Contingent charging is being thrust into the spotlight again as clients continue to pay for defined benefit pension transfers, but an outright ban does not look imminent.
The FCA has long warned charges that depend on a particular outcome – ‘contingent’ fees – are a higher risk for IFAs. They may not affect the outcome of the advice, just as commission may not have – but they sit uncomfortably with the new fee-led advisory world for many.
It is particularly uncomfortable in the context of DB transfers. The sums are large, the decision often finely balanced and the right option is unique to every client. It is also an area where the regulator is already taking some considerable interest.
Yet a survey of advisers by AJ Bell in June showed that around half still charge on a contingent basis for defined benefit pension transfers. Clients pay a percentage of the transfer value, and advisers only receive payment if the transfer goes ahead.
SimplyBiz recently had a deal with Selectapension where advisers received a 40 per cent referral fee if a transfer went ahead. National advice firm True Potential has controversially handed out leaflets advertising its final salary transfer scheme to members of the British Steel Pension Scheme – onstensibly to generate advice fees.
At first glance, the conflicts of interests are clear. Capital Asset Management chief executive Alan Smith says: “It’s down to the magic word ‘incentives’. If you study a lot of the negative incidents in financial services over the previous 25 to 30 years, you can trace them back to poor incentives.
“As human beings, we are prone to enlightened self-interest. We can tick boxes and be compliant, but if course of action A brings in nothing, and course of action B brings in thousands of pounds, it is an ethical and moral challenge.”
He notes the FCA’s starting point is that the majority of those with DB schemes should not be advised to switch, yet the actual percentage of those being advised to switch is far higher. There is also a cross-subsidy issue: in theory, those clients that receive a free recommendation to stay are being subsidised by those that leave.
The FCA, for its part, stops short of an outright ban. The rules currently state that when an adviser charges on a contingent basis they should consider conflicts of interest and ensure there are “appropriate controls” in place.
FCA director of supervision Megan Butler (profiled on page 8), says: “We have been very clear and have reminded firms that we expect them to manage any of those potential conflicts of interest. We all recognise there is an inherent conflict of interest so firms need to be very careful about how they are managing it.
“Be really clear on what the costs are, what the fees are, where they are going and, importantly, and this is a point we are trying to emphasise, this is not just about the upfront fee. It’s about the fees that are actually embedded in a fund that may be the destination. We would observe that there is a focus on the initial fee, but less focus on the ongoing charges, some of which can be very substantial and they are sufficiently substantial to be relevant to the decision as to whether that final destination is suitable.”
The case for contingency
The arguments for contingent charging are often based around the willingness and ability of the client to pay for advice to remain in a DB scheme. Supporters say many clients don’t have the money upfront to pay for the advice and therefore can only pay from the fund. They also point out that this type of charging is commonplace in other professions. In conveyancing, for example, homebuyers do not always pay when the transaction does not go through.
Equally, if an adviser gives bad advice on DB transfers, there is still a regulatory backstop for the client, regardless of charging structure.
Regulatory consultant Rory Percival says the regulator is likely to stop short of an outright ban, but advisers should not neglect the advantages of introducing non-contingent charging.
He says: “One non-contingent charging firm I work with said that clients liked the transparency of this type of fee structure. It meant they could completely trust the advice they were given, and they thought they were getting more clients as a result.”
While there is a psychological challenge to changing fees, many who have done it are pleased with the result, and it had not been a significant issue for clients.
“It is not all or nothing,” Percival adds. “You can do it on a trial basis for a period of time, or offer a choice.”
Wingate Financial Planning IFA Alistair Cunningham says his firm does not allow pension transfer advice to be paid for from the pension fund. They have had no negative feedback from their clients on it, who understand what they are getting.
Finance writer and former adviser Jason Butler says: “The cost of the advice should be the same whether a transfer is recommended or not and the advice firm should presume that the client will arrange any transfer transaction themselves when determining their advice fees.
“Transacting a transfer is a separate service and can be provided by any firm, whether they have the original advice or not, and should be subject to a separate fee, but which reflects the actual work involved (not much) and risk to the firm (very little).”
Others are convinced a ban is needed. Montfort head of financial planning Eugen Neagu says: “A rule must be implemented whereby each firm should instead charge a minimum amount which covers the cost of its advice to the client may a transfer not subsequently ensue.
“We found the regulator very reluctant this summer, however I believe they are now under pressure to reconsider their initial strategy.”