I don’t think enough attention is getting paid to credit risk in the debate on contingent charging.
Clients of IFAs sign up to Terms of Business that typically offer a means of remuneration for the IFA from the money that the IFA is advising on. Where there is no money, such as in the purchase of life insurance, or other protection products , there is a commission payable by the insurer. Either way, there is certainty of getting paid which is why IFAs like their creditors to be funds and insurers rather than their clients.
This is not always the case. IFAs who have wealthy clients find they are used to writing cheques and paying VAT on professional services. So contingent charging is less needed in certain circles. However, given the choice of paying VAT on the service or not, I know which I would choose.
So the system reverts to contingent charging as the line of least resistance. IFAs do not want to spend a lot of time chasing creditors, insurers and the operators of fund platforms make good creditors who pay on time and are easily chased when they don’t.
So what if we move to fee charging for all?
The argument that is given for retaining contingent charging is that it promotes advice to a much wider range of potential clients. In practice, advisers would not do business with clients who potentially didn’t pay their bills.
Direct fees are not only more transparent, they are more expensive (as they are typically loaded with VAT) and they are paid for out of taxed income, rather than out of a tax-exempt fund (pension) or a loaded premium of a life policy. Direct fees are painful and they don’t always get paid.
There is a side of me that says “welcome to the real world” till I realise that actuarial consultancies (like most large law firms) don’t have private client departments – other than for the super-wealthy.
The problem is not so simple as it appears. IFAs are necessarily dealing with private clients and we have around 25,000 of them in the UK. Without contingent charging, I imagine it wouldn’t just be the breadth of advice that would suffer, it would be the number of advisers – capacity.
Alternatives
This has been the central problem of the RDR and it isn’t going away. The FCA recognise that there are hardship cases where advice is needed and can’t be paid for up front – hence the carve outs in CP19/25. Al Rush has argued for them and I agree.
The question is where do you draw the line.
At what point do you accept that independent financial advice is a luxury item beyond the means of most people (who will have to make do with DIY management – unadvised drawdown- the purchase of commission paying products like equity-release and annuities?
I don’t have a problem with an advisory market that targets IFA as a premium service that is bloody expensive but worth it.
I don’t have a problem with the idea of an annuity broker like Retirement Line who declares its commissions upfront.
I do have a problem with the idea of “free advice” that is “mutton dressed as lamb” product selling.
If this sounds regressive – perhaps it is.
The fable that IFA should be available to all is both unrealistic and actually harmful. That’s because of the credit risk of running a mass market fee-based service and the perils of contingent charging.
Much better to split out IFA as a fee charging service that requires VAT to be paid on the fees and for the fees to be paid out of taxed income.
Anything else is not IFA – it is advice that is product dependent.
The improvement in standards of IFA since the RDR is self-evident. There is now a mass-affluent market which it can serve on the basis of charging fees without tax subsidy.
If that means that some of the business plans of IFAs – predicated on serving another part of the market using contingent charging have to be withdrawn – so be it. They were rubbish business plans which carried the potential for consumer detriment and therefore regulatory and political risk
For years IFAs have ignored the regulatory risks of contingent charging.
Now those risks are being exposed, many networks will suffer, some small advisers will go out of business. The numbers of IFAs will reduce as will turnover. Profits will also reduce.
All of this is necessary because the IFA has to move onto a more sustainable remuneration model if he or she is to be considered as a provider of a professional service rather than a product salesman.
For confident IFAs like David Penney, an upfront fee charging model is no problem
It is having the confidence to do this, and the confidence in your client to pay the fee, which is key. You probably look at this more confidently than Paul Feeney. If I felt comfortable of an 80% recovery rate I would be charging fees, otherwise, as a businessman, I’d go CC.
— Pension Plowman (@henryhtapper) August 2, 2019
But most IFAs and IFA networks cannot be confident of a high fee recovery rate. The credit risk of unpaid invoices looks immense and taking the step beyond contingent charging too daunting.
The pain of taking that step cannot be underestimated and that is why contingent charging is the issue it is.
IFAs will only get paid by direct fees, if they are considered worth it. Most IFAs are worth it, contingent charging has had its day and so have the financial advisers who can’t live without it.
