FOOL'S EYE VIEW
IFA Commissions Are Back On The Menu

By James Carlisle
October 31, 2002

Providing people with the right products, despite an unwillingness to pay for advice, is a problem that continues to cause headaches in the financial services industry. However, the Financial Services Authority (FSA) has suggested another solution this week. Despite the appearance of a climb-down from the radical proposals made back in January, the new 'menu-based' approach is worth trying. As ever, though, there will be problems.

The original proposals

The original proposals were borne out of research that showed just how badly the market for financial advice was working. Consumers were confused by the status of advisers and how they were paid, apparently not even realising that they had to pay for the commissions that advisers received for selling them a product. Worse than this, although sadly no great surprise, was the finding that, in some circumstances, financial advisers had a bias towards recommending products that paid them higher commissions.

Since the 'commission bias' was mostly found among the supposed 'Independent' Financial Advisers (IFAs), the meat of January's proposals was the plan to abolish the old regime, known as polarisation, which distinguished between IFAs (who could sell any product on the market) and 'tied agents' (who could only sell products created by the company that they were tied to). (We should hear more about the consultation on these plans by the end of the year.)

Alongside the abolition of polarisation, the FSA made a range of further 'complementary' proposals. Hidden away among these was the issue that probably worried the industry most: a plan to do away with commissions for independent advice, leaving the advisers charging only an upfront fee. This would have the effect of leaving independent advisers to compete, and be remunerated, solely on the value of their advice. Consultations with the industry, however, have left the FSA backing away from the original plan.

'Menus'

The new proposal is for advisers to provide customers, at an early stage, with a 'menu' setting out:

• The types of service that an adviser is offering;
• For independent advice, the option of paying by way of an upfront fee, together with a fee scale, and;
• Where there is the option of paying by commission, the commission that the adviser normally charges for a range of popular products, set alongside the typical rates charged across the industry.

So commissions have crept back in as a means of charging for independent advice. Much of the fault for their reintroduction, however, comes back to us. Unfortunately, we're just not very happy to pay fees upfront for financial advice.

Good advice doesn't come cheap and it ought to be good advice if there's competition for it. People might pay, say, £300 for a few hours of top quality advice, but they're unlikely to pay £150 for half-decent advice. So, with a purely fee-based system, people might end up with a choice between paying lots for good advice or paying nothing for nothing. Unfortunately, human nature or a simple lack of funds would probably leave too many people taking the 'do nothing' option.

Can't pay, won't pay

So the FSA faces the same old chestnut that the Sandler Review had to deal with earlier this year. How do you provide financial advice, of a sufficiently high quality, to people who either can't or won't pay for it?

Sandler's approach was mainly focussed towards the 'can't pays' and aimed to provide several homogenous financial products that would do pretty well for most people, thus avoiding the need for expensive advice. The FSA's fresh suggestion of a 'menu-based' approach seems to take more account of the 'won't pays' and is based on the idea that independent advisers be allowed to continue bundling up the cost of advice with the cost of a product (the commissions that we seem happier to pay), but that they must tell us exactly how much these are, thereby pushing down the price down.

It's not much different from the pricing mechanism for any other product or service in a free market. The trouble is that it's not, at present, much of a free market. While the payment for advice can still be bundled into the cost of a product, there will be market distortions. Still, some sort of compromise does seem necessary and the proposals are worth a try. The challenge will be to try to encourage competition. That will involve not only the increased disclosure proposed by the FSA, but also greater steps to educate consumers.

More: The FSA's Earlier Proposals | Sandler Review