FINANCIAL SERVICES RESEARCH FORUM Dinner 5 November 2007

Financial Advice or Commission Driven Sales?

Hello. After that introduction you’re probably thinking Good God! We’re a serious research forum and they book a two-bit journalist to talk to us!

Just one news item worth reporting before we get on. Less than half of secondary school pupils are learning a language other than English. Which is bad news for those hoping more would start to learn about financial services. Becaseu they’ll never be able to understand things like this

I want to talk to you tonight about financial advice. Because in the permanent revolution that the Financial Services Politburo imposes we are at what the Chinese would call an interesting time.

I’m not a financial adviser – not in the regulated sense anyway – but I get an awful lot of letters and emails from people who want my advice about their money. This is a random sample from my recent mailbox.

Inheritance tax, income zombie funds, tax for the over 65s, charges for paying by cheque, is direct debit safe, current accounts that pay interest, electricity bills, power of attorney, help for carers, tax codes, premium bonds, Financial Services Compensation Scheme, taxation of old style pensions, council tax, care home fees, using debit cards abroad, problems with pension protection insurance, claiming back bank charges.

Now those are all emails and letters wanting help about money. People you might say in need of financial advice. So why do they come to me rather than the 20-30,000 IFAs (no one seems to know how many and the FSA doesn’t count them) or the 30-40,000 financial advisers employed by banks and insurance companies?

And remember I am a journalist. From time to time Mori the opinion pollsters ask the public who they trust. In its latest for last year – doctors come top – 92% of us trust them. Police 61%, civil servants 48%, business leaders 31%, politicians 20% and even politicians come above journalists who take bottom place at 19%.

But when Mori did another poll about where people get their financial advice internet is just 5%, friends and family 7%, building societies 13%, banks 17%, IFAs 19% and way out in front are newspapers 31%. So they may not trust journalists but they trust us twice as much as you lot. And they trust us to give advice and information about that most important thing – their money. And if it comes to that love, bringing up babies, what property to buy, and where to go on holiday.

So why are journalists trusted on money?

Let’s go back to that list of topics in my mailbox. You can classify them in many ways but here are a dozen common topics.

1. Tax
2. Social security
3. Pensions
4. Savings
5. Investments
6. Credit cards
7. Borrowing
8. Mortgages
9. Insurance
10. Compensation
11. Banking
12. Council tax

As I said, they’re all about money. And the people who write or email all want advice. But how many of those requests – some of them heartfelt pleas – could be met by a financial adviser? Pensions – yes as long as it wasn’t state pensions which dominates my mailbox. Investments yes. Mortgages – some advisers of course. Insurance yes. And errr that’s it. Out of the twelve financial topics maybe four could be advised on by a financial adviser. , though you might have to go to two or three different advisers to get all of them covered.

And it doesn’t take a genius to see that those four subjects are the ones where advice leads to a sale and what do sales mean? Commission! Pensions, mortgages, investments, insurance – the four pillars on which the edifice that is financial services rests.

Nothing there for the person who wants to borrow £80 to buy a pair of school shoes for her eleven year old. Nothing there for a carer who can’t manage on her £48 a week and doesn’t know what else to claim or if she can work. Nothing there for the 70 year old who has £100,000 in a Halifax Liquid Gold account and wants to know where to get a better rate of interest. Nothing there for someone who wants to find the best deal on a credit card given her current spending patterns and financial needs.

A year or so ago I made a speech to a meeting of Independent Financial Advisers. One of the topics of the day was set by the FSA as ‘fair and not misleading’. My talk was inevitably called ‘not fair and misleading’. And I explained that the term financial adviser was itself not fair and misleading. Because at the heart of regulated financial advice there is a sale and at the heart of the sale there is payment. And the heart of the payment there is the cancer of commission.

And that’s why people come to journalists – of all untrusted people – for financial advice. Because we don’t earn commission. We don’t need to guide them towards an investment bond that pays them 5% a year and me 7% commission rather than Northern Rock paying a solid 6.3% backed by the Government. When it comes to BBC journalism anyway, we have our code of impartiality and accuracy and fairness. And I have to say that even in newspapers whose editorial matter is tabloid, the financial pages are generally very good. The Mail on Sunday personal finance editor for example was voted last week personal finance journalist of the year. And whether your approach is to read The Daily Telegraph and bin The Guardian or the other way around both have been winners in previous years of best personal finance section.

There is out there a great hunger for financial advice. But it is not satisfied by financial advisers.

Because of commission. I once read out a list of financial scandals and asked if any of them would have happened if commission had not been involved. I did it once and people walked out. But now it’s common ground. Commission does influence sales. It was responsible for financial scandals. The FSA says so. The research – if you read it honestly – says so. And just go down the list of the firms fined or banned by the FSA for mistreating customers. Would those firms be in trouble without commission biasing what they did? Look at the great financial scandals of the past – from pensions mis-selling to mortgage endowments to payment protection insurance – would those have happened without commission driven sales?

