It’s a sales approach that has endured, despite concerns about an obvious conflict of interest. To meet the cost of providing financial advice to consumers, financial advisors or brokers are paid commission from banks, insurance companies and investment managers when they sell their products.
Now however, change is afoot. In January of this year, the UK moved to ban the practice of paying for financial advice via commission, by introducing the Retail Distribution Review (RDR) regime. This effectively bans commission paid by investment and insurance providers to distributors, such as brokers and financial advisors, on the sale of investment products (protection products, such as term life assurance, are currently outside the remit of the review).
Instead, advisors now have to make their money by charging an up-front fee for advice, or taking their fee from a customer’s investment.
But what have the consequences of the new regime been? And should Ireland learn from the experience of the UK and take a similar approach?
The goal of the UK’s approach is to remove the conflicts of interest that exist when advisors are paid to sell certain products. Firstly, there is an obvious incentive for advisors to sell certain products if they offer a greater commission than others; and secondly, there is a “trading bias”, whereby advisors only make money if they sell a product, so are therefore more inclined to recommend you buy a product – even if you don’t really need one.
The UK authorities also hope the new regime will cut down on mis-selling. In 2009 the Financial Services Authority said that commission-based selling was at the "root" of such scandals over the years.
So are UK consumers willing to pay for advice?
“It’s hard to tell at this stage. Until we see the full-year comparisons of the amount of business being done, it’s hard to get an appreciation of the full impact of RDR,” says Chris Hannant, director general at the UK representative body, the Association of Professional Financial Advisors (APFA), although he notes that “it was certainly the case that business was slowish for the first couple of months of the year”.
After all advice is not cheap – research by UK website unbiased.co.uk shows that the average cost of an initial meeting and financial review is around £500, while investing £50,000 will cost around £1,500.
In the UK, advisors can now charge clients in one of two ways: through a set fee; or by taking a cut of the investment. This can still make it difficult for investors to work out just how much the advisor is charging them – after all a £500 fee, or a 0.5 per cent deduction from monthly contributions, won’t be instantly comparable.
In Ireland, you can expect to pay between €80-€200 an hour for financial advice, or a fixed fee of between €1,000 and €3,000.
Fee-based financial advisor David Quinn, of Investwise, says he hasn’t had any problems getting paid directly and that there is a growing demand for fee-only advice.
“It’s very easy to justify how I can make my fees,” he says, pointing out that a higher annual management fee as a result of a commission structure, will cost you considerably more over time than a €500 initial charge.
But is there an appetite to do something similar in Ireland?
For Quinn, the concept has appeal.
“In principle, banning commission would be a good idea because it gets rid of any obvious conflict,” he says, but he doubts that there would be political will to do so, given that it might result in some brokers going out of business.
Indeed the UK experience has seen as many as 20 per cent of financial advisors give up their profession, with numbers falling from around 26,000 to 20,000.
Another outcome of the regime change in the UK is that some high street banks have simply stopped offering financial advice to customers – or only do so to high net worth clients. Indeed the number of bank advisers has dropped by 44 per cent, to 4,800, since the new rules were introduced.
“Banks stepped away from advice because they thought they couldn’t make it pay,” notes Hannant.
One reason for the reduced number of advisors noted by Hannant is a reluctance on the part of some advisers to do the new exams that go hand-in-hand with the new regime. For Quinn, however, another likely factor is the scale of the drop in earnings.
High commission
In Ireland, for example, Quinn says that commission rates are so high that they are "artificially keeping a lot of businesses running, unbeknownst to customers". "At brokers' conferences I see a lot of flash cars – income levels are too high for the level of work that's being done," he says.
Indeed in an era when price pressure on most things is downward, some of the commission rates on offer to financial advisors can appear staggering. For example, commission on a typical life insurance policy is about 120 per cent of the first year’s premium – so if you pay €50 a month, your broker could be pocketing €600 for selling it to you. Or a €50,000 investment could earn an advisor about €2,250 in commission.
Not only that, but if the client renews a policy, the advisor will be in line for an additional renewal fee, plus, if they sell enough of a particular firm’s products, they might be in line for additional loyalty, or “override” bonuses.
The use of commisson can also lead to “churning”, whereby brokers are incentivised to keep moving clients to new products once exit penalties come to an end to earn new business commissions.
Another problem is that investors think the commission is coming out of the arrangement between the broker/insurer. So they’re getting the benefit of free advice, the cost of which is borne by the product distributor. But this isn’t actually the case – it’s the client who pays.
Indeed Quinn points out that if no commission was being charged on a pension/investment product, investors could expect to shoulder an annual management fee of about 0.25 to 0.3 per cent. With the commission model however, the fee is typcially as high as 1-1.5 per cent.
“Investors don’t realise that they could be getting it (investment product) for a fraction of the price,” he says.
Already in the UK, investors have seen the benefit of the new regime in pushing down the cost of products to a more realistic management fee. And this is likely to continue. “What we expect, over time, will be more transparency and pressure on costs,” says Hannant.
So will we see a similar RDR approach in Ireland?
A spokesman for the Central Bank says it "will monitor the progress of these initiatives", and points out that at present, the Consumer Protection Code, which was introduced in 2012, requires that any commission arrangements don't "impair the intermediary's duty to act in the consumer's best interest and must not give rise to a conflict of interest between the intermediary and the consumer".
In effect, this means that a broker or financial advisor must inform their client of any commission they are earning. But is this enough?
Mis-selling in Ireland
Quinn notes the declaration of fees and commissions are typically "very well hidden in the back of policy documentation".
And, while mis-selling is clearly a problem in Ireland – in the first half of the year it accounted for about two-thirds of all complaints to the Financial Ombudsman – the link between it and commission is not as clearly drawn as it is in the UK.
For example, according to a spokesman for the office, commission and fees are something it considers when examining such a complaint, but it notes that complaints are typically “not so much about commission charged, but whether or not the product should have been sold to the complainant in the first place”.
This doesn’t address the issue of whether or not the product would ever have been recommended in the first place however, if commission wasn’t part of the deal.
But in any case, it may not be up to the Irish authorities on what approach to take to commission. The second iterations of both the Markets in Financial Instruments Directive (MiFID) II and the Insurance Mediation Directive (IMD) are currently being reviewed at EU level, and while current indications are that Europe won’t seek to emulate the UK’s RDR regime, neither have yet been finalised. Not only that, but a Mortgage Credit Directive is also coming on-stream. This will govern the manner in which mortgage brokers remunerate their staff.
