July 4, 2012 1 Comment

This article was originally commissioned and published in April 2012 for Investment Life & Pensions Moneyfacts publication. It is written by Tom Murray, Head of Product Strategy at Exaxe.

The Financial Services Authority is still struggling to get the Simplified Advice model out into the market. It is hardly surprising, as there is a fundamental contradiction at the heart of the whole Simplified Advice model that nobody wishes to tackle.

Decades ago, or so it seems at this stage, when the Retail Distribution Review (RDR) was first proposed, industry reaction focused primarily on the fact that it would deprive large swathes of consumers from access to advice by enforcing an upfront acknowledgment of the cost. It was believed that many consumers would be put off by the idea of paying the going rate for advice, even though they are currently paying the same amount, if not more, via commission payments.

Market surveys, since then, have backed this position including the Association of British Insurers’ discovery that while the average cost of giving a full financial health check to a customer was £670, customers believed it should be in the region of £0 – £50. This was despite the fact that disclosure regulation has made customers aware that they pay far more than £50 already.

Fee disclosure is an odd sales model

It is clear that, faced with a pricelist before starting the advice, many would-be customers will turn on their heels and walk straight out of the office. This is particularly true of those with smaller investments, as the benefit of the advice would not appear to be worth the money that would have to be paid up front.

Even the ability to charge the advice cost to the product, which is very similar in effect to commission, does not help the situation as customers surveyed appear to be very reluctant to sign up to the payment. This has to be down to human nature, as they are happy to ignore the commission disclosed in the documents, probably because it appears to be paid by someone else, i.e. the product provider.

And indeed, who can blame them. No other industry is forced to display the effect of its fees and charges to the customer. No one walks into a car showroom and is shown a model of a car and then pointed to the luxury model and told ‘this is what you could afford if we weren’t charging any money for our services, overhead or profits’.

As the provider currently pays the commission declared in the disclosure documentation, customers generally ignore it but the fee approach mandated by the RDR means that customers now have to actively acquiesce to the payment of these charges. No one can be confident that they will.

When in doubt, add complexity

Based on the industry reaction, the FSA came up with an extra two approaches – Basic Advice and Simplified Advice. Basic Advice essentially is the provision of information on the product type and on the various options available within the Stakeholder product set, without any recommendation as to the suitability of the products or even of the product type itself. This works for the confident investor who knows what they want and any resulting sales can be made on a commission basis in the post RDR world.

It’s when the FSA introduced Simplified Advice that the wheel fell off the wagon. The concept was to provide a cut-price version of full advice, so that those who needed financial advice but couldn’t, or wouldn’t, pay the full price, could still have access to some advice in order to organise their financial affairs. This is the beast that they are still having trouble driving to the market, as every attempt seems to create more problems than it solves.

The reason for this is that the FSA is still not facing up to the fact that there is a flaw at the heart of this approach which none of its solution cannot repair You cannot keep urging higher levels of professionalism on the Financial Services sector and at the same time try to provide a cut-price version of it. It just can’t work.

What do consumers want?

When people seek advice, they look to get the total benefit of the knowledge of the individual they consult, whether the advice is financial, legal, or medical. No one would go to a doctor and request an opinion that was based on a limited number of symptoms nor would they want legal advice that only covered a subset of the issues that were involved in their particular legal case.

Subsequently, when an individual goes for financial advice, they definitely do not want to get an opinion that only reflects a fraction of their overall position. Optimal management of their financial affairs requires an assessment of the totality of their assets and liabilities, a view of the future values of both of these and an evaluation of these against the customer’s general financial life plan.

Irrespective of the wording of the regulations, it is hard to see how we can prevent accusations of mis-selling in the future. If bad advice is given because material facts were not known, we cannot claim it is the responsibility of the consumer to know which facts are material – if they were that knowledgeable, they will be self-investing rather than seeking advice.

Round peg into a square hole

Despite this contradiction, the FSA are pressing on with the introduction of the Simplified Advice model, terrified of being blamed for moving financial advice beyond the reach of the majority of savers and into an elite category. So they keep plugging away at the concept, trying on the one hand to ensure any advisers providing simplified advice are fully responsible for the advice they’re giving, while on the other hand trying to reduce the work involved so that the overall cost can be held at a much lower level. It is a contradiction that dooms to failure any hope of a viable model.

