The commission landscape has changed markedly for corporate advisers in recent months and the impact of both personal accounts and the retail distribution review is only weekly to accelerate the push towards a fee-based world.
Earlier this year, Friends Provident followed the likes of Clerical Medical, Prudential and Standard Life in moving away from the initial commission-driven group personal pensions mass market as the economic realities of the model bit hard.
Elsewhere, over the summer, Scottish Widows introduced retrospective clawback on all single premium and transfer payments into its GPP policies, and many expect the squeeze on commission structures to continue with the looming regulatory changes likely to force other insurers to act in the run up to 2012.
Only Norwich Union, Axa, Aegon Scottish Equitable and Scottish Widows remain big players in the initial commission-based GPP and group stakeholder markets. All claim to now have more stringent controls in place to prevent widespread abuse of this in the form of churning.
“We still pay upfront commission but like other providers, we are looking far more closely at the types of employers and schemes we are taking on,” says Steve Folkard, head of pensions and savings policy at Axa.
Those life companies that have largely moved away from this model remain sceptical about how this type of business can ever be made profitable, however.
Alasdair Buchanan, group head of communications at Scottish Life, points to Friends Provident, which was forced to admit in its strategic review that chasing volume and market share had ultimately proven damaging to its balance sheet. (See left)
“What is different about these other companies following the same model? Very little. The detail may be different but the principles are the same,” he says. “None of these companies have persistency levels that are remarkably better than the industry’s, which are getting worse year by year, most notably in the intermediary sector.”
Scottish Life introduced its Financial Adviser’s Fee in 2003 (see below) and Buchanan believes that although some insurers have followed suit, more will have to remove the carrot of commission for the health of their businesses.
“It is changing and the reality is that with Friends Provident following the likes of Prudential and Clerical Medical in stopping paying commission or significantly reducing it, what other choice is there apart from eventually moving to fees,” says Iain Henshall, a principal consultant at Towry Law.
However, that reality can continue to be delayed by advisers as long as other insurers continue to pursue the upfront commission model, regardless of how short-termist that outlook may appear, he admits.
Henshall says Towry Law’s transition of its corporate clients to a fee-based model over the last year did involve a lot of work. Although some clients were lost, a number of new one were also gained, particularly among companies that were dissatisfied by the lack of ongoing servicing from their commission-based advisers.
Many argue that is difficult for a listed insurer to take the kind of medium- to longer-term strategic view that Standard and Friends have done, when removing commission will invariably hit both sales and market share and consequently its share price and executives’ bonuses.
“Companies are very concerned about market share and upsetting important elements of their distribution is difficult to do,” says David Bird, head of pensions at Towers Perrin. “I find it an odd decision to buy in business in that way and you point the finger at advisers, but throughout human history money has always been a big motivator and you can argue that the clients are no worse off.”
Certainly if juicy upfront commissions are on offer and clawback periods only average four years, elements of the corporate adviser community will continue to take advantage of it and undoubtedly many firms are reliant on that model.
But, because of this and the reasons deterring some insurers from moving away from upfront commission, many feel that regulatory intervention, be it implicit or explicit, is both possible and arguably needed to break the cycle.
“The FSA could lend a lot of help here and if it does go for the group market in the retail distribution review, it will hasten the end of commission,” says John Lawson, head of pension policy at Standard Life.
Although it has not been formally announced by the FSA, Buchanan believes “it is now quite clear” that the RDR will incorporate the corporate sector as well as the individual market with CAR the cornerstone of its push to separate the sales and advice processes. This greater transparency will result in more employers questioning the level of servicing they are getting from an adviser to justify their remuneration.
This centres on the fact that employers will be able to compare products at the factory gate price before advice is factored in. “The advice can then be added on top and agreed with the customer. Where commission is paid there is no way of knowing the net cost,” says Lawson. “This is good for a competitive market because you would know what the price of products is and could then compare them directly. It would also improve persistency because you do not need to churn business every four years if you are paid fees and take trail rather than initial commission.”
However, the underlying differences between the group and individual markets could complicate any attempt to impose CAR on corporate pensions, says Folkard.
He points out that with GPPs the negotiations around advice are almost exclusively carried out with the employer and things like group sessions are essential for most IFAs to be able to service employees economically.
“Maybe there needs to be a halfway house where the employer controls costs and the employee needs to understand what is coming out of their contract,” Folkard says.
Even if the RDR in itself is not enough to end commission, the onset of personal accounts in 2012 is likely to add further pressure on upfront payments. Given the expected long lead time of the RDR, the two regimes could even end up being introduced within months of each other.
“The introduction of personal accounts is a massive issue and will bring about a big change for the pensions market with the entry of a new provider that has the potential to take away a lot of business from insurers in a way in which advisers will not have any role in advice or communications,” Bird says.
