For the first time, IFAs are being dragged into investigations into the life insurance business with Gordon Brown's Budget announcement last week of a new review into retail investment.
Brown has fully accepted Myner's report into institutional investment patterns. In his Budget speech, Brown said he was backing the recommendations to promote long-term investment and protect investors.
The more astute were quick to seize upon this seemingly innocuous comment from the Chancellor – the part of the report on life insurance that recommends there should be”a separate independent review of capital and information flows around personal investment products”.
IFAs are going to be in the firing line. “It might be thought that the use of IFAs would compensate for the lack of consumer understanding,” says the report.
It then goes on to focus on the fact that IFAs are usually “rewarded” by commission paid by the life offices and claims: “This casts doubt over how competition operates in the industry from the consumer's perspective. These doubts are particularly strong in the case of with-profits policies.”
Overall, Myners report concludes that “There are several factors distorting competition in the life industry, especially as regards with-profits.”
Among the factors singled out are “financial incentives to advisers and sellers, mostly through the commission system, which are unrelated to investment performance”.
Other issues the report points to are consumer ignorance and life companies manipulation of free-asset ratios.
The report sets out the parameters for the new review which include underlying competition, information flows to consumers, advisers' incentives and skills and product charging structures.
Influential financial analyst Ned Cazalet of Cazalet Financial Consulting agrees with the report's finding of commission-led bias among IFAs. He says: “There is clearly evidence that certain investment products are being sold in preference to others.”
He says: “Why do IFAs never sell invest-ment trusts even though they outperform. Is it because they do not attract commission other than at launch? And why were IFAs selling endowments right up until recently?” Cazalet claims that IFAs are easily fooled by life offices' manipulation of free-asset ratios. “It is embarrassing to see the life offices doing this and it is even more embarrassing to see IFAs falling for it.”
He slams what he sees as IFAs' poor investment skill base, claiming: “Past performance is not a rational basis for selection.”
Cazalet believes the IFA sector will be challenged by the private banking and private stockbroking sectors for investment advice as IFAs are forced to move upmarket.
Beyond these specific criticisms, Cazalet sees general structural problems that will threaten IFAs. He claims that the present retail financial structures are still those of the high-inflation past.
Given that a low-inflation environment is likely to be around for the foreseeable future, with annual investment returns unlikely to exceed 7 per cent, Cazalet sees little scope for the present level of charges, and by implication, the intermediary channel.
He says: “If you add charges of 3 or 4 per cent, you might as well put your money on deposit. The 1 per cent world makes sense in a low-inflation economy.”
As a result, he predicts there will be massive changes to the life industry in terms of products, financing, charges and distribution. Cazalet believes a major shift is already under way, and the death of the direct salesforces is only the beginning.
“In five years, the industry will be unrecognisable from that which was there in the early 90s,” he says. Cazalet believes the review is coming at an opportune time.
Aifa disagrees and has responded angrily to the Myners' report going beyond its remit and dragging the personal investment sector through yet another review.
The FSA is conducting its own review into with-profits – which the Myners' report graciously says it will take into account – the Faculty & Institute of Actuaries' working party has reported on the same subject and the Consumers' Association has published its own vitriolic report on the subject.
Aifa points to the London Economics report commissioned last year as part of the polarisation review. It specifically investigated the question of commission-led bias distortions to the market. The report found: “It is often argued that providers offering higher commission will buy market share. We did not find evidence to support this.”
It concluded: “Commission differences would therefore appear to be a reflection of how returns are divided between manufacturer and distributor rather than a source of consumer detriment.” But while the report's comments on polarisation were adopted, its findings on commission bias have not gained the same currency.
The full parameter and implications of the “son of Myners” review are yet to become apparent. How are IFAs responding to this latest spotlight on the retail investing business?
Michael Philips partner Michael Both finds the prospect of a new probe deeply depressing. He says: “Clearly, the Government want to discredit IFAs in every way possible and this will be another nail in the coffin of the IFA.”
He dismisses the charge of IFAs distorting the market through commission bias, pointing out that commission has to be disclosed. He says: “You won't find that IFAs are any worse than anyone else. Why don't politicians spend the same amount of time and money into investigating themselves?” Torquil Clark head of pensions development Tom McPhail takes a more optimistic view. “All of this is pushing the industry in the right direction and if we are doing things wrong, then this could help us to do things better. Anything that improves the image of IFAs will be good,” he says.
Emphasising the importance of advice, he says: “The quality of advice is of more importance than a couple of basis points on charges.”
The Myners' report opens bravely by citing economist John Maynard Keynes on the stultifying effect of decisions by committee. Keynes was referring to investment decisions but perhaps the application could be wider:
“Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.”