Even with its best efforts, industry estimates show that simplified advice will retail at c. £200, which is still way beyond what the average customer believes they should pay to receive advice. Based on these findings, it seems unlikely that customers will feel that they will have received value for money for a simplified process that costs four times as much as they expected to pay and yet still doesn’t give them the confidence that all their needs are being met.

When you’re in a hole, stop digging!

Maybe it is time to stop adding further complexity in a doomed attempt to make this work and look at other providers of advice and see can we learn some lessons from them. In the legal arena, if you can’t afford legal advice, you can go to the government sponsored Legal Services Commission for defence against prosecution. There are also various citizen advice bureaus for those who wish to get legal assistance to work through other legal issues themselves or do without it.

Similarly, in countries where the health service is not free at the point of provision, those who can’t afford to pay for medical advice either have to do without or fall into a government provided safety net where free medical advice is given, although usually only on an emergency basis.

The financial services sector is constantly being exhorted to raise its professional standards. A part of that process surely is to value our own knowledge in the same way that other professions value theirs and face the fact that large numbers of the population cannot or will not pay the requisite amount for that service, in which case they will have to do without it. If this is seen as an unacceptable exclusion of the lower and middle earners from access to financial advice, as I believe it is, then the government needs to seek remedies as it did for other professions.

Radical solution required

In the same way that the government provides access to medical and legal advice at times of need, there could be government provision for access to financial advice when it is needed most. The two most obvious times for this are at the start and end of one’s working life – i.e. at the beginning of the accumulation process and at the beginning of the decumulation process.

The start of working life moment could easily be handled by the provision of basic financial advice as part of the normal school curriculum. This should be aimed at ensuring everyone is fully aware of the need to save for their own future and the basics of how to do so.
The other key financial moment for a person is at the crystallisation of their pension; a time in all workers’ lives when they need good advice. It is essential for everyone to have access to expertise in order to get a holistic view of his or her financial situation, before they take any irreversible decisions. This is an ideal point for the government to step in.

Waste not, want not

Although the idea of a government sponsored full advice centre has merits, I believe that it would be better to leverage the existing network of professional advisors by introducing a voucher system, which would entitle the retiree to a full financial health-check and optimal advice in making that once in a lifetime decision about what they should do with their pension savings.

This approach has a number of advantages. Firstly it would allow the adviser to give the time to the customer to ensure that the best advice was given. Secondly it would maintain a free market in advice and avoid the distortions of a two-level system. Thirdly, it would prevent retirees from making an incorrect decision that could literally damage the rest of their lives.

While there would be a cost associated with this, it would not come close to what it will cost the taxpayer to have increasing numbers of pensioners reliant on state support. Better-off pensioners will weigh far lighter on state expenditure than poorer ones, both in terms of the provision of basic needs and in terms of healthcare requirements.

Radical changes require radical thinking

There may be other approaches that will provide better ways to ensure that financial advice does not become the sole preserve of the wealthy. Whatever system is ultimately chosen, we need to get away from the idea that some halfway house between full advice and no advice is achievable. Until we face up to that, we are wasting time and money trying to hammer a square peg into a round hole.

Customers only want full advice, as partial advice is a ridiculous concept, particularly when the customer is not knowledgeable enough to know why they only need partial advice. The FSA stubbornly sticking to the original formula is doing no one any good, least of all the unfortunate clients who will ultimately be the victims of this approach.

The FSA need to face up to the fact that raising the standards also raises the price. That’s the problem they have to deal with and trying to ignore that fact is doomed to failure.

Tom Murray

Twitter: @TomMurrayDublin

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About Tom Murray

Tom is Head of Product Strategy at Exaxe with primary responsibility of overseeing product direction. Tom has extensive experience of managing web based insurance software from conceptual design through to commercial release and beyond. Tom has been leading the development of the Exaxe Internet insurance architecture since August 1999.