He believes that the industry could well see a large-scale migration of corporate pensions to personal accounts while the GPP market is likely to dwindle in the run up to their introduction as employers who have not yet set up provision hold out until 2012.
With so much GPP business having a long-dated break-even point it is hard to imagine that insurers will not become increasingly wary of paying high initial commission with such a threat imminent and the recent actions by Scottish Widows, for example, are at least in part a reaction to this.
Philip Hutchinson, corporate pensions director at Pointon York Sipp Solutions, believes that the threat is over-egged, however, and the target market of corporate advisers and personal accounts is fundamentally different.
“Those companies that are serious about pensions have already done something and personal accounts will be taken up by companies that have either no interest or cannot afford it,” he says.
Although he agrees that these companies will be sucked into the new regime, Bird says that he has been surprised by the number of companies he has spoken to, including large blue chips, that are keen to offload their pension schemes.
“It is very possible that companies move away from providing pensions themselves and personal accounts become norm. Levelling down does not have to mean that the employer spend goes down, just that personal accounts become the benchmark and employees are rewarded in different ways around that,” Bird says.
If this is a likely scenario and the market is to shrink, advisers could be said to have two paths to choose.
They can move to a fee-based ongoing servicing-led model ahead of the RDR and personal accounts. Alternatively, the cynic could say they have two more spins of the churning dice.
“Advisers have a gilt-edged opportunity to make more money rebroking a scheme now and then again in 2012 with personal accounts likely to be delayed until 2013-2014,” says Lawson.
This would present an exit strategy for commission-based advisers looking to leave the industry ahead of the pending changes.
He admits that this would “probably be unhealthy” for the industry but such is its state of health that the RDR and personal accounts are being imposed upon it due to its problems with building trust and encouraging people to save.
Whatever advisers choose to do in the meantime, they would be wise not to expect the current levels of initial commission be available for ever.
Expert View
The kettle’s boiling
John Dean, chief executive, intermediary division, Royal London
The value-destroying nature of much the pension business written by insurers was once again laid bare earlier this year when Friends Provident pulled out of the group market.
Following a strategic review, the insurer admitted that the capital intensity of paying out initial commission on new corporate business was unsustainable and it was being forced to streamline its operations across several markets.
Like many of its rivals, Friends has had to take a massive financial hit as falling persistency rates compelled it to slash the assumptions made on the value of this business.
Chief financial officer Jim Smart said: “A focus on financial rigour will result in a more selective approach to writing new business in the UK.”
But why did it take such an erosion of Friends’ capital base before it adopted this new approach?
It is now over two and a half years since Ned Cazalet’s seminal report, ‘Polly put the kettle on’, highlighted the inherent problems of paying large upfront commission on AMC-based business that can be switched to another provider.
He revealed that the break-even point for typical plans was 16 years for a 25 year regular premium plan yet barely half of them remained in full force after four years.
Cazalet warned that this was “financially disastrous for life offices” but much of the impact was hidden because of the flawed assumptions being made by providers about persistency.
Over the past two years these have come home to roost with virtually all of the major insurers taking £100m-plus hits on “adverse persistency experiences” since the insurance sage’s report.
Who is driving the CAR?
John Dean, Chief executive, intermediary division, Royal London
Scottish Life introduced the Financial Adviser’s Fee (FAF) five years ago in response to its concerns about the unprofitability of paying large upfront commission on stakeholder-style group contracts.
The FAF is effectively a forerunner of Customer Agreed Remuneration (CAR) whereby the corporate adviser agrees a fee for his work with the client and this cost is then passed on to the employees through deductions from their contributions to the policy.
Scottish Life’s latest figures show that over 90 per cent of its new business is now written using a fee-based structure, up from 50 per cent in May 2004.
“We believe that the use of CAR models, such as our Financial Adviser’s Fee, offer a fairer, more transparent and more sustainable solution than traditional initial commission models,” says John Deane, chief executive of the intermediary division of Royal London, Scottish Life’ parent. “With CAR, the adviser and client agree payment at the outset and it is charged upfront, rather than by increasing the annual management charge (AMC) over the life of the plan.”
Scottish Life clearly benefits from not having to fund upfront commission and the client can be said to gain from the cost of this commission not being loaded into the policy’s AMC- assuming they stick with the policy long-term.
However, Iain Henshall, a principal consultant at Towry Law, prefers to be remunerated by the employer to ensure that the cost of ongoing servicing is covered.
“Scottish Life is on our panel but we do not use the Financial Adviser’s Fee anymore. We try and charge a straight fee rather than have the employee paying for the work that we are doing for the employer on member benefits,” he says.