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Chain reaction

Winchester White director Aileen Croft questions the pay now, reap rewards later value chain for life cover and pensions and says a new model is long overdue

We are nearing the crossroads of distribution models for the long-term savings and pensions industry. Some would say we have been there for many years but have not been able to decide the right direction to take. The industry is over-reliant on the IFA/multi-tie sector for distribution – upfront commissions/fees for future value add is not sustainable, and is at the heart of the dilemma facing the sector.

A recent article on the pensions and long term savings market included the statement: “This is a value chain without any value in it.” This might give a clue to what is stifling the creation of the next generation of life and pensions delivery for the UK.

The use of the value chain (developed by business guru Michael Porter in the 80s) as an analysis tool for the life and pension industry is fundamentally flawed.

Within the industry, we have a mixture of service chains and value chains, where the delivery of the end product to the customer occurs many years after what is termed “the sale”. The long-term savings market does deliver value to the end customer – provided it is viewed as a long-term product by everyone involved in the “value chain”.

In a normal manufacturing value chain (for which Porter’s model was originally built), each component derived its payment for the value add on delivery of its end product. In simple terms, the raw material is transformed by the manufacturer and sold to the distributor, who then sells it on to the end consumer.

In the financial services industry, the product is built over the lifetime of the contract and the inputs are provided by the end consumer, who has paid the distributor upfront for a product that they won’t have for, in some cases, 25 years. We all know this is at the heart of the industry’s problems.

Policies are purchased (or sold) for the long term but the distributor is paid almost immediately. No wonder that we have experienced misselling and loss of trust in the industry.

If we are to continue to use the traditional value chain analogy, we must draw from it how we retain and deliver to the end customer the real value that exists in the long term savings value chain. We tend to obscure this value from the consumer by a distribution model which erodes value in the early years of the policy.

We have now moved on to viewing financial advice as a product in itself, which takes us part of the way on a journey away from the commission environment and all the negativity it conjures up. But the industry still designs commission payment into the product and fee-based advice is more often than not funded by this commission. So is advice a stand-alone product or not?

Obviously, if it results in no investment, then it is clear (in the fee-based model) the client will pay for advice “out of their own pocket”. That value chain can comprise purely of the delivery of advice but once the advice is wrapped in a purchase, the lines become blurred between the “advice” value chain and the “long-term savings” value chain.

Putting this grey area aside, fee-based advice works for the high-net-worth individual but the ideal model for the remainder of the market will require something smarter than that.

Let’s take a simple product example. Buying term protection online via an IFA web-site, where it could be argued the value add is merely pulling comparisons together, still pays the IFA an initial commission that is designed into the product by the life company. So the consumer gets no real advice and uses a cheap channel (for the IFA) but the life company is paying the same distribution cost – or, in some cases, more.

There is a need to ensure that the provider of financial advice can have a viable business and the current model tends to perpetuate the longstanding model of upfront payment for future, potential, value add.

Other countries have successfully adopted models that are based on, for example, funds under management or trail fees. Therefore, we know it is possible to operate efficiently without the commission basis for rewarding sales.

However, in the UK we are dancing around the real obstacle to change – which is the power of the distributor in the current environment. The IFA/multi-tie sector has a 70 per cent market share in APE terms, which has risen consistently over the years at the expense of the tied channels.

The industry is, therefore, more and more reliant on IFAs to provide access to the market, and is willing to invest in and support these operations to keep this access channel open – even if these businesses make little or no return for them.

Investment in networks by life companies over recent years has confirmed that the industry cannot see a way to get their products to market other than via expensive and, in many cases, unviable multi-ties.

For as long as the balance of power remains as it is, it would take a very brave life company executive team to break away from tradition and move over entirely to a model delivering “sales” payment over the policy lifetime (as value was created).

The industry has shown its ability to adapt over the years to external regulatory and legislative changes. Now would be a good time for the collective brainpower and the huge resources within the industry to create a sustainable model for the future, which will help to shed the givens of the past and the horror stories associated with it.

Perhaps the solution will require a collaboration within the industry that it has not achieved to date. The purpose would be to support the distribution channels through the transition from the current short term reward to a model which builds an in-force book for the distributor.

This model would deliver reward for the value add over the lifetime of the savings or pension plan. This arrangement already operates in the UK for general insurance, so perhaps we can create a value chain where the value is transparent for each element of the chain and over the lifetime of the policy during which value is created?

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