RDR AWARNESS PART 16- ADVISOR REMUNERATION MODELS INTERNATIONALLY

When it comes to anyone’s income it obviously becomes a very sensitive matter and any proposal impacting on such income streams will induce a high level of debate as I have observed during many RDR workgroup and committee meetings with various organisations and affiliations.

Chapter 4 and proposals HH; II, JJ, LL, MM, NN, OO, PP and QQ deal with this subject matter in detail and its intend is to deal with conflict of interest and influence and fairness to the consumer on fees and cost. It speaks to disclosure of fees, standards for fees, up-front and on-going product advice fees, fee collections by product providers, servicing fees on investment products, selling and servicing risk products, replacement policy fees and prohibitions on commissions, commission on “legacy” products and finally conflicted remuneration on section 14 transfers.

After studying post-RDR countries outcomes on RDR remuneration models it is very interesting to note how models have evolved and it is clear that models differ vastly and how new models come into play as old ones evolve or loopholes is found. It is also clear that models have to accommodate various tenures of advisors within an industry and special arrangement to be made to accommodate “ newbies” into the industry and other to accommodate the “ golden oldies” in the industry who are close to the end of their tenure or career in the industry.

It is also clear that South Africa will possibly be the first country to run RDR on both investment and risk (protection) products and this will bring to fruit further new remuneration models as we already observing in anticipation and where advisors is being pro-active.

 The models which I am observing are as follow:

Pure fee base models. With this model financial advisors give only advice and do not sell any products of any kind and do not work on referral kickbacks at all and therefore could be perceived as pure independent financial advisors (IFA’s) or planners as there simply is no conflict of interest or influence of any nature and this tie up perfectly with the oxford dictionary which describe an independent as ……..”free from outside control; not subject to another’s authority”… This breed of pure IFA’s advisors charge a fee and invoice the client accordingly as and when advice is completed and this cover upfront advice for a financial plan and on-going advice on such a plan and in general. They either charge fees for producing a plan at a fixed agreed rate or they charge an hourly fee rate for on-going advice in general and as and when advice is required.

The one problem with this model is sustainability in my opinion as it simply means the advisor must give on-going advice on a regular basis and sustain its client base as there is not really opportunity to build passive income streams.

• Pure fee base retainer model: There is group of advisors who has taken it one step further and are creating a much more sustainable model and they work on the same basis as the pure fee base advisor but they have been able to convert their fee base practice into a “retained fee base “model where they sign advice agreements with their clients to retain their services at a specific monthly rate and this rate give their clients unlimited access to their resources on an on-going basis.
  
  I really like this model as it does away with the perceptions clients have that every time they contact there advisor there will be an invoice to follow and this in my opinion will drive clients away from advice when life changing events happen and they need advice mostly and it will also result in clients then moving away from very skilled fee base advisors to advisors who work on models which may not be in the best interest of the client.
  
  This model certainly create very good passive income through on-going servicing of the clients financial plan and portfolio and is much more sustainable as long as you work with the right amount of clients and niche market who can afford this monthly retainer fee and as long as the advisor have a great value proposition to justify such fees and being paid for it. Such a value proposition would have to include a good balance of experience, accreditations, designations, affiliation membership, partner associations, succession and continuity partnership, technology systems and most of all professionalism within your practice with great support staff.

Hybrid model between fee base, trailer fees and commission
There is no doubt that the hybrid systems are currently still enjoying the most support and in my opinion mostly because it takes time under RDR models to build a sustainable income to replace loss of income streams ( taking a haircut) following post-RDR or with pro-active RDR models. These models are also followed where the first two can simply not be implemented with sustainability because of client education and affordability or where the right value proposition has not evolved sufficiently. It may include a combination of all 3 types of fees, retainers and commissions or it may include any part of it only at any given time as the practice evolve during the fee base transition process.

