Retail Distribution Review

Written evidence submitted by Alan Lakey, Highclere Financial Services

COMMISSION – THE CONSUMERS CHOICE

The FSA is careful to only use research that supports its preferred proposition. This submission provides contrary evidence without the intrusion of personal opinion.

FSA research conducted by Oxera, in June 2009, 1 concluded, "…Commission can be seen as a margin that providers pay to intermediaries for distributing their products. On the face of it, providers have to pay this margin out of their total costs, and one would expect to find that levels of charges and commissions paid by different providers are strongly correlated. If this is the case, then higher commissions would be associated with consumer detriment. We know of no quantitative research demonstrating this to be the case, however."

"In the case of retail financial services, there is a perception that both product and provider bias has existed in the past, although actual evidence to support this perception has often been hard to identify. In a 2002 study for the FSA, evidence was found of provider bias, but only for single premium products, while there was no evidence of such bias for regular premium products. With regard to product bias, the study found evidence of this in certain products, such as ISA’s and investment bonds, but it was not widespread. Since then further research has reached similar conclusions."

The FSA accepts that the current UK system compares well with other countries. "Despite differing financial capability strategies, business models, remuneration structures etc, there are no models that have succeeded in tackling such issues in a way that has worked better than in the UK." 2

The FSA assures that it has no mandate to adjust commission rates but somehow feels it appropriate to reduce consumer choice by abolishing commission.

The RDR originated, in June 2006, with then FSA chief John Tiner. "Comments such as, ‘the current distribution model is broke’ were on peoples lips. In fairness, however, the team was quick to point out that for every statement such as this, you could always find a quite contradictory account elsewhere." 3 This repudiates the fiction that the RDR resulted from industry pressures.

Evidence highlighting the iniquity of commission is scant and the FSA admits that it is combating dubious thinking as much as reality. Sheila Nicoll stated, in November 2009, "We want to remove the influence of product providers over the remuneration of advisers and ensure that the perception, and indeed reality, of bias is removed." 4

Revealingly, nine months later, her colleague Peter Smith provided an alternative view, "Product bias will still be possible within the market but I do not think it is a feature of the restricted channel, I think it is a fact of life." 5

In searching for ‘financial nirvana’ the FSA is demolishing the financial services infrastructure and discouraging a significant number of consumers from engaging with the industry. During October 2008 JP Morgan research noted, "Interestingly, fee-based options appear highly unpopular with only 3% of respondents wanting to pay a time-based fee and only 5% welcoming the idea of an ongoing monthly or annual fee.  Commission paid by the product provider proved at least three times more popular than either of these fee-based alternatives." 6

A September 2010 KPMG survey disclosed, "A new survey by KPMG of over 3,000 consumers has found that less than a third would be prepared to pay for one hour's professional financial advice, and that of those who would pay over half would only be prepared to pay £50 or less while only one percent would be willing to pay over £200." 7

CRA research for the FSA, published in January 2002 2, highlighted that,

§ ‘The advice market is not riddled with bias.’

§ ‘There is no detectable bias on regular premium products.’

§ ‘The role of commission in stimulating the sale of savings products may be socially beneficial in the current UK situation.’"

It also offered the following conclusions;

Provider Bias: "It is often argued that providers offering higher commission will ‘buy’ market share. We did not find evidence to support this."

Payment Type: "It is often suggested that the trend from regular premium products to single premium products might be put down to differences in commission. This is contradicted by the fact that commission on regular premium is normally larger than the single premium equivalent."

Product Bias: "It is suggested that differences in commission could be the explanation for the growth in the investment bond market relative to the unit trust market. However, the RIY in both products appears to be very similar, suggesting that at least on this measure the impact on consumers is limited. Commission differences would therefore appear to be a reflection of how returns are divided between manufacturer and distributor rather than a source of detriment to consumers." 8

The FSA points to the CRA/ABI study from 2005 9 as proof that advice to buy unit trusts, rather than ISAs, causes annual consumer detriment of £70m. This conveniently ignores the findings of their own 2002 study, which revealed, "The initial commission paid is the same as the equity ISA and thus again while the advice led to a loss of the slight tax advantage of ISAs, it does not appear to have been induced by commission."

The 2005 study reached the following conclusions;

§ "No evidence of bias being present across the advice market"

§ "No evidence of bias to oversell"

§ "We therefore conclude that the problems of perception are greater than the reality"

The authors offered the following pertinent comment; "We concluded that there was no evidence that artificially moving to such a regime (fee only) would lead to benefits since consumers choosing to pay on a fee basis do not receive better advice than those opting for a commission basis."

A September 2010 study by CoreData Research revealed advisers offloading mass market clients. "The trend is being driven, in part, by hard-up investors either unwilling or unable to pay fees" 10

A January 2010 consumer poll by ICM found that 50% would refuse to pay anything for independent advice and would rather not receive advice at all. 17% say they would be willing to pay less than £25 p.h. and less than 3% would be prepared to pay over £100 p.h. 11

Commission Capping?

Another CRA report for the FSA, titled ‘An Empirical Investigation into the Effects of the Menu’, 3 May 2007 12, postulated the view that a form of commission agreement would work to the interest of consumers. "If providers who offer commission rates below the market average are encouraged to raise their rates, while providers who offer commission rates above the market average are encouraged to reduce their rates, then this could result in a reduction in the level of dispersion in commission rates without actually changing the overall market average. To the extent that information asymmetries could result in some consumers suffering particularly large detriment through purchasing poor value product due to high levels of commission, it is possible that this could nonetheless result in consumer benefits."