Henry you are right but this has been going on for some time. In 1988 there were 10 times the number of of advisers paid by commission which is why so many people have pensions, life cover and ISAs with around 60% of new business through IFAs
What you are observing is a measure introduced to deal with the few unethical firms exploiting vulnerable people The recent FCA paper describes the work of a pensions transfer report as 25 hours work for a fee of between £2500 and £3500. this is turnover NOT income for the individual IFA.
Given that the professional firms tend to work on 33% for wages at £33 to £46.20 per hour In London you cannot get the qualified staff to work for this. The consequence is that those still paying commissions thrive, vertically integrated, while an independent financial adviser is not viable
This country seems to be in a phase of many (apparently) untended consequences
Automating the system and having tools like AgeWage is probably the best answer
Dear Henry, I have just read you blog “without contingent charging will IFA-s get paid?” Your comments are naive, Ill-informed and bordering on libellous.
It is over 30 years ago that I designed and marketed the methodology that I used in my own IFA practice ‘Fee-Pac’. No! I am not advertising; this is just a statement of fact. Many IFAs and other professional business operators, purchased ‘Fee-Pac’ and/ or came to the seminars that I ran in the 1980s/ 90s on the principles of a fee-based practice. Many adopted it and used it for everyday clients. It still applies today.
The clients paid a monthly retainer and in return received a bespoke personal financial planning service which did not rely wholly and solely on the payment of commissions from product providers. Where commissions were paid, in my own practice, the amount paid in commission was set against the amount paid in fees assessed in November each year. Cheques were sent to clients who had overpaid for the time spent on their account. A working balance was always retained. Indeed, I have just recently sent a cheque to a client of mine in the Falkland Islands for £2340 in overpaid fees.
As for commissions, my practice, because of ‘Fee-Pac’, never ever took indemnity terms. It was indemnity terms that created most if not all of the problems of the financial services industry in the 1970/80s. Many advisors did not realise that indemnity commissions were loans from Insurance companies on which interest was paid and deducted if the contract did not continue for the specified term.
I witnessed IFAs repaying £40,000 in a month, yes £40,000 in commission, owed because the super SASS pension scheme that they arranged had failed to be maintained before the specified period for full commission payment had elapsed.
The problem with commentary is like yours is ‘supposition’ and the only voices that you perhaps listen to those that deal with high net worth individuals. Or is that my miss directed supposition? You are welcome to come and speak to me. I’ll tell you some stories. Almost 40 years ago colleagues and I set up little groups of advisors, 16 to 20 advisors in a group, the first being the Russell Study Group in the Russell Hotel in London. We came from all parts of the country four times per year for the day. We exchanged ideas. We talk to each other about how we ran our businesses. Facts not supposition. The interesting thing is that everyone in that group of 16 to 20 people ran their business in a different way. We were all entrepreneurs from differing backgrounds.
Your overarching observations, to me, are based on pure ignorance as to how an IFA practice works. You simply have no idea. And for the record; most of the people that I have met, and there are many, who work within the regulatory industry are just as the devoid of fact as this particular article is. They are making the rules by which the insurance industry operates based upon the observations of a cohort of theorists.
‘Average people’ will pay a reasonable monthly fee but it has to be set up correctly and operated effectively.
There is nothing wrong with commission payments. There is everything wrong with indemnity terms.
Changing for time spent with clients is not a problem. If advice is given correctly and the underlying contracts stay in force it is not a problem.
Your comments regarding VAT are naive in the extreme. I voluntarily registered my business for VAT even before I had a turnover that warranted it, because then I could claim VAT back on my computer equipment, my fuel (widespread client base), the capital cost of my car, and many other operating costs concerning my office. Perhaps that’s why I am a Chartered Financial Planner so much derided by the actuarial, legal, and accountancy professions, and I use the word profession advisedly. Equitable Life comes to mind.
I do read your blogs and I do agree with much of what you say but your comments on ‘contingency charging’ are just so simplistic that they are meaningless and misguiding.
Many people take and act on what you say. You have a responsibility to make sure that what you say has at least some element of credibility. This article has very little if anything to commend it.
The facts in the FCA report are clear. Most transfer business is contingently charged for. Most of the revenue reported by financial advisers is not based on upfront fees but from funds under management and commissions on protection etc, Those IFAs who work on a fee model – and I know a lot, will be reading this blog and not taking exception, because they are confident – see the quote from David Penny who is typical of the kind of IFAs I want to promote through my work at AgeWage. I suspect you are another – though I wish you wouldn’t get quite so angry with me!