Commission levels for regulated business are greater than can be supported by the product. This is clearly unsustainable over the longer term. Increasing product commoditisation and cost transparency continue to place pressure on commission levels, potentially reducing them by more than two-thirds over the next couple of years.
So far, little has been done to address the situation. Advisers have been prepared to offer financial advice to their customers regardless of affordability.
For product providers, the fear of new business walking straight into the arms of their competitors is overwhelming, particularly as adviser panels continue to reduce.
Understanding the profitability of customers will be vital to ensure longer-term survival for both providers and advisers. They need to be planning now by migrating to different operating methods. Lack of action could prove fatal. The message is clear – adapt or die.
Advice will continue to play a central role in the distribution of financial services as consumers take on more responsibility for their financial affairs and the state continues to withdraw its accountability. But is advice simply too expensive to provide in the 1 per cent world? Can advisers operate profitably on reduced commission levels? Can providers assist in the transition to a new reward system?
The challenge is how to deliver clear and objective advice to the customer at a price they are prepared to pay and that the provider and adviser can support within a low-cost environment.
Considerable investment is being made in developing web-enabled distribution, including information and comparison tools that are starting to impinge on the advice process. Although the web will not replace all distribution mechanisms, it can be used in conjunction with the phone and face-to-face meetings to replace costly non-value-added services offered by advisers, such as the provision of basic information, collection of personal data and administration of their accounts. Success will be based on offering advice that is easy to access and at a cost relative to the size of the client's wallet. This implies the need to move away from offering the same level of service to everyone.
For some advisers, the impact of reduced commission focuses their attention on plugging the profit gap. The higher the current commission earnings, the bigger the void to be filled. The web can help advisers who need to move towards targeting higher-net-worth individuals at the expense of mass-market customers.
Like it or not, remuneration models drive behaviour. Front-end-loaded commission encourages frequent sales of new business, with little incentive for developing further business from the same customers or keeping the business on the books. The hunting culture prevails and churning is an accepted risk.
However, research by Cap Gemini Ernst & Young indicates that, for advisers and providers to stand any chance of being profitable in the 1 per cent world, a new culture shift is required. Assuming the charges for all types of product fall in line with stakeholder, average commission levels could reduce by up to 70 per cent. Advisers will need to increase productivity at least threefold to meet current income levels.
Relying on the generation of business solely from the existing customer base will not be adequate to meet existing income levels. A migration towards bigger case sizes may become the only option.
Nevertheless, advisers will still need to devote the majority of their time and effort to the development of existing relationships, adopting a farming rather than a hunting role.
The rewards for both adviser and provider will become more significant for business already on the books where commission is based on the value of funds under management. Nevertheless, it will be unwise for advisers to rely on trail commission to sustain income over the longer term.
Many customers do not appreciate the value of advice given. Commission has tended to form part of the product premium. Fees, on the other hand, have to be paid upfront with VAT on top. Take note, a level playing field is required. Consumers are prepared to pay a fee for advice given by other professions, such as architects, so why not a financial adviser?
The jump from commission to fees is challenging for adviser and customer alike and any new model needs to be able to bridge the gap between the full-commission and fee-only models. Longer term, fees are the only way to ensure adequate income is generated. This will mean shortterm pain for many but this can be alleviated through an interim regime combining fees and commission.
In response to this situation, Cap Gemini Ernst & Young has considered a new proposition that offers an integrated approach to advice provision. Separating advice from the product sale should reinforce the value of advice. Customer confidence should also increase as the advice offered is seen to be more objective.
At an initial level, the customer pays an annual flat service fee for use of the adviser's services over the internet or digital TV. Services may include comparison tables, simple calculators (developed by providers), guidance and even automated advisory services. The annual fee creates a stickiness factor by encouraging the client to regularly use the adviser's services.
If further pressure is placed on commission levels in the future, the annual fee can be used to bridge the gap.
By data mining the customer base to reveal information that might otherwise go undetected and to investigate customer behaviour trends, the adviser and provider can work together on customer profiling and proactively generate additional leads from existing clients.
The second level of service offers a teleservice option in addition to the web-based services to customers who wish to have a discussion with an adviser. The customer pays an extra fee in exchange for advice received in the same way as they would pay an architect for drawing up plans of their house.
Should the customer decide to make a purchase on the back of the adviser's recommendations, the commission from the product purchase can be used to offset the fees or the product could be offered at a premium net of commission. Alternatively, customers may even be encouraged to buy direct where it is in the their interests.
For those clients requiring face-to-face advice in addition to the above service levels, a higher fee is charged. In determining the fee, it will become increasingly important for advisers and providers to understand the longer-term value of customers.
This remuneration model provides a compromise between the extremes of commission-only and fees-only, enabling the value of advice to be recognised and accepted, while at the same time helping advisers shift to the1 per cent world. It needs to be implemented at the same time as embracing new methods of working.
Currently, advisers are in a strong position to demand their price from providers but the world is changing rapidly. Unless advisers adapt to a new remuneration model, their livelihood will wither on the vine.