CRA9 also considered the benefits of standardising commission; "The different commission structures will make apparently similar products difficult to compare." It is notable that it did not consider the removal of commission as a valid option.

FSA/BMRB Consumer Research 65A 13, in Feb 2008, found; "Consumers were not at all concerned with details about how the adviser was paid."

In 2002 the FSA proposed a Defined Payment System for independent advice. However, cost benefit studies showed that there were various problems with this proposal as many customers were unwilling to enter a fee-based market, and advisers incentives to seek out new customers would be reduced. Evidence for this comes from various sources:

· 'IFA Promotion/B-different found that only 11 per cent of consumers were willing to pay fees (with 63 per cent preferring commission and 20 per cent preferring fees with commission offset); 'If we only knew our sell by date',

· Swiss Re (2001) found that less than 2.5 per cent of consumers were prepared to pay more than £75 and less than 1 per cent were prepared to pay more than £100.

· Continental Research found that 70 per cent of consumers thought that any fee should be less than £70.

· The FSA found that consumers were willing to pay an average of around £70 per hour or a total fee of around £130. 14

January 2007 found the OFT noting 15, "There are several factors that appear to provide a rationale for the use of commission rates in the financial advice market:

· Consumers tend to prefer paying by commission, despite the fact that this may cost them more in the long run than if they were to pay a fixed fee at the beginning. This may be due to a preference for spreading payment over a longer period, or because it gives consumers the perception of receiving free advice."

CRA 9 noted a NOP survey into consumers views of lack of value for money in financial services.

Commission based IFA 14%

Fee based IFA 42%

Possibly surprised at this outcome they justified it thus, "It is likely that this partly reflects the fact that commission based IFAs receive their commission through the product charges (and shoppers did not have to pay this) whereas fee based IFAs had to be paid through a separate cheque. As no purchase was made, this cheque did actually have to be paid by the shoppers.

This throws considerable doubt on the likelihood of the fee based market growing significantly in the light of depolarisation. Furthermore, it may also support the reason that most consumers start relationships with IFAs on a commission basis and later move to a fee basis once advisers have had the opportunity to demonstrate their value, which is hard to judge on the basis of one or two meetings and one piece of advice.

Commission based models has been heavily criticised by the Treasury Select Committee (TSC) and therefore it was important to test whether it might be attractive to encourage models of remuneration that were not conditional on sales, that is, encouraging the fee based sector.

A large increase in the fee based market, with remuneration that is unconditional on sales, is inconsistent with market realities. In particular, it is clear from the evidence in Chapter 2 that consumers do not like fees and are unwilling to pay them. That is, the amount that consumers are willing to pay as a fee for financial advice is much less than what it would actually cost to pay for advice through fees.

Based on evidence from consumer surveys, consumers would not purchase advice from advisers operating on a fee basis given the current rates of fees. Hence a wholesale move towards fees would lead to a dramatic decline in the advice market with a corresponding reduction in the number of consumers purchasing products and making long-term savings provision."

OFT 15 also commented, "Another interesting point to take from this CRA study is their conclusion that artificially moving to fee based regime would not lead to benefits, based on the argument that no evidence of biased advice due to commission is found, and as such consumers would not receive better advice if they were to pay by fee."

Commission has one further function, it provides an incentive for advisers to prospect for new clients. Searching for new clients using a menu of fees will fail for the simple reason that it introduces a negative into an otherwise positive situation. Additionally, FSA research has highlighted that consumers frequently need prompting. "Many went on to say that they were unlikely to have sought advice or purchased a product themselves without this convenient and proactive approach from their adviser". 16

The FSA is aware of market realities; "Commission-based firms do have an awareness of the profitability of individual relationships and are more willing, or have a greater need, to cross-subsidise over time. This reflects comments from intermediaries in the qualitative interviews that, for example, certain products (e.g. ISAs) are effectively seen as ‘loss leaders’ for the firm and that such work is done in the hope of either generating future business from the individual or to generate future referrals." 17

January 2011

References:

1 http://www.fsa.gov.uk/pubs/other/oxera_rdr.pdf

2 http://www.fsa.gov.uk/pubs/discussion/dp07_01.pdf

3 http://www.fsa.gov.uk/pages/Library/Communication/Speeches/2006/0614_jt.shtml

4 http://www.fsa.gov.uk/pages/Library/Communication/Speeches/2009/1118_sn.shtml

5 http://www.moneymarketing.co.uk/adviser-news/restricted-advice-will-bring-back-bias/1016699.article

6 http://www.jpmorgan.com/pages/jpmorgan/am/uk/press_office/tcf-from-the-horses-mouth

7 http://rd.kpmg.co.uk/WhatWeDo/23161.htm

8 http://www.fsa.gov.uk/pubs/other/pol_res1.pdf

9 http://www.crai.com/uploadedFiles/RELATING_MATERIALS/Publications/Consultant_publications/files/pub_4152/pdf

10 http://www.ifaonline.co.uk/ifaonline/news/1732336/advisers-offloading-mass-market-clients

11 http://www.moneymarketing.co.uk/regulation/public-reject-paying-fees-for-advice/1005356.article

12 http://www.fsa.gov.uk/pubs/other/CRAreport_menu.pdf

13 http://www.fsa.gov.uk/pubs/consumer-research/crpr65a.pdf

14 http://www.fsa.gov.uk/pubs/cp/cp121.pdf

15 http://www.dotecon.com/publications/crannexes.pdf

16 http://www.fsa.gov.uk/pubs/consumer-research/crpr70.pdf

17 http://www.fsa.gov.uk/pubs/other/deloitte_research.pdf