I wrote this piece to clarify my views after a reporter from Mortgage Strategy reported my comments on commission after a speech I gave to the Building Societies Association meeting on 23 May 2007
In about a month the FSA will publish its conclusions on how financial products should be sold. Its Retail Distribution Review will look at the role of commission and how it affects the advice given by advisers and brokers to their customers. We already know that commission does affect the advice given because it affects sales. When a provider wants to sell more of a product or draw a new one to the attention of advisers it raises the commission on that item. When it wants to sell less of an unprofitable line – such as some stakeholder pensions – it cuts the commission. Such is business.
The simple fact that commission levels affect overall sales does not mean that any individual adviser will always be influenced more by the commission they will earn than the interests of their client. But the very presence of commission creates a conflict of interest between the adviser and the client. The best mortgage for the client to buy may not be the best mortgage for the adviser to sell. That is a conflict which individual brokers will resolve in their own individual way. The best will ignore the commission. Others will not.
So a customer for a mortgage – or an investment or a car or a computer – who is faced with a person who makes their living from commission on sales should be cautious. Because at least part of the adviser’s motivation in recommending a product could be the commission they will earn.
That was the point I made in answer to a question at the Building Societies Association Annual Meeting at Bournemouth on 23 May. If I had said "close your windows when you go out or you might get burgled" the 99% of passers by who are honest would not be offended. And the 99% of decent, hard working, and modestly remunerated mortgage brokers should not be upset when someone says you cannot fully trust advice which is given in a commission environment. It is common sense.
There is another danger which commission brings. Two years ago I investigated the role of commission in the financial sales process for Radio 4. A broker told me that the commission paid on mortgage products was so low that he had to sell other products, mainly insurance, to make a living. In that sense he agreed that the mortgage sale was a loss leader for selling life insurance, critical illness insurance, payment protection insurance, even home and contents insurance. Sales of some of those products have been criticised by the FSA regulator as inappropriate. So again a customer has to beware of what is being sold with the mortgage. You can read or listen to that programme The Sins of Commission
Since that programme was made a new danger has emerged. Many brokers who are ‘whole of market’ for mortgages (which under the FSA’s confusing rules does not mean they have to cover the whole of the market) are tied agents when it comes to insurance sales. So even where the type of insurance is appropriate, the particular product sold by the broker may not be the best value to cover that risk. Customers may well do better buying the mortgage from the broker but checking independently what insurance they need and shopping around for it. And of course some brokers are not ‘whole of market’ even for mortgage products. Their advice will always be partial and they should be avoided.
The profession of mortgage broking is relatively new. Twenty years ago people who wanted to buy a house went to their local bank or building society and took one of the few products available. There were no best buy tables. No discount, fixed, or capped deals. Buying a mortgage was simple, if poor value. Today there is far more choice. Perhaps too much. Two weeks ago MoneyFacts told me it had 10,665 different mortgage products on its database. A year ago it was 6437. In one sense that shows competition is working. It is creating choice and driving down prices. But in another sense it is not. It is presenting people with a choice of products so baffling that it is impossible for an individual to say which is the best for their particular needs.
Unable to choose rationally between the bewildering array they turn for help to an expert. Recent estimates suggest that three quarters of all mortgage sales are made through brokers and in the mortgage market as it exists brokers are essential. But they have to be paid. And even if their pay is disguised as commission from the lender – and many brokers take a fee as well as commission – ultimately the customer pays in a higher price for the mortgage. In many cases the commission the provider pays to the broker is taken from the customer very directly as part of the arrangement fee.
So mortgage broking has become a new cost of buying a home. It may be small compared with the estate agent, the removal firm, and stamp duty. But unlike them it is repeated every few years when the home is re-mortgaged to get another best deal. In such a complex market paying for a good mortgage broker is the one expense of moving that can save money in the long run. Which is why it is so important for customers to treat that advice cautiously and to be sure it is given in their interest not the interest of earning commission.
11 June 2007