Wanted! More independent financial advisers

The UK’s need for IFAs has never been so great, writes John Baxter, head of Macquarie’s veracity asset. transformation service

Twenty years ago there were more than 200,000 registered individuals in the UK who could give the public financial advice or sell financial products. Today, that number has dropped to just over 20,000 and, if some reports are to be believed, this number will fall further as a result of the Retail Distribution Review (RDR). It is a moot point whether the public is better served now than two decades ago, but what is clear is there will be a need for more professional advisers in the years to come.

There has never been a better time to be involved in the financial advice sector. The credit crunch, declining markets and the higher standards required by the RDR have had a significant impact on the sector, but an evolution is needed and a more robust sector will follow.

An ageing population

The UK has an ageing demographic, limited funding for welfare and there is an inevitable shift in retirement planning from defined benefit final salary schemes to defined contribution personal pension schemes. Product providers are introducing increasingly complex solutions and, as a result of the economic crisis there is an uncertain future in terms of tax and legislation.

For advisers, the uncertainty brings further opportunity to deliver high-quality advice to clients. There has never been greater need for professional financial advice as there is today and the need will be even greater in the future.

To ensure the professional advice community not only survives but flourishes the sector is undergoing a transformation at every level. One of the most important ways is clients’ investment experience, which is transforming from a shopping trip of products that were popular to an institutional class investment experience serviced via wrap platforms.

The remuneration of the service provided by advisers is also changing. With this comes the need to transform the business models from a transactional proposition reliant on indemnity commissions to a service model paid for by recurring fee-based revenues. The culmination of these changes is to move the financial services sector from a sales industry into an advice profession.

Unfortunately, it has become clear that a number of advisers see the changes in the sector as simply an exercise in changing their remuneration methodology from indemnity commission to trail commission. The changes to remuneration in themselves do not make the business RDR-ready. In fact, it is most likely the changes may aid the business financially this year but will be storing up problems for future years.

The sustainable business models post-RDR will be highly efficient transactional models providing fee-based service models to clients. For these business models to work effectively in practice, advisers are changing not just their charging structure but their behaviours and their systems.

Business models

The transactional model needs to harness the capabilities of the technology available to advisers. This will aid a more effective delivery of the execution of the transaction and create a ‘smarter’ business.

In terms of the service business model, defining the client proposition and segmenting the client bank is critical to ensure the proposition is compatible with the profile of the client. The likelihood that 0.5% trail remuneration will be the appropriate charging amount for an ongoing service model in the post-RDR world is highly unlikely. All fee-based businesses face the constant challenge of developing a proposition that is value for money and profitable.

Advisers are currently defining their proposition, calculating the cost to deliver profitably and then deciding what the charge will be. Depending on the proposition this could be more or less than 0.5% per annum. It is also likely to require some underpinning with minimums to prevent the next market downturn bankrupting the business and some diversification of remuneration models to differentiate the initial or ad hoc advice charging methodology from the ongoing service proposition charging methodology.

Cross-subsidisation

The traditional adviser model was, for the most part, transactional and predicated upon the need to sell new products to new clients in exchange for upfront commissions. This model used to work, and therein lies the problem. It worked because of cross-subsidisation. The clients who bought products from an adviser were either subsidising the clients who did not buy that year or the time the adviser spent looking for new clients.

The margins were such that if enough clients bought a particular product, then the ones that had bought in the past could be serviced without the need to always sell a new policy.

This subsidisation has been dying the death of a thousand cuts for more than a decade. The margins have fallen as a result of initiatives such as stakeholder and CAT standard products being introduced. At the same time the costs of being a regulated business have been going up. This model no longer works.

Sadly, the good advisers still trying to provide an ongoing service to clients who have bought products in the past are the ones that are hurting the most. They are operating an ongoing service model, but their remuneration is transactional.

How long would a car dealership survive if the price of purchasing the car included free servicing for life? If the servicing cost was built in properly it is likely the cars would be so expensive few people would buy them. If the cost was appropriate the firm will go bankrupt anyway in its attempts to service cars for free.

One of the main outcomes of the Impact of Incentives part of the RDR was the desire to see the client charges ‘matching’ with the timing of the delivery of the service. This will ultimately prove beneficial for both the client and the adviser.

From the clients’ perspective, they are more likely to receive the ongoing service that a successful financial plan and investment experience requires. From the adviser’s perspective, their profitability will be more robust and predictable. This will enable them to plan properly for the future of the business, unlike in the past where fixed costs were taken on in the hope that a variable income stream could pay for them.

So, while the number of advisers required for the future of the financial advice sector is an interesting debate, it will only really be settled with the benefit of hindsight. However, our position remains that there has never been a better time to be in the advice sector. The businesses that can implement a robust service model will have a lucrative future with fulfilling roles for their staff. Most important, their clients can look forward to being well served by a professional adviser sector as they approach the uncertain times ahead.