The commission system for long-term savings in the United Kingdom creates the potential for advisor bias and, as a result, independent financial advisors (known in America as brokers) need to become genuinely independent, through changes in the system of remuneration, says a report of the U.K. long-term retail savings market.
Research conducted by the U.K. regulator, the Financial Services Authority, “found statistically significant evidence of advisors recommending one providers offering over another because it paid a higher commission,” according to the “Sandler Review,” an analysis of the U.K. retail savings market, under the direction of Ron Sandler, the former chief executive of Lloyds of London.
To prevent the inherent conflict of interest, make it more difficult for commission bias to exist and create stronger commercial incentives for IFAs to become genuinely independent, the review suggests that remuneration should be “the subject of negotiation purely between the advisor and the consumer with no provider involvement.”
“I am keen to see advisors rewards, even if not paid in the form of an upfront fee, being negotiated between the advisor and his client, rather than determined by negotiation between advisor and provider, from which so many perverse incentives flow,” says Sandler in the forward to his report.
“This method of payment would enable the development of a properly functioning market in advice,” the report continues. “Consumers would be much more aware that they were purchasing advice, distinct from the product, at a cost.”
The report suggests that the payment could take a number of forms:
- A conventional hourly or fixed fee, which would be paid regardless of whether a sale was completed;
- Contingent on a sale, as commission is currently;
- Expressed as a percentage of the value of the assets under management.
“At the start of a relationship, and periodically thereafter, the advisor would present the consumer with a tariff sheet setting out his charges,” the report says.
The review recommends that the independence of an advisor should be compatible with a sales-contingent fee.
“Making payment for advice contingent on a sale of some sort tends to bias the advisor against recommending that the consumer do nothing, even if that is the best advice,” the review notes.
The definition of an “independent advisor” should be that he or she is an advisor who is not paid by a provider, the report says, adding that the use of the word “advisor” should be restricted to those who meet this criterion for independence.
“While advisor covers a wide range of relationships, it principally carries the connotation of acting solely in the interest of the client,” the review affirms. “A term such as financial product distributor more accurately describes an advisor whose remuneration arrangements are decided with product providers. Restricting the use of advisor in this way would enhance the value of independent status.”
The review recommends greater transparency about the true commercial relationships between providers, distributors and consumers, so consumers are less likely to perceive commission-remunerated advice as free.
The report also discusses the problem of “consumer weakness.” In other words, the complexity and opacity of products contributes to “the wider problem of consumer reluctance to save, particularly in lower-income segments,” the review says.
Such “consumer weakness” leads consumers to rely heavily on advice, the report says.
“The dominance of advised sales means that the focus of competition for providers is on winning distribution rather than on providing simple, good value products at the end consumer,” the Sandler Review contends.
The review notes that the predominance of such “advised sales” has two implications for the functioning of the market:
- It transforms the basis of competition among product providers, so that the “real consumer for the product provider tends to be the advisor, rather than the consumer.”
- It has a fundamental impact on the economics of distribution since advice has a fixed cost element. “However modest consumers incomes and however simple their financial affairs, a certain minimum amount of time has to be spent gathering relevant information about them and informing them of all the options,” the report says.
While it generally takes longer to advise affluent customers who may have more complex needs, “the increase in time is not normally proportional to the increase in wealth,” the report says.
“A consumer with 100,000 to invest does not take 10 times longer to advise than a consumer with 10,000 to invest,” the report says.
Since fees are paid as a percentage, this system “encourages advisors to concentrate their efforts on the more affluent consumers,” according to the report.
Regarding commissions, the report notes that there is evidence from consumer research carried out by the FSA that consumers of financial advice feel that fees, as opposed to commissions, are preferable, due to concerns commission might bias advice.
“However, the same research found that most consumers were not prepared to pay the level of hourly fee that fee-based IFAs are currently charging. The appropriate hourly fee suggested by consumers for IFA services ranged from 10 to 200 per hour, with an average of 70, against the range of fees actually charged of 120 to 250 per hour.”
(The Sandler Review can be assessed online at www.hm-treasury.gov.uk.)
Reproduced from National Underwriter Life & Health/Financial Services Edition, August 5, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.