm will have to decide on the type of charging structure they will adopt. This can be an hourly rate, percentage or fixed fees and there could be charges for different levels of service. This will apply to all firms that give retail investment advice including banks, IFA’s, wealth managers and stock brokers. Under this system it will be the client and the adviser who will agree on the level and type of remuneration to be paid not the product provider. This system is designed to lend a degree of transparency to the subject of fee charging in the world of retail financial services. But will it achieve the desired aims and how does a client take full advantage of the new transparency?
To put this into context it is true to say that the vast majority of the British public are at best agnostic about their own finances. The last survey conducted in this area estimated there was a £9 trillion savings gap in the UK. In short, planning for a financial future beyond the next holiday is not a priority for the majority of the population. Consequently paying for financial advice does not feature high on the agenda, irrespective of how any fees are structured or agreed between client and advisors. A recent survey found that 50 per cent of the UK population would not be prepared to pay for financial advice and a further 33 per cent believed such advice is worth less than £300. Against this backdrop it is little wonder that major players such as Barclays have decided to close their financial planning service.
Nevertheless good financial planning should be viewed as an investment and not an unnecessary cost. We worked with an IFA who recently advised our client – a professional musician – to obtain income protection and when he subsequently fractured his wrist he avoided severe financial loss.
I suspect more adviser firms will look to work with HNW and UHNW clients. There is a perception these clients are more understanding of fees per se and also have the capacity to pay them. However, unless there is genuine client engagement in the fee process, there is a danger post-RDR that the transparency on fees is not fully explored by clients. An open discussion between client and adviser should determine what any advice fee covers and what level of service they can expect on an on-going basis.
The FSA believe 15 per cent of all investment advisors will leave their advising roles post RDR. Kicking a habit is never easy…
Paul Panayi is CEO, Optimus Family Manifesto™ – Creating Smart Family Offices