2013 is the year when a large proportion of advisers will be taking a long, hard look at their suppliers. Platforms, adviser technology providers, networks and DA service firms will all come under scrutiny as advisers look to forge the right partnerships that will help them to thrive in a post-RDR world.
And the most important decision for a large number will be to do with networks. Firstly, should I be part of one? And then (if your answer is yes), which one should I choose? While the answers will be depend upon the proposition you want to deliver to your clients, your long term business plans and your personal appetite for risk, I have compiled a checklist that I hope you find helpful.
The first five questions are all based around the fundamental and critical conundrum, “Is your network likely to survive RDR?”, because let’s face it, if your answer isn’t a resounding yes to this, there is no point proceeding on to questions 6-10.
1. How well has it managed its liabilities in the past?
Or to put it another way, “Can it secure PI insurance – for itself, for you and at a price you can both afford?” The demise of Honister amply demonstrated the consequences of inadequate compliance. If the PI markets lose confidence in you, it is game over. One of the recurring certainties in financial advice seems to be that some of your actions in the past (no matter how well intentioned at the time) will come back to haunt you – you just don’t know when or how much it will cost. This has led to even fewer insurers willing to provide advisers and networks with PI insurance. One of the tangible advantages of being in a large network is the ability to obtain PI insurance – but the cost and quality will vary considerably.
2 Is the network profitable?
This is important. Making sustainable profits is the cornerstone of any business. Why would you trust your business to a group who can’t run a successful business themselves? And every successful business needs to be profitable – or one day its right to exist must surely be seriously questioned. The problem is, very few networks are profitable and even those that do sneak into the black don’t do it particularly convincingly. Sesame Bankhall Group, a business that has prided itself on delivering annual profits, only made £2.2m in 2011 on total revenues of £170m, and its AR network actually posted a loss of £2.5m (after paying out a massive £11.4m in claims).
Openwork, a network that has never made a profit, posted a whopping £13.3m loss last year (which was put down to accounting anomalies and restructure and RDR costs). Intrinsic was £2.5m in the red (also due to RDR), Tenet posted a £300k loss, Positive Solutions lost £106,000. Lighthouse made a tiny profit. Even though many of these networks are forecasting profits in 2012, this is a sector that has been doing it tough for years – and for many, the truly difficult times are still to come.
A sub-question to this one is, “What is the network doing to streamline its operations?” Just like everyone else in retail financial services, networks need to reduce their on-going costs. With very few exceptions, you are likely to find that their people costs are too high, their processes are too complex and not customer-centric, their use of IT is ineffectual or they are burdened with a mountain of shareholder debt (and sometimes all four!).
Demonstrating a track record of sound financial management is important; however it is also backward-looking. What you really want to know is the likelihood that the network will be sustainably profitable post-RDR. Network revenues will inevitably take a hit due to a decrease in revenues from investment business. How well has your network modelled this and are you comfortable with their assumptions?
3. Is its business model sustainable?
This is the big one. The traditional network business model has been transparently broken for much of the last decade. If it wasn’t for life companies “investing” in networks (primarily due to a misguided fear of losing market share if they didn’t) very few would still be operating. The revenues generated from member fees and keeping a slice of commission have rarely outweighed the extortionate costs of compliance and redress. And the almost unlimited and unquantifiable liabilities inherent within the network business model have valued most networks at little more than the amount of cash in their bank accounts (and sometimes several tens of millions less!). So, they had to do something.
The likely survivors have managed to diversify their revenue streams through a combination of:
- Strengthening the mortgage and protection parts of their business (which will offset the inevitable downturn in investment revenue next year),
- Expanding into other related services such as conveyancing,
- Offering advisers the choice to be IFA or restricted, and perhaps even
- Offering advisers the choice of being directly authorised or an AR of the network.
- But the key driver of elusive shareholder value for networks is exactly the same as that for IFA firms – building recurring revenue streams.
It is really only the threat of RDR that spurred the vast majority of networks on to create their own fund management arms and building their own investment platforms, … both critical to their future.
You especially need to understand your network’s strategy in these areas. Is its fund management strategy robust and does it add genuine value to the investor? Is its platform strategy robust? Will the network’s advisers embrace it?
To be amongst the survivors, your network must create recurring and compounding revenue streams, primarily through building substantial funds under administration on their platform. Are you confident they will do this? Will you and your fellow network members work with them to make this happen?
Platforms and fund management have the potential to transform a network’s business and perhaps even (finally) generate genuine long term shareholder value. But it will take time. So the next questions you should ask is, “Does the network have the capital reserves and genuine shareholder support to weather the oncoming storm?”
4. Does it have the capital reserves necessary to satisfy the FSA’s “plausible but nasty” scenario within their Threshold Condition 4?
In other words, in the eyes of the FSA, is the network solvent – and likely to remain so? Obviously I don’t have to stress how important this is. Just ask your network the question and probe their answers intensely with a quizzical and hyper-critical eye.
5. Are its shareholders genuinely willing to stand behind the business if it gets into trouble?
I have used the word “genuinely” on purpose. Every Lifeco with a shareholding in a network will say they stand behind their investment and that they have put their brand and reputation on the line. The “conventional wisdom” is that the FSA will take a very dim view of any Lifeco that lets a network fold, but I am not so sure this is as true as many would like to believe.
In 2004, Skandia closed its Bankhall network which at the time was the second biggest AR network in the industry with around 6000 members. It doesn’t seem to have done this insurer any long term reputational damage whatsoever. Commercial reality will come before esoteric reputational risk every time. My rule of thumb is … if the network actually delivers significant business to its life company shareholder/s, there will be a commercial imperative to continuing to support it through the difficult times ahead. Very few networks have such a symbiotic relationship with their shareholders.
In fact, in the past, some IFAs have gone out of their way to not sell the products of the Lifeco that owns shares in their network. Such a Quixotic act of independence may backfire badly in a post-RDR world. The best way to ensure your network’s survival post-RDR may actually be to champion the cause of its shareholder/s. Another sweet irony of the new world in which we will find ourselves in just a few short weeks’ time.
… to be continued. Questions 6-10 to be published next week.
Campbell is managing director of consulting firm, Campbell Macpherson & Associates. His career has included executive roles in Openwork, Zurich and Sesame.
PS: Questions 6-10 will be:
6. How are the network’s directors remunerated?
7. When it comes to PI insurance, are you costing me money or saving me money?
8. Why shouldn’t I become directly authorised?
9. What happens to my trail commission if I leave?
10. How can you help my business become outrageously successful?