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Commission chaos

Lies, damn lies and commission equivalent. It’s the information age. Everybody has access to more information: more is good, even more is better. Unless, of course, it’s misleading information.

This is never more true than with the new menu regime and the concept of commission equivalent. This information often appears to show significantly higher or lower levels of commission being paid to tied advisers or product providers’ salesforces than to IFAs.

But before explaining why this happens, it is important to ask some fundamental consumer questions:

Does the menu have any bearing on the cost of the product to the customer? No. The customer does not pay commission or commission equivalent, the customer pays charges. Do the charges vary according to the channel used? No. There is normally no channel bias with respect to charges on investment products.

Does Legal & General, for instance, pay agents 7.5 per cent commission on unit trusts as the menu might appear to show? No it does not.

Why then can the comm-ission equivalent be so much higher or lower than the market level of commission? Quite simply because the calculation approach is entirely different – it is comparing apples with oranges.

The FSA requires product providers to use commission equivalent wherever advisers are funded in any way other than through a straight-forward arm’s length commission arrangement. The fundamental idea is that commission equivalent should measure and include all the costs that would have to be met from the open market commission paid to an IFA or multi-tied adviser.

For a tied agent firm, that is usually easy. It receives commission and may get other benefits and services (for example, computer software or business support services) from its host pro-vider. These costs are added on to give a comparison with an IFA that can’t accept such benefits or services.

When a life company sets commission rates for tied agents, it is likely to aim for an overall cost of generating new business that is similar to that for IFA business. (If one channel is significantly more expensive than the other, why use it?)

But sales through IFAs involve significant broker consultant costs as well as commission and there is no equivalent role in relation to tied agents. As virtually all costs relating to tied agents have to go into commission equivalent, it is likely that this will be higher than IFA commission.

Life gets even more complex for a life company’s employed salesforce or a bank selling products from an in-house life company or fund manager. The rules say you have to add up all the advisers’ salaries, benefits and related costs – such as accommodation and office support – and apportion the total across the sales made.

Just how you apportion costs between products, taking into account relative bonuses or the relative values of different products to the firm, is an art form in itself.

Then there is the issue of bank branch costs. Branches are often in prime locations and full of costly technology and security equipment. Advisers do not need or use all this, so there is lots of scope for debate on how much to include in commission equivalent calculations.

Finally comes the vexed issue of a profit margin. Adviser firms paid through commission hope to make a profit from it after paying all their costs. So it seems logical to add in a profit margin when calculating commission equivalent.

The snag is, what should you add in? All FSA prescribes is an assumed profit margin of 15 per cent “unless the firm can demon-strate that another figure (higher or lower) is more appropriate”.

A Bank that receives open market commission on lump- sum investment products sold to customers with substantial deposit balances should be able to generate a profit margin well in excess of 15 per cent, even taking into account the cost of those expensive branches.

But a bank selling similar in-house products is unlikely go out of its way to add a much higher profit margin than 15 per cent into its commission equivalent calculation. The result? A remarkably low level of commission equivalent is disclosed.

Is it surprising that commission equivalent, given a wide variety of different business models and some quite subjective calculations, often ends up producing quite different answers from open market commission rates?

If you’ve managed to read this far, do you still believe consumers can safely draw conclusions from such comparisons?

From where I am sitting, the answer is a definite no. At the end of the day, it is not a “notional” commission figure that really matters to customers, it is the charges they have to pay.

John Maud is strategy director at Legal & General


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