12th November 2013
I wanna tell you a story
I ‘wanna’ tell you a story, as Max Bygraves used to say, of how the world of easy mass-market access to advice, now in intensive care, will see the life support machine finally turned off.
The potential for complete catastrophe cannot and should not be underestimated if our on-site snapshot poll of some 1,500 advisers was to be a guide. Over 95% say removal would be 'catastrophic'.
I am very aware that from the FCA’s perspective, and that of the TSC, the regulatory focus is always, rightly, going to be on consumer detriment. But, if FOS figures are a guide, adviser-caused consumer detriment is very low indeed and something that the regulators are well aware of.
However, with the focus seemingly being solely on the consumer, some foreseen warnings, while they are clearly being flagged, will continue to be ignored and as a result matters will only get worse.
The adviser community and their clients are seeing a system that has worked quite well indeed for the mass market, and for very many years, being swept away.
Trail removal will ultimately destroy many possibilities of aftercare and ongoing service to many adviser firms’ customers (low end savers as Mark Garnier MP refers to them). And by that, I also mean the resulting further reductions in adviser numbers as the quest for the perfect zero risk financial services consumer world will be met by the perfect regulatory storm.
Trail removal is part of that ‘storm seeding’ possibility and the initial removal date of April 2016 is approaching fast although some provider firms have jumped ship already.
I am not sure that politicians, regulators or even in some cases financial advisers are aware of the potential consumer detriment and commercial devastation that will, without doubt, follow if the problem is not addressed now.
Here are some points to consider regarding trail, it’s origin and importance to both advisers and their customers/ clients:
- Trail or renewal commission formed part of adviser remuneration in most pre RDR contracts. Trail is a contractually binding adviser expectation.
- It is managed and administered mostly by provider legacy computer systems that have not got an ability to ‘menu-ize’ in retrospect without huge cost and that is not seen as a viable or worthwhile spend
- Trail is small in individual monetary amounts, paid subject to contracts remaining in force to an end date, maturity or claim event
Not all advisers took ‘initial commission’ preferring to build up value and income streams from an increasing number of small but regular monthly payments, again paid subject to the contract remaining in force to an end date, maturity or claim event. - The accumulated value of trail, regular and/or renewal commissions, accrued over many years through many individual client policies, provides a recurring and stable income stream to the firm, in addition it creates the embedded value/ worth in an adviser business.
- Trail was/ is a substantial part of adviser retirement or exit plans too as any advisory business owner would look to sell this income stream along with the goodwill of their business.
- Up to and beyond RDR, firms were buying or selling businesses based mostly on the assumption that this income source will continue for many years to come.
- The advantage to acquiring firms is that it provides an immediate revenue stream, increases their client bank, and the recurring trail income they have acquired can often be their primary means to fully fund the buyout.
- Disadvantages to sellers are that the purchase money is not paid up front, often being paid over a number of years, typically 3 and has little security for the unpaid value.
- If the acquiring firm collapses in that time (looking forward) due to the discontinuance of trail, the total seller’s consideration may not ever be seen in full.
- More disadvantages lay ahead for the buyer if that trail revenue ceases, the value the firm thought they had paid for in their acquisition is reduced or disappears.
- But they still have a contractual obligation to buy a business, over a 3-year term for example, that they can no longer afford.
Now we must consider the potential ‘knock on’ problems relating to the removal of trail commission, this I believe has not been understood as fully as it should.
Removal of the accumulated value of trail, regular and/or renewal commissions (that were the embedded revenue streams and value in an adviser business) by design, default or regulatory intent destroys the value of that firm to the extent that it no longer has any worth and so nobody will want to buy it.
What happens to their clients if the firm simply closes down?
Removal of trail commissions could mean that the acquiring firm is unable to pay the full consideration or in some cases none of the consideration.
The loser in this scenario is the seller, their resulting loss could be huge.
The outcome could be that the seller then sues for the unpaid monies due to them, but, the buying business may be so unsustainable, for lack of this trail, that it closes as it cannot meet it’s liabilities as they fall due any longer. What happens to the clients?
