By GRAHAM FROST 26/09/2006
If you’re familiar with Bestinvest you will know that we have what is probably the most vociferous anti-initial commission stance in the industry. We have long held the view that high initial commissions are the root cause of almost all mis-selling in the financial advice industry. However despite the obvious link, the industry and its regulator, the Financial Services Authority (FSA), has done little to date to quell this practice.
| "It was a pleasant surprise when the FSA Chairman recently spoke out against initial commissions..." |
It was therefore a pleasant surprise when the FSA Chairman, Callum McCarthy, spoke out against the initial commission regime at a recent Savings & Pensions Industry Leaders’ Summit. The essence of his speech was that rewards and incentives dictate behaviour, i.e. if it’s profitable to cheat (mis-sell) then there’s always some who will. McCarthy expressed concern that providers were shooting themselves in the foot through being more concerned about business volume rather than quality, giving the example that around half of customers who buy regular premium personal pensions cease contributions within four years.
You would think product providers might have learned from their past mistakes, but Norwich Union’s recent announcement that it will pay indemnity commission on its ISAs suggests not. NU’s new terms allow advisers to earn 20% of the 1st year’s contribution up front. For example, assuming a £500 monthly saving into a fund over five years the adviser would receive £1,200 upfront from NU, rather than £15 in each of the 60 months as would typically be the case. Although NU will claw back commission from advisers if the premiums are not maintained for five years (as a deterrent to ‘churning’) this is surely a prime case of a product provider trying (perhaps unprofitably) to buy their way into a market via sky high commissions. Insurers also continue to pay initial commissions of 6-7% or more on with-profits bond sales, at a time when this investment type is arguably very unattractive to investors.
McCarthy went on to say “The consumer does no better than providers under the present remuneration model. This suffers from product bias, provider bias and churn.” However, while he accepted that the regulator has some responsibility to push through change via regulation, his view is that “the solution to the problem must lie principally with the industry.”
This gives cause for concern as, based on experience to date, there’s little chance of the industry pushing for a fundamental change in the way advisers are remunerated. It’s a ‘Catch 22’ situation: on the premise that some advisers will always bias advice to boost their earnings then even if a provider wants to move away from initial commissions, it’s unlikely they will for fear that competitors (who continue to pay such commissions) will simply get the business instead.
To make matters worse, some of the largest IFA companies comprise ‘networks’ of advisers, whose business models are potentially flawed. Such companies typically handle compliance, marketing and administration for advisers in return for a cut of the commission (or fees) that the adviser generates. However, evidence suggests that it’s commonplace for advisers to routinely jump from one network to another with their client bank in tow, giving rise to the possibility of periodic churning of products to generate yet more initial commissions. Because some networks pay away more commission to their advisers than is probably commercially viable, with the further risk of commission claw backs after the adviser has departed (due to ‘churning’), it’s not hard to see why some of these companies have little hope of survival. In fact, there have already been some high profile casualties this year alone. And the misery doesn’t stop there; when such companies collapse it’s common for mis-selling compensation claims to arise, leaving the rest of the industry to pick up the tab via penal Financial Services Compensation Scheme (FSCS) levies. More worrying for consumers is that the advisers who work for these companies are rarely salaried, i.e. their income is likely to depend solely on how much commission (or fees) they generate, hence the fear they will bias advice towards high initial commission paying products.
| "If the FSA was to ban initial commissions mis-selling would mostly be eradicated overnight." |
We believe the solution is actually very simple. If the FSA were to ban, or at least cap, initial commissions and place a far greater emphasis on recurring revenues, mis-selling would mostly be eradicated overnight. However, while Mr McCarthy’s heart is obviously in the right place, we fear that any subsequent regulatory changes will be too weak to stamp out the shadier practices within our industry. Perhaps the saving grace will be market forces; investors are increasingly wising up and those advisers that treat their customers fairly are gaining market share. If this trend continues then unscrupulous advisers will ultimately have to change or be driven out of business.