CP121 introduces the concept of a lower tier of financial advisers to provide the mass market with low-cost advice on simple products. However, we at AT Kearney question the overall commercial viability and feasibility of these proposals as they appear to fall down on three levels.
First, the commission that can be earned on simple Catmarked products means that a lower-tier adviser would need to reach superhuman levels of productivity to break even.
Second, providing regulated face-to-face advice would require the cost of supporting and delivering the sales process to be cut back to such a level that regulatory risks would increase to unacceptable levels.
Third, CP121 suggests very few ideas for increasing the motivation of lower-paid people to save more. The likely outcome is that those for whom stakeholder was designed will, yet again, be left behind.
Perhaps some of the above issues could be addressed partially through product bundling and developing innovative low-cost advisory processes. But we believe that the retail banks and big IFA firms, which are best placed to offer lower-tier advice, would be better served by building best of breed product multi-ties should they want to exploit the proposals outlined in CP121.
Restrictive product commission
We developed a cost-benefit analysis model to assess the financial aspects of the lower-tier advice proposals in CP121.
Using a set of standard assumptions for the typical cost of training and supporting a direct salesforce providing advice on four simple Catmark-style products (stakeholder pensions, Isas, conventional term insurance policies and traditional annuities), we estimate that a lower-tier adviser would need to achieve annual sales of over £480,000 to break even within three years. This represents 19 cases a week using standard assumptions for typical case sizes for these products.
This far exceeds the volumes currently achieved by direct salesforces, which are typically armed with a broader and higher-margin product range and which target more affluent customers than those whom CP121 is intended to benefit.
The main stumbling block in our analysis, which many will find in the FSA's propo-sals, is in trying to justify the cost of providing advice while the level of commission payable on Catmarked or 1 per cent products is so restrictive.
While CP121 calls for innovative forms of advice, the reality is most people trust face-to-face advice rather than online or automated alternatives. Therefore, in economic terms, either the restrictions on margins will need to be relaxed or providers will have to introduce some form of fee-based arrangement to make the proposals commercially viable.
On this latter point, assuming a more conservative set of assumptions in terms of sales volumes, our cost-ben-efit analysis model demonstrates that a provider would need to charge £110 for each financial review to make the proposals work financially. This may not be the best way stimulate a savings culture.
Essential support and advisory costs
The premise that lower-tier advisers can operate by slimming down the red tape and paperwork is unsustainable. To come close to operating efficiently while selling 1 per cent products, our analysis of the lower-tier advice concept indicates that the annual cost of supporting and training an adviser would need to be below £30,000, that is, around 25 per cent of the current level of operating a direct salesperson today.
This implies that only a very basic training and competence scheme can be afforded and that traditional advice-related essentials such fact-finds, key features documents, reasons-why letters and audit trails would need to be dispensed with or largely automated to enable customers to self-serve. Either option is likely to worry providers as automated advice, while likely to evolve in some form, is still largely unproven and the prospect of cutting back on regulatory procedures is likely to keep executives awake at night.
Limited impact on the savings gap
The intent of CP121 is to be commended but it is clear that many of the proposals in their current form have deficiencies and need to be thought through more clearly.
With respect to the proposals which are intended to benefit those in lower-income brackets and tackle financial exclusion, there is nothing in the document to increase the motivation of lower-paid groups to save more or for distributors to provide lower-tier advice.
Furthermore, as outlined above, the lower-tier adviser is likely to struggle economically, given the margin and cost pressures and the low premiums from lower-income savers.
As a result, the temptation will be for lower-tier advisers to target the more profitable middle-income market. Many customers in this segment may currently be served by IFAs, therefore resulting in yet another source of competition to IFAs, in addition to that which may evolve from depolarisation in the form of best of breed product multi-ties. Yet again, this will leave behind those for whom stakeholder was designed.
Responding to these challenges
Assuming that the proposals for lower-tier advice will be implemented as outlined in CP121, we believe that, to respond to the challenges outlined above, providers will need to develop bundled product propositions and new sales and delivery capabilities to exploit this change in the market.
In terms of product offerings, given the margin pressures, lower-tier advice will only make commercial sense if the regulated packaged products outlined in CP121 are sold alongside other currently non-regulated products, such as mortgages or general insurance, to increase income and case sizes. Therefore, we believe that potential lower-tier advisers should consider how they could best bundle a range of products within a combined product offering.
In terms of new sales and delivery capabilities, lower-tier advisers will need to develop a low-cost operating model to target and attract customers to the sales process, to automate significant elements of the sales process while ensuring that customers are sufficiently reassured in the absence of a face-to-face adviser to proceed through the process and actually transact and, finally, to ensure a compliant process exists from a regulatory perspective that can be delivered and supported at low cost.
Will there be any winners in terms of financial institutions? We believe that the major retail banks are potentially well positioned to offer lower-tier advice as many have the essential components in place, for example, access to simple packaged products and a range of non-regulated products to create a bundled proposition, access to customer profiles and established relationships to enable low-cost and effective targeting of potential customers.
However, we question whether the banks will be sufficiently motivated to embrace lower-tier advice, given the cost and profitability challenges of the proposition and the regulatory risks associated with what are effectively low-margin and low-premium products.
With regard to the depolarisation proposals, retail banks may be better served by concentrating on how to make multi-ties work.
The bigger IFAs may also be tempted to take advantage of the lower-tier advice proposals. The proposals could present an opportunity for bigger IFAs to move less profitable customers into a pareddown advisory service and thus allow their more experienced IFAs to focus on higher-value customers.
However, IFAs contemplating this route will need to manage a number of challenges, such as how to ascertain a customer's potential profitability before committing expensive advisory resources to the sales process and then to steer the person down the appropriate advisory channel.
There will be the inevitable risk to the IFA's brand as customers confuse the partial service offered by the lower-tier adviser with the full service expected from a fully qualified adviser.
These challenges are additional to those relating to financial viability and regulatory risk outlined above.
As with the retail banks, as an alternative to the lower-tier advice concept, the option of building a separately branded distributor firm to offer partial advice on a limited range of best of breed but higher-margin, products may prove more attractive and feasible to IFAs who want to try something adventurous.
Overall, we believe that financial institutions wanting to capitalise on the depolarisation proposals should make their investments elsewhere.
Unless the FSA's proposals are revised significantly, we remain unconvinced that customers will benefit and that lower-tier advisers will ever pay their way.