Acquiring firms may have paid the seller in full for the businesses they have acquired, but no longer get the monthly income trail- a big cash flow hit. This could mean it can no longer meet the regulatory fees and other costs involved in running the business and they close down.
What happens to their clients?
The consumer is a very big loser too in all this. They may prefer that trail pays for ongoing servicing and advice. Removal would mean they would then have to pay a fee that they may not wish to or be able to afford to do.
What happens to them?
The possible outcome, the perfect storm.
The loss of trail, a regular income flow, could make many adviser businesses unsustainable; in fact the effect would be catastrophic if our poll of nearly 1,100 advisers is a good indicator.
Many advisory businesses, both in the IFA and banking sector have closed in the run up to RDR leaving many orphan clients, most of those the RDR survivor firms will not/ would not service as they would not/ could not pay fees that trail commissions have often, historically subsidised.
Politicians on the TSC are focused on this problem to the extent that they may look at the adviser gap effect in mid to late 2014 but it will get a lot worse before it gets better.
Fewer adviser firms mean higher regulatory costs for those that are left.
It also means that the liabilities of those firms, such as they may be, that have closed down will pass to the FSCS for any miss selling issues.
Those firms remaining in business will ultimately pay for any claims against these firms by higher FSCS levies and their PI costs will hike, if they can actually get it.
Many of those surviving firms may find, due to increasing regulatory costs that they can no longer pay those levies and close down. What happens to their clients?
The result, more burden on the FSCS and higher costs for the firms left is the outcome And fewer firms to fund the FCA and FOS regulatory costs.
But the biggest losers of all could be network clients.
Networks are also under pressure from the outcome of the recent FCA paper on inducements.They are coming under big financial pressures as the impact of FCA inducement removal could run to millions a year from their cash flow.
To see their trail removed will mean the lack of cash seeing increased budget balancing cost falling on their members, who may not wish to pay, or cannot afford to pay, preferring instead to leave and start their own firm or move to another advisory firm- if they can, or leave the industry.
Network collapses have a detrimental ‘tsunami like’ financial effect on those firms that are left and particularly in that brave new post RDR world.
Disenfranchised ‘consumers’ (clients) are left with nobody to turn to for advice, if they do not wish to or are unable to pay fees and in fact even if they do wish to pay fees.
The tsunami is coming, but are the regulators ready to deal with it, and will the consumer understand as it washes over them that what was being done in their name by regulation is the very thing that has made the disaster happen.
This requires urgent attention and a regulatory stop placed on the removal of contractually agreed trail to provide stability in a sector already under much transitional and evolutionary financial pressure.
Or will the tsunami, when it has passed, result in no need for regulation as there is nothing left to regulate.
Max Bygraves died in 2012, if our poll is even a half accurate guide, many advisory firms will die and many consumers will be very badly served as a result in 2016 unless something is done.
Now that would be a story!
Comments (4)
The FCA is undoubtedly trying its best but it clearly has no idea what it is doing by rushing round like a bull in a china shop rather than working to carefully improve the outcomes and availability of advice to consumers.
It seems that unless you advise a client for a fee the advice is tainted and the client doesn't trust the adviser. After almost 40 years of providing advice I can say without any doubt my clients trust me, they are happy to pay me a fee or commission, they are fed up with rules being changed and certainly don't see the need for it. It must be easier to focus and regulate the product and its suitability rather than have a product free for all, with the advice being regulated? This way we could go back to mass marketing and bancassurance for simple products that meet specific needs and specific clients. When someone needs more they can have more and pay more.
If you buy a car you know that it is safe (but some are safer than others), meets certain minimum standards (but some exceed it by more) is manufactured by a certain company and the seller is tied or able to offer from the whole market. Not complicated as the product is regulated and has to meet certain standards. We should work in the same way. As far as I know we are the only industry that operates with the salesman/adviser regulated and the product isn't!
When I set up an ISA or any other product and send out 50+ pages of small print I know the lunatics are in charge. You can get a payday loan with a few clicks (or any other form of borrowing) but can't save without huge add on costs? Regulators should hang their head in shame.
