The FSA working party on consultancy charging had its in augural meeting at the start of October, beginning preliminary attempts to unravel the complexities involved in moving to a new fee model set out under the retail distribution review.
The group has until the end of February to tackle the as yet unanswered questions hanging over the proposals which effectively bring commission charging and factoring to an end for all pension schemes set up after 2012.
So far the plans have met with mixed reactions; the provider community seems broadly rather happy with the new arrangements since many had already moved to consultancy charging type models, or were keen to see a new level of transparency applied to fee structures.
But certain sectors of the advisory community face greater upheaval in adjusting to the post-RDR world and, for some, it may even be a catalyst for withdrawal from the market. Consolidation and acquisition is already rife in this sector, even among some of the very biggest players, but it is the smaller firms who may feel vulnerable.
Robin Hames, head of technical and marketing at Bluefin, says: “It is the smaller firms with less capital behind them that are more reliant on the indemnity commission model. While the move to consultancy charging is not a ’big bang’ – the regulator isn’t saying ’it’s no more indemnity commission on anything from day one’ – it will still lead to consolidation in the market.”
The difficulty the industry faces is the ongoing uncertainty over how consultancy charging will work in practice; while advisers need to get ready for the inevitable change, in the absence of concrete plans any adjustment to age old business models won’t be easy.
Chris Goodeve-Ballard, member of the consultancy charging working party and consultant at Aon Hewitt, says: “This is not an easy issue which is why we are where we are [holding a working party]. Consultancy charging doesn’t come in until 2013 so there is time to work a sensible way around it, we just don’t know what that sensible way is yet.”
In the interim, then, advisers and providers will have to base their strategy on the ’knowns’ and await the outcome of the working party to deal with the ’unknowns’. The first step, therefore, is to review current service offerings and abandon those that are unlikely to work in the post-RDR environment.
Christian Apsey, principal corporate consultant at AWD Chase de Vere, says: “Corporate advisers will need to review their services and charging structures for the post-RDR world and ensure they are able to communicate the benefits effectively to both employers and employees.”
Communicating change will be a critical consideration for advisers since their services will no longer be taken care of via commission, meaning clients will need to appreciate the value of financial advice and be prepared to dig into already depleted company coffers to pay for it. Alternatively, IFAs will need to convince the individual employee or end user that they need advice which cannot be provided for free.
“The general public as a whole doesn’t value financial advice enough to be willing to pay for it. This is because many people have believed that financial advice has been free in the past or that it has been paid for by their employers, when in fact they have been paying themselves through charges in their policies. An important job for the corporate advice industry is to educate individuals on the benefits of taking independent financial advice,” Apsey says.
As fees pass to both individuals and companies, transparency will become of paramount importance. Simply offering a suite of bundled products – some of which will be inappropriate or surplus to requirements for many scheme members – will no longer work. Advisers instead will have to offer a range of services from which clients can choose and then pay for accordingly.
Apsey says advisers need to agree the services with the employer, how this will be paid for and then embark on a series of presentations with employees to explain what’s on offer.
“Potentially with charges coming directly from contributions, an explanation of the service will be required. Without proper explanation this is likely to lead to questions from employees and possible distrust of the benefits offered by their employers,” he says.
The advent of auto-enrolment, just one year before consultancy charging comes into force, will have a profound effect on what employers and employees consider valuable. Since employees will be forced to opt out of joining the company pensions scheme and inertia will probably see vast increases in take up, the role of the adviser in persuading individuals to sign up to pension saving becomes almost obsolete. In future the intermediary’s role could be more focused on explaining how the pension scheme works and why individuals have been automatically enrolled.
Hames says: “There will be a greater emphasis on education and communication as opposed to advice, and auto-enrolment may even lead employers to question what they are paying for. A lot of adviser firms who have sold one to one advice as a key part of their pitch may find enthusiasm wanes as the cost of providing that advice will be directly demonstrated in the charging structure and may be prohibitive.”
At the same time, however, the Pensions Regulator has made clear that employers have a governance responsibility to members to ensure their DC schemes are run well and that savers make the right investment choices with appropriate support. Consequently there remains a role for advisers in providing that support to members so long as they demonstrate good value for money.
“The regulator is going to be showing greater interest in governance, so while the employer might want to strip out certain advisory services the regulator will be making sure they are maintaining and enhancing them. So advisers will need to prove they can do it in the most cost effective way,” Hames says.
Demonstrating value for money, or at least cushioning the blow for individuals not used to seeing the upfront cost of advice, is set to become more difficult for IFAs with the removal of factoring. In some cases, this step could see upfront costs of as much as 30 per cent, amounts that few in the industry consider palatable.
