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Wading into the River of commission
One of the beauties of the internet is that it allows anoraks like me the opportunity to trawl up and down the backwaters of archived commentary and analysis, turning up all sorts of weird stuff that few people have either the need or desire to remember.
It is amazing what you stumble across the minute you start clicking away. For example, only last week I read a letter in Money Marketing in which West Midlands IFA Frank Dennis railed against FSA proposals to do away with commission payments for IFAs.
Frank referred to a report on commission prepared for the ABI by research firm Charles River Associates (CRA) in 2005. This, he argued, “found little criticism of the commission system of remuneration”.
As soon as I read his comments, this particular report struck a vague bell. Just in case, however, I thought I had better go on the internet and check it out. Within a few clicks, I stumbled on to a site called PanaceaIFA, a “community” for small directly regulated IFAs who come together to help each other with information relevant to their work.
There, embedded in an article published last December, was a link to the report in question. But what was also interesting was the article itself. In it, the author tells of how he received “some very interesting yet disturbing information” from Alan Lakey, a fellow columnist on this paper.
Basically, Alan had also been carrying out some research and, mystified by references to work carried out by CRA on behalf of the FSA in 2004, had sought to obtain this report.
It subsequently turned out that the report in question was the one prepared for the ABI one year later.
According to the PanaceaIFA report: “The conclusions [of CRA] support the majority of the arguments that IFAs and others have been using against key aspects of the RDR.”
Yet, the writer says: “To our knowledge, this document has not previously made it into the public domain and very possibly with good reason. Why the secrecy?”
But the publication of the research was commented on within the trade press by many leading figures in the financial services industry.
At the time, the ABI put forward a proposal whereby IFAs would no longer be paid by means of a big up-front commission but by a much smaller, regular stream of lifelong income, set out in an annual state- ment given to clients.
At the time, I wrote saying it was nonsense. More important, David Severn, then newly appointed director general at Aifa, had great fun ridiculing the idea, asking whether this would be the preferred method of payment for the research work carried out by CRA.
The CRA report was dissected and widely written about by senior industry figures.
Contrary to the idea that there was no harm at all in commission-based systems, the CRA report actually says that its research found that this had “not got worse” compared with research it had itself carried out years earlier - in this case on behalf of the FSA in 2002.
What did the FSA report say? Well, in a mystery- shopping expedition, one in five consumers needing to make a lump sum investment were not recommended an Isa, as they should have been. Instead, they were advised to buy a product paying, on average, 5.7 per cent commission compared with 3.1 per cent for an Isa.
One in six people who went to an IFA and 5 per cent of those who saw a tied agent were recommended a unit-linked bond from a life insurer.
This was considered to be an inappropriate product by the expert panel that subsequently reviewed the advice. The average commission paid on sales of unit-linked bonds was 7.1 per cent, while its closest substitute, a unit trust, paid 3.4 per cent.
The CRA report in 2002 calculated that the “consumer detriment” of commission bias was about £140m a year, relatively little in terms of annual premiums of £10bn at the time - until you read that it deliberately avoided looking at the effect of bias between similar products on offer from different providers, paying different levels of commission.
I appreciate that one IFA’s definition of “little criticism of the commission system of remuneration” may differ from mine. But I still think that it would be a mistake to view the 2005 CRA report for the ABI as giving advisers a clean sheet.
Nic Cicutti can be contacted at nic@inspiredmoney.co.uk
Readers' comments (7)
Alan Lakey | 14 Jan 2010 9:41 am
Nic is quite correct in stating that the ABI and earlier FSA funded research found incidents of product bias.
Both reports highlighted that apart from single premium with profits and distribution bonds tere was little evidence of bias.
Both reports stated that bias was not evident in any regular premium savings plan.
The ABI version also made tow pointed comments. "No evidence of bias being prevalent across the advice market", and, "We therefore conclude that the problems of perception are greater than the reality".
Perhaps, more telling, was the following observation. "One of the models tested was a fee based model - we concluded that there was no evidence that artificially moving to such a regime, to the exclusion of commission, 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."
In conclusion, there will always be a minority who seek out the best deal for themselves. This is human nature and should be dealt with in two ways - firstly by capping commission and making the rate the same for bonds and unit trusts.
Secondly, by the FSA actually regulating as opposed to trying to change a system where the impact on 95% of advisers is the price for 'regulating' the 5% minority.
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Alan Mellor | 14 Jan 2010 5:07 pm
Good article Nic, does any adviser who has worked in this business for a little while belive truly that commission does not bias advice. Whether fees are different and all the rest of the noise aside. Self interest colours thoughts and actions clearly, the challenge is to ensure this natural bias is kept in check. Clients agreeing a charge with an adviser must be better than this charge being set by a third party.
Any one care to agree? Be honest now...