Neil
Neil Franklin 15/11/2013 09:02
Clive S. Davis 18/11/2013 13:22
Derek Bradley 03/12/2013 15:29
Perhaps those sufficiently interested in the impact of withdrawing Trail Commissions on good, genuine, honest, hard working industry professionals, who have dedicated a lifetime of work to this industry and to their clients, will read my circumstances with compassion and an open mind, and then explain to me how I am supposed to retrospectively adjust my personal and business planning, so that I can enjoy the retirement of which some would rob me.
Please forgive my lengthy diatribe which follows -- but please take th etrouble to read and digest its content - and then tell me jsy what i am supposed to do!!
I have worked in 'Life and Pensions' for my entire working life since 1966 (except for a 2 yr period). Originally employed for 4 years in Administration, I then moved into Broker Sales as an Inspector. Working for three companies over the ensuing 20 years I ended up in around 1980 as a Branch Manger for a small mutual company.
The impact of Regulation in the 1980's on a small Mutual meant they had little choice but to switch to specialise in Tied Agency sales, and I found myself responsible for training new industry entrants to become 'authorised' within a few weeks of joining the company. This I found unacceptable and I finally quit to start my own business as an IFA in 1990.
By acquiring good quality businesses and client banks from established, retiring IFAs, I began slowly building a good client list. Given an elderly client base, the majority of my business was in investments - Bonds, Unit Trusts, PEP/ISAs, IHT Planning etc.
At a very early stage I decided to forego a good slice of the available initial commission on, say an Investment Bond (Say 7% to 9%, as would typically have been taken by a bank) in favour of a reduced intial commission and a regular Trail payment for the life of the contract. (Typically 3% plus 0.5% per annum trail).
Clients were ALWAYS informed of these charges, indeed they were an important part of my sales approach, as I explained that by incorporating a trail payment into a product meant that the client could show value in that product to a new adviser, should they ever find that the service from my self was unsatisfactory. Trail commission enabled me to provide them with an ongoing service as well as empowering them to dismiss me and transfer elsewhere should they choose to do so.
I then set about providing an ongoing and regular programme of reviews and servicing for all clients in order to secure them to me. In 24 years I can state that I lost very, very few clients to other IFAs.
This decision to take a Trail commission was made for other reasons too. There was an active industry debate regarding investment bonds being sold ONLY for commission. In some respects there wasa case for such a view when the full initial commission was paid out at commencement. I disagreed with this and tended to favour Bonds, for their simplicity and ease of comprehension by more elderly clients, but I adjusted the commission to demonstrate a clear ABSENCE of commission bias. And i used UTs where appropriate.
The tax advantages/disadvantages of Bonds vs Unit Trusts changed with almost every budget and the debate raged over many years. To this day there remain differing views. The constant aspect of the debate was,and is, however, commission; with those espousing the advantages of Unit Trusts regularly stating that sellers of Bonds did do solely for commission reasons. That is an untruth.
I was also seeking to build a long term business and by building up over many years an increasing base of regular income from Trail commission, the pressures to SELL at every opportunity, which has blighted the Life and Pensions industry for far too many years, was minimised. Eventually I achieved a balance whereby 70% of my business was trail income, 25% came from new business with existing clients and 5% from new clients, usually recommended.
I had no pressure to sell to survive and was able to give an advice and administration service of the highest order. It should also be noted that at no time did I ever make any form of additional charge for on-going work. Trail commission was, if you will, a payment for support sevices. (Paid by the Insurance Company)
Further, and of CRITICAL importance to this debate, is the fact that the charges to the client were IDENTICAL -- whether one took 3% plus 0.5% trail OR between 7% and 9% intitial as a lump sum (as most large sales organisations did). I repeat - The product charges were IDENTICAL and thus the client is paying no more even if the trail continues for another 20 years or more!
And then along came RDR. At age 65 I had a choice to make which I had not envisaged during my business development years. I had planned to continue to provide a service to my clients for so long as I could physically and mentally do so. The FSA had other ideas.
