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The end of commission-biased financial advice?
By Faith Glasgow
There are changes afoot in the way financial advisers do business - and, as a result, consumers should benefit from higher standards and a more transparent and trustworthy service.The industry watchdog, the Financial Services Authority (FSA), is reviewing the whole system of financial advice and how people pay for it and the products they buy. Don't hold your breath, though: the Retail Distribution Review (RDR), as it is known, has been rumbling along for the past two years, and the proposals the FSA has just published in its consultation paper won't take effect until 2012.But, although the rules are still under discussion, they've largely been given the thumbs-up so far by experts and consumer groups.So what are the key proposals? There are three main areas, affecting personal pensions, annuities, life insurance and critical illness insurance, as well as packaged investments, including individual savings accounts, unit trusts and investment trusts savings plans.1. No commissionThe first major rethink involves getting rid of the commission system whereby advisers are paid by the firms producing the products the advisers recommend. It's easy to understand why commission-based arrangements have been popular with consumers, because they don't have to pay the adviser upfront; instead, the commission effectively comes out of the products they buy.But according to the FSA, consumers have been mis-sold a hefty £14.5 billion of products - including endowment policies and pensions - over the past 20 years. Those inappropriate sales have been driven by the high commission rates paid on particular products. In some cases, commissions of up to 8% are still available from life companies, if advisers choose to take them - the offshore and onshore bond markets are a notorious case in point.Such a situation could obviously be open to abuse. Most of us struggle to understand the workings of the financial products we need, and have little idea whether they're right for us, so we rely heavily on professional guidance. But how can we trust the recommendations of someone whose income is dependent on making a sale, and who could earn more from one product than from another?The alternative to commission-based advice is the fee-based service offered by some IFAs. Under this arrangement, you pay an hourly rate or, in some cases, agree a flat rate for a particular job. If you decide to buy a product, you get back any commission paid to the adviser (or it's reinvested for you). Not surprisingly, it's not widely popular, as many people don't want to hand over a separate fee for the advice they get, and see the commission system as less painful.One sort of compromise is an arrangement known as 'fee-offset commission' - the adviser works on a fee basis, but if you decide to buy a product and the adviser receives commission, it's offset against your fee bill, in order to reduce the amount you actually pay out.The RDR proposals have taken the commission bull by the horns. From 2012, insurance and investment companies will no longer be allowed to pay commission or offer other inducements to advisers to sell their products. Instead, payment for advice will be agreed beforehand by the adviser and the consumer (probably based on the adviser's standard charge card).But be warned: some products that pay broker commissions, such as household and motor insurance, do not fall under the RDR, so the way they are sold and paid for will not be affected.David Elms, chief executive of unbiased.co.uk, said: "The new system will be a transparent negotiation between advisers and clients. Clients will still be able to choose whether to pay an hourly fee, or have the charges deducted from their investment, and they can also choose to spread the payment in instalments from their regular contract payments."From a consumer's point of view, therefore, the payment system may feel in practice pretty much as it did under the old regime. The difference will be that payments are fully agreed in advance and, crucially, that product providers are out of the picture.Mike Horseman, managing director of IFA firm Cockburn Lucas, explained: "For consumers, the RDR is an excellent development because it means real transparency - an end to the myth that advice is free just because the provider's paying the adviser out of your money. If the consumer chooses to pay their fee out of their contract, that's fine, but the product providers will no longer dictate terms."However, Elms cautioned: "There's potentially a problem as far as payment taken from small-scale regular savings plans is concerned - I can't quite see how adviser payments will be arranged in practice." The main difficulty is that monthly payments go directly to the product provider, bypassing the adviser. Elms is concerned that, unless this is sorted out, it could damage the culture of regular savings that the government is so keen to encourage.Restricted advice through banks (see below) will be provided by bank employees and focus on in-house products, so commission is not an issue. But the RDR outlines a code of practice to govern the pay of individual advisers.2. Advice vs salesThe second big change is to do with clarity and will make it much clearer what particular advisers can do for consumers - and, in some cases, what they can't do.The financial advice industry at the moment is very complicated. IFAs sell from the whole of the market (although in practice some may favour particular firms, perhaps because of the generous commission). Then there are 'multi-tied' agents who can sell the products of a limited range of firms. Below them are 'tied' agents, offering advice on the investments and insurance policies of a particular firm - typically, a high-street bank.The FSA wants to ensure that people understand what kind of advice they're getting; that is, whether it covers the whole of the market or just a corner of it. The RDR proposals aim to simplify things.From 2012, all investment firms will have to clearly describe their services as either 'independent advice' or 'restricted advice'. There will be no halfway-house.Anyone billed as an 'independent adviser' will have to select products drawn from the entire financial market; provide unbiased and unrestricted advice based on what's best for the client; and meet all the requirements laid out in the RDR, as far as minimum levels of capital and qualifications are concerned.Restricted agents, working mainly through banks, will have to spell out to clients (and inform them in writing) which firms they represent and the limited range of products that they can advise on.3. New qualificationsThirdly, the RDR will push up qualification standards across the board. The aim is to improve the image of financial advice, and give it professional status, alongside the likes of solicitors and accountants.At present, advisers are expected to have a minimum QCF3 qualification, which is equivalent to A-level standard. Elms explained: "The new system will require both IFAs and restricted advisers to have at least QCF4, which is roughly equal to the first year of a university degree."The FSA also wants to introduce an independent Professional Standards Board to keep an eye on standards.Horseman said: "It will probably mean fewer advisers around, as a lot are now past the age for taking more professional exams, while others won't have the necessary capital. And those who have been relying on earning high commissions by flogging a lot of policies, rather than focusing on customer needs, are unlikely to carry on. But that means that those left will be the best of the bunch."
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