Balancing the ingredients for a perfect financial practice

23 July 2008 | | Gareth Stokes

One of the major developments in the South African financial services industry in recent years is the drive to promote professionalism among all stakeholders. This need has been driven by regulation, including the Financial Advisory and Intermediary Service (FAIS) Act which came into effect in 2004.

Professional status will certainly make it easier to address many of the challenges that hang over the industry today. It would guide financial advisers in deciding whether to run their practices on a fee or commission basis… And it would cast more light on the ongoing product versus advice debate too. FAnews Online would like to further these debates by including in today’s newsletter an article titled Advice or Products? Fee or Commission? The article represents the views of Ian van Schoor, CEO of Marketing, Sales and Distribution at Liberty Group and we hope you find some of his thoughts useful as you develop your financial services practice...

Advice or Products? Fee or Commission?

A survey commissioned by Xchange Solutions for Markinor found within consumers an “overriding trend to associate financial advice with financial products.” This in turn gives rise to a moral dilemma for financial planners i.e. should his/her loyalty lie with the customer or with the product provider? The true question is whether this conflict should even be allowed to exist.

A Draconian measure to eliminate this conflict of interest is proposed in the discussion document on ‘Contractual Savings in South Africa’. It suggests three distinct roles, that of sales agent, independent adviser or product provider. A financial adviser can choose one role and one role only. ‘Advice based financial advisers’ can only charge fees whilst ‘salesmen’ can receive commission.

In this perfect financial world a documented financial plan will be drawn up by the financial adviser (for a fee paid by the client) who will then pass the client over to a salesman to execute the plan by supplying the financial products necessary (for a commission paid by the product provider). While noble in intent, this proposal raises more questions than answers when one critically analyses the ramifications of such a process. Who owns the client? Where does the primary relationship lie? Does execution only business warrant a commission or even a salesperson? Who will regulate the process? Do any of the role players have the right to veto if they think the best interests of the client are not being served? Will fees and commissions be regulated or controlled and if so who will regulate these? Many more questions arise.

This proposal is offered as a solution to commission based sales but the unintended consequences such as fee padding and double charges may only further load the costs incurred by the client. That there are financial advisers who offer an end to end professional service based on the real needs and best interests of the client is indisputable as is the fact that commission driven sales also occur. There are those who argue that a more practical solution lies in not making fees and commissions mutually exclusive but rather in fees and commission. If acceptable cost parameters can be established for an end to end process and the remuneration of the financial adviser could be constructed of both fee and commission.

The fee versus commission debate evokes such divided and hotly contested views from both sides of the spectrum.

Many of the Private Banking Models in South Africa strongly support the fee based arguments that pre-suppose the purchase of product from financial service providers and in turn strongly contest the future of commission based models.

As committed as we are to the evolution of professionalism in the financial advice spectrum, I remain unconvinced that the solution lies in whether or not remuneration models are fee or commission based. Fee based remuneration is funded by product providers and albeit that they are presented differently to the customer – the economic impact to consumer is often not materially different from traditional commission based models.

In my view, there is room for both. In the largest and most competitive market in the world, the US, the commission system is alive and well and continues to co-exist with professional financial planning and advice. On the other hand, some of the Private Banking Models in Europe, many of which have been copied in South Africa are also gaining momentum.

These models are not revolutionary but have found strong support in the South African market in recent times, mainly as a consequence of the up-fronting of commission practice in the Life Industry which has now come under regulatory supervision.

This commission practice should not in its own right disqualify a commission model in favour of a fee model – both models are funded on the same or similar economic principles. The true difference lies in how financial service organisations employ them.

The real professionals fear neither a fee nor commissioned based environment as they endeavour to do the right thing for their clients. The driving force of their actions is to honour the code of professionalism. The truly professional financial adviser will succeed irrespective of remuneration structures.

Editor’s thought:
We’re often amazed by how many questions still remain regarding the role of a financial adviser in the new financial services industry. With the volume of industry wide discussion and regulation that has been completed surely a suitable and acceptable model could have been drawn up by now. Do you think creating three distinct roles – the sales agent, independent adviser and product provider is the best way to go? Add your comments below, or send them to editor@fanews.co.za

Comments

Added by GG, 30 Jul 2008

I read the article by Ian van Schoor and was not going to get involved in this debate but could not let the following go unchallenged “Fee based remuneration is funded by product providers and albeit that they are presented differently to the customer – the economic impact to consumer is often not materially different from traditional commission based models.” Not sure how he can make such a statement – as someone who has not earned commission on an investment or life product for about 4-5 years now, I can tell you that the advisor not taking commission makes a substantial difference to the consumer. On average, the premium on life business is reduced by 15-30% when there is no commission taken (this should be higher as according to LOA figures about 35% of the cost of new business is commission). On investment business, the saving to the consumer is up to 3% in commission and in most cases, the manco will reduce their admin fee to 0% as well – a total saving of ±5% on the investment. The issue is not really about fee or commission though – it is about sales targets, the pressure to keep generating new business and ultimately, how we are incentivised (read Freakonomics for more on this)…while agents/brokers are pressurised/incentivised to generate new business, we are always going to see pressure to generate new business and this is often not in the client’s best interests. It is time that the companies took a long hard look at their business models.
Report Abuse