I was informed I must either take exams which I considered (rightly or wrongly) to be peurile after I had already completed over 45 years of industry service, or I must cease trading. I thus decided to sell my business, whilst trying to ensure that my clients continued to receive that service and support I had promised them would be provided, in return for the 0.5% trail income.
PLEASE bear in mind once again that the Trail commission being paid is NOT at the client expense. I will explain later how this works in terms of how Life Offices costed their products.
Eventually the sale of my businees was agreed on amicable terms with an excellent firm of IFAs, who have taken on board the continued servicing of my clients, and have already shown a genuine commitment to them.
As part of the sales agreement I will continue to receive a percentage of the income derived from my client base (including Trail) for life.
I am now terrified that my retirement income is about to be decimated by the uneducated and ill-guided apparatchiks at the FCA and, because I am not permitted to continue to give investment advice and have now sold my client base, I am completely unable to do anything to prevent this! If my trail and renewal commission is stopped I will find myself wholly dependant upon the old-age pension and State support with no other income whatsoever.
Can this be right? Can this be Legal?
Perhaps if some of the changes of the FSA/FCA had been introduced with less clamour and less haste then there may have been an opportunity to put things right in an orderly fashion and to speak with clients to make necessary changes.
Had I known in 1990 that trail commissions would cease after I retired then I would have taken the 7% commissions on offer and invested 4% into a Pension Plan. I calculate that I could have invested some £600,000 or more and produced a pension fund of £1 Million plus had I done so. (Of course this would not have been the right thing to do for my clients but I guess I should not have concerned myself with such niceties)
A pension fund of £1 Million would generate a perfectly acceptable retirement income, thank you.
Oh! and once again, I repeat - This could have been achieved with the charges to the client being IDENTICAL.
At this point it may be helpful to explain as far as I am able and in very simplistic basic terms HOW it is that Life Offices calculate the commissions they are paying on, say, an Investment Bond. My analysis is an oversimplification but may go some way to explain for the uninitiated how trail is at NO ADDITIONAL COST to the client!
A Life Office begins by working out its admin costs and then looks at how much it needs for Marketing costs on any given product. Marketing cost is reflected by commission rates as this is the means of paying for marketing used by most providers.
In assessing how much they need to charge to cover commission costs they will look at the total sum payable and the period of time over which they can anticipate receiving income from the charges.
For example: a bond may on average have a 'life' of say 10 years before it is surrendered or the client dies. Thus the life office can assume it must recover its marketing costs in that ten year period. This is typically done via the Annual Management Charge.
So let us assume that the Initial commission payable to ABC BANK Ltd is 9%. The Annual Management Charge may be set at say 1.5% of which 0.9% is in respect of commission paid out and the balance covers staff, investment costs etc etc.
BUT what if the plan continues in being after ten years? - The annual Management Charge remains the same and hence the 0.9% is still being charged! Whether or not commission is being paid out. If an adviser takes 3% initially and 0.5% per annum then the Life Office is able to continue making that 0.5% payment so long as the bond is in force and the annual management charge remains at the level originally set and accepted by the client. Some offices will reflect this 'bonus' in reduced charges after a certain period on force or by a 'bonus' enhancement to the plan.
The variety of means of dealing with this item created a 'market-place' whereby IFAs could analyze and select the product best suited to his client given his knowledge of their situation. For the majority of my clients the product they were buying was intended to remain in place for life!
In essence the rate, frequency and nature of the commission is a matter negotiated between the Life Office and the Adviser. The Plan charges were identical regardless of that agreement.
The above is by way of explanation of how things WERE done before RDR. I make no comment upon whether the basis was right, wrong, fair or unfair. I merely set it out for information.
My point is however, that it is wholly unfair and inappropriate for any regulator to ignore the impact of their deisions, however laudible for the future, upon individuals, who have worked within the system, to the benefit of their clients in the best way possibe within that system, for an entire working lifetime and now have no ability to make changes or to review hostoric well meant advice.
Grosvenor
Grosvenor 19/12/2013 14:19
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