I am currently reading a book about how small changes in the tide can have big effects on communities, either decimating or rejuvenating them. It struck me that there are analogies in our field. Sometimes imperceptibly small changes can have a big impact and none more so than when they are instigated by external forces. The problem with external forces is that they can never fully understand the field in which we work or have the same degree of affection that we who work in financial services have.
Five years ago, it would have been inconceivable that PI insurers could change the face and shape of IFA businesses but this is exactly what is happening. Small IFAs are particularly hard hit. In a sense, this reflects the economies of scale of dealing with smaller IFAs. This has been echoed in our dealings with clients. If they are too small to pay our fees, they become uneconomical to deal with.
For small IFAs, who have already faced a barrage of changes over the last few years, this could well sound the final death knell. With no PI cover, they will be forced to retire or join a bigger outfit. Many sole traders who have particular ways of dealing with their clients will find that this means cultural changes as well as others. If clients are used to dealing with an IFA in a particular way and they have to change this methodology, this can have big implications for the availability of independent financial advice.
I am afraid the PI debate is not over and that things are likely to remain difficult, whatever changes may take place on the regulatory front in order to facilitate PI cover for IFAs.
What about capital adequacy? If a firm has fewer than 25 RIs, then the capital adequacy requirements for those not handling client money are fairly benign. That 26th individual means that capital adequacy requirements shoot up dramatically.
For our own firm, it means a 70-fold increase in capital resources. Yes, you have read that figure correctly. This restricts growth of IFAs at this particular stage. There are models that are profitable for fewer than 25 RIs but there are no firms with 26 RIs which are not handling clients' money. It simply does not make any business sense at this number.
So, here we have capital adequacy affecting the shape of an IFA business. Do you remain at fewer than 25 RIs, with all the frustrations this causes a firm that wants to grow, or do you shoot over this amount pretty rapidly, because your 26th RI has to be some hell of a producer.
Stakeholder is another good example. Look what the 1 per cent cap has done for the market. Companies have chosen not to be involved with this business because it simply has not been economical to do so. Companies have even closed to life and pension business and the origins of this can in part be traced back to stakeholder. The market is consolidating and this means less choice for consumers.
This is a classic example of lack of understanding from the Government impacting directly on our industry and ultimately on the consumer. As an IFA, I am not convinced that less choice is good for consumers.
Now we have the changes to with-profits as discussed in the Sandler report. The writing is definitely on the wall for these contracts and providers have not been slow to respond.
I suspect many of them are breathing huge sighs of relief at an external reason for ditching their with-profits contracts. Three poor years in the equity markets and eating into reserves to pay out bonuses is not a particularly desirable place to be. So, we will see a new breed of “son-of-with-profits” products on the market.
Whether or not these will be better for the consumer, only time will tell. But I for one will mourn the passing of traditional with-profits, which I believe has served investors well in the past, as is borne out by the results of many of my clients' investments.
It is not always possible to see where these small changes are leading us. Thinking through these strategies is not something that the people who propose them are particularly skilled at or, I feel, are particularly interested in doing. They think they have the solution and then it is up to the rest of us to make it work. If it does not work, it is not their pigeon.
I wonder what 2003 will bring as far as small changes are concerned? Things that may seem benign at first do need to be carefully thought through by us. Sometimes they can take you to the strangest places.
Amanda Davidson is a partner at Holden Meehan