M uch has been written about non-providerfunded commission in the last few weeks but little has been said in the way of defining factory gate pricing and the options it will offer.
Let us forget about the world of financial services and think bathrooms. If you have ever had a bathroom fitted, I expect you will remember how much you spent on the bath, shower and units, and how much you paid the plumber to fit it.
You may have researched a range of products before the fitting took place, so you may already have known what your basic shower cost or how much extra you would have to pay for a power shower.
This is a process we all understand so why can’t we make financial products as clear? Well, we can. It is called factory gate pricing. In this model, charges are transparent, so customers know what they are paying for in addition to the basic cost of the product.
Instead of having a single charge to cover commission and provider expenses, the factory gate model separates the charges that cover adviser remuneration from other charges in the contract.
The provider expenses cover everything that is not paid to the adviser. This is the factory gate price – the equivalent of parts when buying your bathroom.
Adviser remuneration – the labour – is funded by an extra annual charge or by deduction from the gross premium before investment. The timing of the actual payment to the adviser usually matches the timing of the deduction of adviser charges, so indemnification is not common. The cost of manufacture and provider charges tend to be covered by a basic annual charge but there is nothing to say there cannot be flat fees or initial charges in addition or as an alternative.
Just like buying a power shower instead of just a standard one, a client may decide to pay extra factory prices for certain features.
The real flexibility comes from the adviser’s remuneration by deciding how advice and distribution is paid for.
Factory gate contracts tend to allow a variety of charge types to cover the adviser costs. These may include an annual charge (a percentage of funds under management), an initial charge (a percentage of premiums), a flat fee or an establishment charge (additional charges for a period but paid to the adviser up front).
Variations can include how long these charges apply for, so an adviser and client may agree that the advice is worth 10 per cent of regular premiums paid for the first five years and 0.5 per cent of funds under management thereafter.
I know you will be saying: “Sorry, but did he say ‘adviser and client may agree’?”
I did and why not? You do not use a plumber without getting an idea of what his costs are first. Neither does the shower manufacturer dictate what a plumber should charge for fitting the shower, so why should the provider of a financial product dictate what adviser remuneration should be?
There are many different financial advisers with varying levels of service and clients with diverse needs. Shouldn’t that remuneration reflects these variations?
Perhaps an adviser using factory gate contracts may decide to work a little like a fee-based adviser. Clients who receive advice but do not go through with a purchase still pay for that advice. This approach has several advantages for both client and adviser.
First, it emphasises the value of advice by placing it at the centre of the discussion. Clients get to understand what they are paying for. Second, advisers are able to build a long-term business model that generates ongoing revenue and rewards best advice rather than creating dependency on short termism.
Unlike entirely fee-based businesses, the factory gate business model allows for fees from successful sales to be paid by commission. As the fee is paid from the product, it can now take many more forms than just a lump sum and can be more tax-efficient for the client.
The perceived lack of transparency over the actual charges for advice in some contracts may raise concerns about meeting requirements on treating customers fairly. With factory gate contracts, these concerns are addressed as clients know the cost agreed with the adviser is the charge that will be deducted from the investment.
Factory gate prices, by definition, do not cover advice costs and this helps encourage persistency.
Why? Well, let us imagine an adviser whose advice is agreed as worth an extra 0.5 per cent annual charge. That adviser now has an incentive to keep the client paying in to their pension and making sure they keep it there.
Or maybe it is too hard for an adviser to move to solely fund-based commission so he takes a 3 per cent initial charge. Consider a £20,000 single-premium case where adviser and client agree £600 as the cost of advice. The client’s initial fund value is therefore £19,400.
But annual charges in the explicit model can be lower because they do not have to fund commission or cover the cost of associated capital. Lower annual charges mean the fund will grow quicker so while early years have a higher reduction in yield than stakeholder, it is better in later years. This structure gives a real incentive to hold on to the plan.
When a combination of short and longer-term remuneration options are used in this way, this can help to address industry concern through increasing the capital value of adviser firms as well providing customers with a greater understanding of what services they are paying for.
No doubt the debate over remuneration models will continue. So whether it is called factory gate pricing, non-provider-funded commission or consumer-agreed pricing, there is sure to be much more written on whether we should pay for parts and labour separately.