Laith Khalaf, pensions analyst at Hargreaves Lansdown, says the prohibition of factoring presents two negative effects for consumers.
The very big boys, looking to service the very largest companies, will be fine but they will face competition from life providers who go direct with a very strong brand
“One is that they see relatively large charges being deducted from their early contributions and as a result opt out of the group pension, thereby losing out on employer contributions. The other is that the employee bears the persistency risk; FSA data show that in 2003 less than half of GPP memberships set up by IFAs were still in force after five years, largely as a result of employee turnover. The upshot is that front-loading the charges for setting up the scheme is likely to have a detrimental effect on the pensions of these early leavers.”
Khalaf adds that under the current factoring system the pension provider bears a lot of the persistency risk and the FSA acknowledges that providers are subsidising initial commission from their own pocket and will not receive economic returns from the GPP business they have written if persistency levels continue to be poor.
“In other words, providers have been shouldering some of the cost of advisory services given to members,” he says.
Apsey believes that explaining high initial deductions can only be done effectively on a face-to-face basis with employees, where it can be demonstrated that while charges are higher in the short-term, over the longer-term they will offer greater value to employees.
He says: “If [communication] is not done effectively then employees are more likely to have a negative perception of their employee benefits. This is bad news for the employers as they are offering benefits that are not valued, bad news for the adviser because they have not given an adequate explanation to their clients and bad news on a wider scale if employees are not engaged with their pensions or other benefits.”
Hames says advisers will have to use common sense when it comes to dealing with upfront costs, and notes that this means keeping fees in single figures.
He says: “If you think about the fuss that was kicked up about Nest having 2 per cent initial charge and here we are at the other end of the spectrum talking about 30 per cent. How do those sit together?”
Providers, too, are concerned about the end of factoring. Scottish Life, which is hugely supportive of the move to consultancy charging, says that a “limited form of factoring”, such as spreading the advice charge over five years with either claw-back or exit charges on a standard industry basis “would have eased concerns without re-introducing bias”.
Goodeve-Ballard says the working party is open to suggestions on dealing with the ’knotty’ issues involved in consultancy charging, which suggests factoring may yet survive under an altered guise, although discussions are still very much in the early stages.
Concerns also hang over the dual charging structures that will exist after consultancy charging comes into force since all schemes set up before 2012 will be allowed to continue under the indemnity commission model. The FSA has attempted to quell fears that there will be a rush of advisers offering unjustified switch advice, promising to monitor this activity carefully, but commentators are sceptical that the regulator is really flexing its muscle.
Mark Futcher, associate at Barnett Waddingham, says: “We need to be careful about churning. It’s been outlawed and the FSA should have clamped down on that. The providers know who does the churning, they have reported them to FSA and nothing has been done.”
Although the final shape of the consultancy charging model remains unclear, it is already obvious that the new rules will create winners and losers. Advisers that have a large existing customer base driving the majority of their revenue will be well placed, but they can’t afford to be complacent.
The general public as a whole doesn’t value financial advice enough to be willing to pay for it.
Hames says: “Advisers who have a settled client base in a fee environment whose revenue is more driven by existing clients rather than new client acquisitions will be less effected but they will still have to engage with clients in a different way and use new technology and think differently.”
He adds that the very largest advisers, particularly those backed by significant capital and supportive shareholders, will enjoy a more certain future than some of their smaller counterparts but they can expect growing competition from providers and even the large accountancy firms.
“The very big boys, looking to service the very largest companies, will be fine but they will face competition from life providers who go direct with a very strong brand; Standard Life and Scottish Widows will seek to leverage more from their brand.
“[Advisers] are also facing competition from the accountancy practices like PricewaterhouseCoopers and KPMG who will come in and set up a scheme on a project basis and then step away leaving the life office to do the enrolling and so on, which begs the question why would you need ongoing advice,” Hames says.
For AWD’s Apsey the winners and losers in the post-RDR world are clear: “The winners will be the employers whose benefits are clearly communicated to and valued by employees and the losers will be those that are not. The winners will be the employees who receive good quality independent financial advice and guidance and the loser will be those who don’t. The winners will be the advisers who adapt to the new RDR world and the loser will be those who don’t.”
There will be an anxious wait for advisers over the next few months, with many stuck in limbo unsure what changes they should make to their business models and what they can communicate to clients. And while there appears to be a prevailing sense that the move to consultancy charging is a positive one with the lion’s share of savers set to benefit, for smaller advisers unable to keep pace with change, the proposals could be nothing short of disaster.