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SIMON MANSELL | 14 Jan 2010 8:46 pm
There seems to be a conventional wisdom" shared by the chattering classes who unfortunately often repeat but but never challenge this wisdom. The problem being: "A lie told often enough becomes truth", and certainly this lie has found its way into the popular mind set of regulatory policy as evidenced in the FSA Retail Distribution Review. Dr Huertas, Director Wholesale Firms Division FSA summed this misguided belief up when he stated: 'Commission-based distribution arrangements tend to lead to conflicts of interest and may result in mis-selling." The Dr went on to say: "How do we solve this conundrum? We are genuinely interested in working with banks to find a way to do so." I might add this was before Northern Rock and the rest fell apart under the FSA watch! We don’t hear te good Dr telling us how the banks are going to solve this bias!
It came as no surprise to me that when challenged to provide evidence to support this myth they struggle. Dr Hueratas for example was unable to site any authoritative study that supports this anti commission proposition.
Commission democratises advice and incentivises sales. It provides "free" advice for those who do not purchase at the risk of exposing them to the challenge of protection against the consequences if death, illness and retirement. Whilst it gets the blame for many ills it should also gain the credit for being the driver behind making Britain's private pension and savings larger than the rest of the European Union's combined, that was before Crash Gordon and the FSA.
Intangible product are sold and not bought and this fact is supported by the debacle of Stakeholder pensions where the anti commission myth took hold and has resulted in fewer personal pensions being sold via advice to individuals quite simply because there is no provision for the cost of advice within the Stakeholder charging structure and many client have an aversion to fee payments. This may be a surprise to those that have never sold as much as a paper bag but it is a reality articulated time and time again by our clients. They "do not" want to pay fees! Association of British Insurers statistics report that the number of new regular premium contracts has fallen by 61% since 1998: http://www.fsa.gov.uk/pubs/cp/cp05_08.pdf section 2.12
The "commission myth" as manifested via Stakeholder has meant that many consumers who should be saving for their retirement are now not given the advice and access to personal pension products that they need and the Retail Distribution review proposals will accelerate the demise of the independent sector.
So in the face of FACT why use Myth. Well perhaps the truth may be found in the writings of Adam Smith the economist 200 years ago. He understood that markets operate automatically and he also understood that that that they can be perverted by vested interest, who use government power to distort this free market system for their own benefits. Adam Smith goes on to say that proposals for any regulation ought to be listened to with great precaution and suspicion as they come from men whose interests is to deceive and even oppress the public. It is a FACT that RDR contains so little fact, logic or substance that it can only be seen from the perspective of those who would benefit from its implementation.
"It is hard to imagine a more stupid or more dangerous way of making decisions than by putting those decisions in the hands of people who pay no price for being wrong."
Source: Thomas Sowell
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John Blackmore | 15 Jan 2010 12:24 pm
@ Alan Mellor. Yes Alan I do care to disagree. Commission does not and never has biased my advice. Not sure what you mean by "a little while" but hope that you will accept that 30+ years qualifies ? More recently 1992 I switched to a fund based model. Taking 0% Initial + 0.25% to 0.5% pa I think my approach would stand up in comparison with a fee based alternative.
Somehow changing the 0.5% pa commission into a fee is going to change me from a corrupt salesman into an Angelic adviser ? Baby and bath water comes to mind.
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Alan Mellor | 15 Jan 2010 2:06 pm
John,
You are assuming my thoughts rather than answering my question. Your model looks clear and transparent by the way.
My point was that a third party setting the amount charged to a client and how the client pays seems a poor way to meet the cost of advice. My question was whether commission biases advice, my experience (20 years for what it's worth) is that it does in many cases. Have you not reviewed a case by another adviser and been amazed by the poor advice and size of the commission? Not exclusive I know to commission based advice, but surely if the client has to agree to pay £x rather than half a groat a day for the first three and a half eons, then the client will understand their payment for advice more clearly and be better informed and able to take a good decision in their own best interest.
To any one else who is whiter than white, that's great but don't you think commission biases 'others'?
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John Blackmore | 15 Jan 2010 2:50 pm
Alan - I'm happy to concede that there are those who see little beyond how much commission they can make.
My belief is that these same people will maximize their fee earnings by doing unnecessary work in order to justify their fees.
Perhaps where we differ is in our views on the ability of clients to understand how they are paying ? You say "Surely " I'm not so sure.
IEven today I see people being ripped off by so called Fee advisers - hardly understanding what is going on.
Now if clients had to pay the fee directly by cheque I would agree with you - but in most cases the commission will simply be re-labelled as fee and deducted from the fund.
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Peter | 19 Jan 2010 9:54 am
I still can't quite understand why the problem couldn't have been more easily solved by limiting commission on any investment product to the same percentage, regardless of product.
It's not that I'm particularly set against fees / qualifications, just that from experience of other professions (and indeed our own industry, profession, occupation or whatever monica you care to use), fees and qualifications don't automatically solve the problem.
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