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.