Is IFA commission under threat? Commission is under regulatory scrutiny with the second stage of polarisation and Paul Myners' suggested retail investment review. There are mounting pressures on commission-based advice. What is behind these changes and what strategies should advisers be using?
The commission-based advice market is under pressure from three main directions.
The internet makes it is easier for savers to compare products. There is a proliferation of websites allowing savers to compare the terms and charging structures of banking products. unit trusts and Isas. It is likely that life insurance and pension products will follow.
Savers are increasingly aware of discount brokers. Commission-based IFAs could find that savvy consumers get a free ride on their advice and buy the products they recommend through a discount broker.
Simplified products are coming on to the market. These enable savers to bypass advice. The Government has said stakeholder pensions and Catmarked Isas, for example, require little or no advice.
This is not much of a threat in itself because most savers do seek advice but it is much easier for savers to free-ride on IFAs' advice on these products.
How should commission-based IFAs respond? Most IFAs offer savers the option of commission-based advice or a fee of some form, offering flexibility to the customer.
This gives IFAs little protection from free-riding and it would be hard to withdraw the commission option entirely. As we all know, there is little demand for fully fee-based advice at the moment.
But there are a number of alternatives which could be better for adviser and customer.
Move to fees only for financial planning and “lifestyle” advice. Savers already seem to value advice on what type of product to hold more than recommendations of particular providers. As provider league tables become more and more accessible, this is likely to intensify. IFAs could respond by charging fees for lifestyle advice, let customers choose the particular provider for themselves and then act as discount broker for them.
Charge fees for advising on simplified products. As simplified products place commission-based IFAs at the greatest risk of free-riding, advisers may do best to charge a (relatively small) fixed fee on these products.
Guarantee that commission is neutral for advisers. This is the route taken in US where commission is at the same rate across all providers and products. The customer can still free-ride but is less likely to be concerned the IFA is suggesting products because of the commission and may be more loyal.
Conditional fees. This would be a flat charge paid by the customer if they buy the product. It could vary by product type but not by provider. Any commission over the flat fee would be rebated. This gets round the up-front character of most IFA fees, sugaring the pill.
Which strategy offers most to IFAs will depend on how customers behave.
Flat commission structures or conditional fees work best where customers are concerned about differential commission and relatively unaware of discount brokers. This looks like yesterday's world as awareness of execution-only offerings is increasing. Consumers remain unaware that buying through these channels forgoes protection on advice.
Fees for simplified products and/or financial planning advice removes the risk of free-riding but any shift towards fee-based advice for certain products needs co-ordination throughout the industry.
IFA and industry trade bodies have an opportunity to shape the future for commission-based advisers.
Tim Wilsdon is principal at Charles River Associates