Added by JS, 23 Jul 2008

Wat is die doel van die Sales Agent?Ek dink nie daar is n plek vir so n persoon nie. Die Finansiele Adviseer moet al die werk doen vir Peanuts en mnr die Verkoopagent stap weg met die Koek. Ek persoonlik dink die huidige stelsel werk.Ek doen al die ontledings plus admin plus nasien diens waarvoor ek nie betaal word nie.Ek vra die minimum kommissie.Tenspyte van dit alles is jy glad nie seker of die Klient wel gaan terug kom vir jou om die besigheid vir hom te doen nie.Ek maak staat dat ek te alle tye vir my klient die allerbeste voorstel wat in sy belang is en sorg dat die diens wat ek lewer te alle tye Professioneel en die aller beste is. Hoekom is dit sleg die Makelaar wat deurentyd onder die vergroortglas is wat sy vergoeding betref.Wat van die dokter,ouditeur,loodgieter ensovoorts.?
Report Abuse

Added by CW, 23 Jul 2008

Thanks for a interesting article. There is one comment that stands out though - Fee based remuneration very clearly comes off the client's investment and is not paid for by the product provider, whereas commission is. I therefore think your observation that fees are paid for by the product provider is incorrect.
Report Abuse

Added by EB, 23 Jul 2008

This is a lot of crap. Of course the banks want this. It enables them to get even more money out the client. A professional Advisor will normally do it for free. The FSB is already gaining momentum regarding Fit and Proper Regulations in an attempt to make sure that FSP’s can do the job correctly. Do they now want to completely kill the insurance world by making it so expensive that all people will go direct without the necessary advise? Seems to me everybody wants to get rid of the old school FSP (the one with the correct training and experience) by down grading their job and giving them the choice to choose between either selling or advice. Why would a client buy from a salesman when he has already paid for advice? I am very sorry for the young new person who wants to be a FSP. He or she will never get there.
Report Abuse

Added by AV, 23 Jul 2008

Solank die verspreidingskanale geklas gaan word as Agentskapstakke, Makelaarsdistribusie, Bankdistribusie en Direkte verkope, sal daar verskille bly oor fooie en / of kommissie. Begin by die wortel van die kwaad wat die woord
Report Abuse

Added by Ingrid Denzin, 23 Jul 2008

Of course the Private Banking Model would favour a fee basis of remuneration. Private banks rip clients off like nobody else with exorbitant fees. Is a CFP really expected to give advice and let someone else take commission on the actual product? Does it pay to be lesser educated than a CFP? Seen this way, the dumber you are, the richer you become. The stupid shall lead. Upfront commission on risk products is to be phased out within a few years in any case. In the meantime, I have noticed that many clients are still resistant to paying fees. Even if you strip the commission off a risk product and offer to implement the product on a fee advisory basis so the client pays far less in the long term, a lot of them don't understand this way of doing things. Most clients believe they are buying from the product provider and not from the financial adviser, so would rather pay the higher long term risk premium i.e. with commission, rather than pay a fee and a lower premium. They don't want to know about the commission the broker gets from the provider, as long as they feel they are not paying the adviser anything. This is very real and not entirely the client's fault, as they have been brainwashed into this way of thinking for a very, very long time by the product providers as well as by adviser bashers like Bruce Cameron. Instead of splitting hairs about who should charges fees and who should get commission, attention should be given to educating the consumer on the various options available of fees versus commission. We certainly don't need another category of middleman. The last thing we need is preaching from the banks, because then we really are in devil's land.
Report Abuse

Added by RJ, 23 Jul 2008

We run a practice where we combine both fees and commission. We do not do a lot of risk business, but when we do, the process before we write a policy is onerous and time consuming. Let us look at it: 1. We meet with the client, and for the first interview we do not charge a fee. 2. A detailed analysis is done of his present situation with regard to current risk cover, financial and family situation, debt, etc. this is done during the interview, but then 3. A formal report in writing is given. 4. If from this it flows that risk cover is in fact needed and can be afforded, we will obtain quotes, normally from 5 or 6 insurance companies. Because of different scenarios it could mean we are asking for 15 to 18 quotes. 5. These are analysed and a formal written confirmation presented to the client, with recommendations. At all times the commission is part of the data presented to the client. The policy can be in place and paperwork done within a week. 6. If we write the business we have no problem taking the commission because of the huge amount of work that goes into it, the responsibility we assume for giving the advice and the fact that the client understands that the work we have done must be paid for. He is given a choice of either fees or commission and at no stage have we had any client react negatively to paying the commission. 7. The intellectual capital available to the client in the advice we give is part of what he is paying for. We make this quite clear to the client, because the work we are doing is for him, not for us. 8. Should he chose, after we have done the work not to take up the policy, in most cases we will send him a bill for the work involved, but clearly it does not cover all the costs to the same extent as commission would do. This too we explain to our clients. 9. I believe that because of the slow, onerous work we do, we have no clients who in the current difficult economic climate, have cancelled their policies. 10. To separate selling from advice is a stupid and senseless suggestion from someone who clearly has not got to grips with the FAIS legislation and the practical aspects of it. A client comes to you for advice, you follow a process, you give the advice and the client follows it – if you have given the correct advice – by purchasing a product. Who takes the liability in the proposed changes between advisors and sales agents? Clearly a suggestion of an idiot with no practical experience in a brokerage. 11. And why should we in our practice be dictated to as to how we levy fees for our clients? Whether the client receives a bill from us; or pays our bill via the commission on a product for the huge amount of work we do is surely between ourselves and our clients? 12. One of the problems I believe we face is that none of the legislators have sat opposite a client with all that involves and to my mind each one should be work shadowing for six months in a brokerage before they are employed at the FSB or elsewhere. In that way they will experience the reality of what they so happily legislate.
Report Abuse

Balancing the ingredients for a perfect financial practice

quick poll

Question

COFI is coming, bringing a wave of change for financial planners. Which one of the following disruptors will have the biggest impact on your business?

Answer

Adviser categorisation Omni CBR Remuneration models We are ready for all of it

View the Results

Balancing the ingredients for a perfect financial practice

Comments

Comment on this Post