However it may also include the waiving of some fees where it is linked to product sales as a consequence of good financial planning and therefore the upfront fee for the financial plan may be waived and the on-going trailer fee for instance may be reduced because the risk product upfront and on-going commission fee in the portfolio will subsidise the loss of the commission on investment products which has fallen away.

• These are only a few simple examples as the scenarios in each RDR country will differ vastly depending on the RDR remuneration systems in place. In South Africa for instance where there could be a combination of commission and as and when fees on risk products this would become a definite model while in the UK where commissions has only been removed on investment products and not risk products there will be two models in place. It will also be different where advisors specialise for instance as investment specialist, risk specialist , employee benefit specialist or health specialist.
• This model may typically include an upfront fee for the drafting of a financial plan and then include an hourly or retainer fee for advice given on an on-going basis and may also include a trailer fee on investment products as a % of the assets under management and commission on risk products.

These models will therefore include hourly rates, fix rates, commission and trailer and legacy fees to name a few.

 Clearly there is huge challenge for us as advisors/planners to work through the most effective remuneration models for our clients and practices and consideration must be given to both advisor gaps and advice gaps being formed during the evolvement of models pre-and post-RDR in different countries as well as sustainability of models and these models will also be impacted significantly depending as what type of advisor you operating within e.g IFA’s , Tied, Restricted, Multi-Tied and within what sector e.g. long term, health, short term or a combination. There is just so many variables and the question come into play on how regulators will monitor the different models through a macro or micro management systems or self-regulatory.

It would be important to not try to re-invent the wheel I believe and there are already specialist practice coaches and consultants out there who can help you design your model within your country and it may be worth paying for such advice where you are not operating contractually. For contractual advisors a lot of the models will be designed with the regulators by the product providers so your concerns will be much less than the non-contractual advisors for instance.

Now that I have put some content to international RDR trends I want to below just focus on the proposed South Africa RDR White Paper which no doubt will differ significantly once the FSB and other stakeholders have negotiated a RDR paper which could result into a win-win for the advisors, consumer and the industry in SA.

The FSB 97 page RDR White Paper include the following comments and which all advisors should take note of in principle and prepare accordingly to be pro-active and even if some of the proposals will change on the final RDR Paper.

The RDR white paper wants to ensure greater clarity on the activities that make up advice, intermediation and outsourced services respectively, as well as on whose behalf the services are rendered and it wants to create the foundation for a clearer set of principles and rules for intermediary remuneration post-RDR to ensure a sustainable model for both the advisor and the consumer.

To achieve the desired RDR outcomes, it is proposed that the future regulatory framework for intermediary remuneration should meet the following criteria:

 Intermediary remuneration should not contribute to conflicts of interest that may undermine suitable product advice and fair outcomes for customers.

As part of this aim, intermediary remuneration should not undermine reasonable customer benefit expectations or inhibit customers’ access to their savings (such as through early termination charges designed to recover commission costs).

• The regulatory framework should recognise the range of services available, the related remuneration for these and who may pay or receive it.
• All remuneration must be reasonable and commensurate with the actual services rendered.
• Remuneration structures should strike a balance between supporting on-going service and adequately compensating intermediaries for up-front advice and intermediary services.
• On-going fees and / or commission may only be paid if on-going advice and services are indeed rendered.
• An intermediary may not be remunerated for the same or a similar service twice.
• All fees paid by customers must be motivated, disclosed and explicitly agreed to by the customer.
• The different types of services and fees should be readily comparable by customers; and
• Remuneration structures should promote a level playing field between different types of intermediaries providing similar services.

 Services to the customer will be split into –

 – Financial planning / non-life insurance risk planning;

– Up-front and on-going product advice.

Services connecting customers and product suppliers will be split into- 

– Sales execution (“selling”) and on-going product maintenance and servicing by intermediaries;

– Non-advice sales execution; aggregation and comparison services; and investment platforms. 

Services to product suppliers through- 

– Binder services

– Other outsourced services. 

