How commission payments of as much as 50% are killing your pension fund

It has always been a contentious issue, so contentious, in fact, that some countries, such as Britain and the Netherlands, have banned it altogether.

Here in Ireland, however, our relationship with how financial advisers and financial intermediaries such as banks get paid for the sale of financial products has always been a bit more vague. Yes, many of us are not very comfortable with the fact that the person recommending a certain product is getting paid for this sale but not enough of us appear ready to pay up front for financial advice, so the situation persists.

So, a new review from the Central Bank seeking views on the risks and benefits to the consumer of the commission structure that currently operates in Ireland is particularly timely.

While it may not lead to any revolutions in the practice – in the past, neither the Central Bank nor the Government has shown any appetite to go down the road of banning commission payments – it will hopefully lead to further improvements in how commission is paid which will safeguard consumers. After all, as the panel shows, commission can have negative consequences for consumers, and not enough of us seem to be aware that while it may appear that it is the financial institution which shoulders the burden of commission payments, it typically isn't. It's you.

As part of the review, the regulator has published a report which shines a light on just how consumers pay commission on financial services products in Ireland – and how much they pay. It provides a useful starting guide to commission rates and how financial intermediaries such as brokers earn them.

Otherwise, you may find out years down the road just how you lost 50 per cent of your first year’s pension premiums by paying your financial adviser.

An easy way to assess the impact of the charges outlined below is to ask your broker for a quote for the product you’re interested in on a “nil commission” basis – and then compare this with the quote that factors in commission.

Mortgages

There are typically two routes to market when it comes to getting a mortgage: go into the local branch of your bank or visit your local mortgage broker who can help you arrange a mortgage with one of a number of lending institutions including AIB, via its broker subsidiary Haven, Permanent TSB and KBC Bank. Bank of Ireland is currently not allowed sell mortgages via the broker channel.

Be aware, however, that the second route will incur some costs. Mortgage Company of Ireland, for example, charges a standard arrangement fee of €499.

And it’s not the only payment brokers may receive for the work involved in arranging your mortgage. They may also be paid a commission by the lending institution for bringing in the business.

According to the Central Bank, this payment is typically 1-1.2 per cent of the amount borrowed, paid on drawdown of the mortgage. Ulster Bank, for example, pays about 1 per cent, while AIB recently increased the commission it pays brokers to 1 per cent from 0.75 per cent for arranging mortgages via its Haven subsidiary.

This means a mortgage valued at €300,000 would result in a fee of €3,000-€3,600 for the broker, while a €600,000 mortgage would mean a commission payment of up to €7,200.

Some providers impose clawbacks if the mortgage account is closed within three years of drawdown, which means the broker may stand to lose part of the commission payment if the mortgage is repaid, which is what happens when someone switches their mortgage to another provider.

Structured deposits

In a world of low interest rates, more and more savers are turning to products such as structured deposits to try to boost their returns while restricting the amount of risk they assume. In essence, structured deposits act like a combination of a deposit and an investment product, where the return depends on the performance of some underlying financial instrument. Typically they will offer some level of capital protection. Irish providers of such products include KBC Bank.

However, while such products can offer a better return than standard deposits, they can be an expensive option, given that commission payments, as illustrated by the Central Bank, can be a hefty drain on the original investment.

For example, some product providers will pay a once-off commission payment of between 1.5-2.5 per cent of the amount deposited. This could mean a payment of up to €500 on a €20,000 investment, or €2,500 on a €100,000 one, to the broker who arranges it for you. A significant payment for what may be a straightforward transaction.

Other commission structures on these products include an up-front payment of 35 per cent of the fees the bank expects to earn during the lifetime of the product, or trail commission of 0.25-0.3 per cent of the value of the fund every year.

Insurance

It’s not just products that have an element of financial advice attached that earn commission, however. Even straightforward insurance products, such as motor, home or travel insurance, earn commission for brokers who sell them.

Commission rates are based on the amount of premium charged for the insurance product, and typically range between 6 per cent and 20 per cent. According to the Central Bank, better rates of commission are usually negotiated individually by some intermediaries, while some profit-share arrangements between general insurers and some larger intermediaries, which could be banks that act as tied agents and sell their products, may also be arranged.

Override commission, which is essentially a bonus, may also be paid to intermediaries, giving an uplift of about 3-5 per cent of their total commission earned.

Insurance commission is often clawed back if the policy is cancelled before it expires.

Life assurance and pensions

Financial advisers can earn considerable amounts from commission on life products given that they typically last for long periods. According to the Central Bank, commission rates of up to 7 per cent of the first year’s premium have been observed, plus an additional 1.5 per cent on the value of the investment fund.

And when it comes to pensions, the rates can be even higher, with the Central Bank noting that on regular payment pensions the commission rate can be as high as 15-50 per cent of the first year’s annual premium, with either a trail commission (up to 7 per cent), or proportion of the fund value thereafter (between 0.05-1 per cent).

Consider an approved retirement fund from Irish Life. According to the fund manager, a €45,000 investment into an AMRF will generate a commission payment of €1,890 in the first year for the intermediary that advised and sold it. Over the course of 20 years, the total remuneration paid to an intermediary comes to €3,313, based on 2 per cent growth. If growth in the ARF had been 5.1 per cent, commission would have risen to €3,659. This means commission paid comes to a hefty 13 per cent of the original sum invested in the ARF (which should also have risen by 2 per cent a year) – a payment which of course reduces the amount invested by the consumer.

Investments

If you buy an investment fund via an intermediary, such as a broker or financial institution, it’s possible that a proportion of your investment will be paid out in commission. Typically, this will be based on a percentage of the investment management fees as well as the value of the fund.

Consider a managed investment fund. The seller of this product could earn up to 3 per cent of the value of the fund, through annual trail commissions of up to 0.75 per cent of the value of the fund and other payments.

Commission on structured retail products, such as tracker bonds, can be even higher, at up to 4.3 per cent, the Central Bank says. Some industry players suggest that in some circumstances it can be as high as 5-8 per cent when the product is sold via a pension contract, as the broker will also earn commission of 3-4 per cent on a pension single premium – and losing as much as €800 of a €10,000 investment on paying your financial adviser may not be what you had in mind when you agreed to invest in the product.

Five reasons why commission is good

It allows consumers to access financial advice

Consumers may prefer to pay for this advice by way of commission rather than paying a fee directly

Commission can incentivise intermediaries to reach out to consumers

Consumers can benefit from free advice if they don’t purchase a product

Commission models help to sustain distribution of products thereby ensuring choice for consumers

Five reasons why commission can be dangerous for consumers

Advisers may be swayed to recommend the products that pay the most commission rather than the one that is best suited to the consumer’s needs

The focus on selling – to earn commission – means an adviser has to recommend an investment, even if it would be in the consumer’s better interest to pay down debt

The risk of overselling of credit products because the larger the credit the larger the commission that arises

Opacity: commission payments that consumers may not be fully aware of how – and how much – the broker is being paid

Increased costs – commission may increase the cost to the consumer of acquiring that product