Fees for financial planning / non-life insurance risk planning (service to customer) 

This is a service rendered to the customer and should accordingly be remunerated by means of a planning fee (a specific type of advice fee), negotiated with the customer. The fee should be pre-agreed directly with the customer on the basis of a clearly disclosed charging structure, with a clear indication of the nature and extent of planning services to be provided. Regulations will not prescribe the quantum or charging basis of the planning fee, although the regulator or, where appropriate, a professional association, may publish benchmark guidelines.

 Advisers who provide more comprehensive planning services should be able to charge more than those whose planning services are more limited. For example, although it is accepted that a tied adviser may in certain circumstances be able to provide financial planning services, it is likely that the financial plan will be more limited than that available from an IFA. Financial planning fees should also take the level of expertise of the planner into account.

 Monitoring of adherence to the financial / risk planning fee guidelines published by the regulator will be the responsibility of the product supplier in the case of tied agents, and the regulator in the case of multi-tied advisers or IFA’s.

Up-front and on-going product advice fees (service to customer) 

Product advice – whether up-front or on-going – is a service rendered to the customer and should accordingly be remunerated by means of an advice fee, negotiated with and paid by the customer. This principle should apply regardless of product type – in other words it should apply consistently to all investment products (whether in the form of an insurance policy or not) as well as to life insurance and short-term insurance risk products. 

An exception would be for qualifying products sold into the low-income market. 

The product supplier should not dictate the advice fee that the adviser may charge, or negotiate the advice fee with the adviser, but may facilitate the payment of the advice fee, as an alternative to the customer paying the fee directly to the adviser. 

For investment products, this can be facilitated by means of a once-off or on-going deduction from the investment value of the product concerned, or from investment contributions made by the customer. 

For risk products or other products where deduction from the product value is not applicable, the advice fee may be collected in instalments as an additional amount, over and above the contribution or premium payable for the product concerned (for example a separate debit order amount). 

The advice fee will have to be differentiated from the product contribution amount as well as from any underlying product charges, and separately disclosed. It should be clear to customers that advice fees – whether facilitated by the product supplier or not – are separate from and in addition to product charges. 

Neither the quantum nor the fee basis for up-front or on-going product advice will be prescribed, although strict disclosure standards will apply. Various charging structures may be negotiated – for example a flat fee, an asset-based “trail” fee, a percentage of contribution, an hourly rate, etc.

 However, a number of conduct standards will be necessary to mitigate the risk of abuse or unfair outcomes arising from this flexible framework. Regulatory guidance on appropriate advice fees should also form part of consumer education initiatives. 

For investment products, product suppliers will be required to provide a facility for deducting advice fees. This will enable customer-agreed deductions from a customer’s investment to pay for financial advice and flexibility in payment options, obviating the need for the customer to have to pay advice fees directly, up-front, or in full. While these deductions from a customer’s investment would need to be facilitated by a product supplier, this is not the same thing as commission, as the remuneration is not set by the product supplier and the product supplier plays no part in the negotiation of the fee amount or fee structure. 

The above approach to advice fees will apply equally to IFAs, multi-tied advisers and tied advisers, to avoid arbitrage and inappropriate migration of IFAs to multi-tied or tied advice models. However, the quantum of product advice fees would be expected to take account of the scope of advice available – IFAs would for example be expected to be able to charge higher fees than those charged by multi-tied or tied advisers, as the case may be. The level of expertise of the adviser concerned would also be relevant. 

Considering both the arguments for and against the as-and-when model, it is proposed that a balance between the as-and-when and up-front models be introduced. 

Lastly I am very confident that the RDR model after negotiations will be a very workable (will never be perfect because of the intrinsic complexity of our industry) model to the advisors out there and it will create a value practice with much more passive income and where you will be remunerated for everything you do as it should be with any profession and as lawyers, doctors and other professions have been doing for many years and it will elevate our industry into a profession and our clients will respect us as professionals and be willing to remunerate us accordingly. For the clients who cannot afford the advice fee there will always be Robo-Advisor and other models which are evolving quickly to prevent and advice gap. 

Kobus Kleyn CFP?