Of course not. And it still is happening – look at the subprime mortgage crisis in the USA. Why were people sold expensive mortgages who had neither deposit nor documentation? Why are two million Americans facing the repossession of their home? Because the interest of the sales staff was different from the interest of their customers. And incidentally different from the interests of the manufacturers of those products. Commission damaged the providers, devastated the customers and only benefited the sales staff who have disappeared with their commission. Commission is a cancer at the heart of the financial services industry.

When I say these things now no one walks out. More and more the debate I hear from the industry is not whether commission is a good thing. Like tax we’d all rather do without it but can’t quite find the way. But rather – with a shrug and a pained expression – what is the alternative? Who would pay for financial advice? What about all those people who cannot pay for financial advice. We’ll come to that later.

The problem with commission is simple. Commission creates a conflict of interest between the customer and the adviser. As a customer you cannot know if the person sitting opposite you is suggesting a product because it is right for you – or for them. And people in financial services ask me why does no one trust us? Actually what they usually ask is how to restore trust in financial services. My first answer is ‘restore?’ my second answer is ‘scrap commission’.

When depolarisation was first discussed and the FSA was considering then what the various people who sold financial products under the new regime should be called I suggested that instead of ‘financial advisor’ the term ‘commission driven sales staff’ might be more accurate. It didn’t happen.

And what did happen was a disaster. And what it will be replaced with is going to be an even bigger one.

Part of trusting the sales process, or the advice process, is knowing who you are dealing with. Before polarisation it was easy. Financial advisers were either tied – they could only sell the products of one company usually the one they worked for, or they were independent. They had in theory to trawl the entire market to find the best product for you. Tied – independent. Or as we used to say in financial journalism – good – bad. Because no one should ever go to a tied agent – they can only sell you the products of their company. So their advice was tainted. You don’t go to Renault for advice on buying a car or even buying a French car – you go to Renault for advice on buying a Renault. And if they call their sales staff motoring advisers you smile wryly and concentrate on the test drive and the CO₂ emissions.

So the polarised financial world was simple. But the FSA decided that having just two poles were anticompetitive. Instead of two kinds of financial advisor there would be three. Independent – still a north pole – tied – still a south pole – and now multi-tied – the east pole – you didn’t think it existed did you? But that the FSA believed it was where the Holy Grail of fair competition was to be found. And it was not so much depolarisation as multipolarisation. Because each of those three poles would be subdivided.

The adviser can

And you can pay in three different ways

So that’s three ways to relate to providers, three ways to relate to you and three ways to charge you. 3x3x3 is 27. So 27 types of investment adviser.

Not just the east pole but the north by north east, nor east by north, south south east, east by south and so on – nearly the full 32 points of the compass. And that is just investment advisors.

The FSA also regulates mortgage advisers and insurance salesmen as well. Now with mortgages there are no stakeholder products and no combination of fees and commission. And here instead of ‘independent’ you have this notion of ‘whole of market’ which just to help consumers know where they stand means something different from ‘the whole of the market’. So there are 3x2x2 = twelve different types of mortgage sales. And the same with insurance – though of course with insurance you don’t have to be told what the commission is because that well it’s been a secret a long time and no harm’s been done has it? So 27 types of investment adviser and 12 types of mortgage broker and 12 types of insurance seller. But you can’t just add them up. Because you can be – and often are – an independent adviser for mortgages but tied for insurance. You can be fee paid for investment but commission paid for insurance. So you have to multiply them and remember that not everyone has to do them all so those who remember their maths the number of permutations of 27, 12, and 12 things is 4731 different theoretical combinations of financial adviser. Not so much boxing the compass as time to splice the mainbrace.

The serious point about this is that when you go for financial advice – or more honestly to buy a financial product – you do not know who is sitting opposite you. The independent mortgage advice might lead to tied insurance advice of unknown quality. The fee based investment advice might be supplemented by an insurance sale that generated commission. The independent equity release sale – a mortgage product – might lead to a recommendation for a tied and commission heavy investment with the money released.

Replacing two kinds of financial adviser with 4731 – multi-polarisation – is bad for consumers. Because when a customer asks themselves ‘who is this person sitting opposite me?’ they cannot know the answer. Cannot know if they can trust the person to recommend products from the whole range available and cannot know if that recommendation could be tainted by commission. Sorry did I say ‘tainted by commission’ what I meant of course was "Remuneration-driven sales can also lead to inappropriate advice... in order to generate income for advisers, often resulting in high levels of early termination of these long term products." The FSA has stolen all my lines – and turned them into gobbledegook.

Anyway, less than three years after the start of depolarisation we are faced with another restructuring. The details are as yet of course unclear. But it seems we will have three new divisions of advice into Professional, General, and Primary advice. Professional and the sort of subdivision of General will be confined to people with incomes of £25,000 to £50,000. Now £25,000 is the median level of full time earnings in the UK. The median of course means that half earn more than that half less so if you stick a pin in the UK population the person who goes ouch is on about £25,000. And £50,000 incidentally is the top tenth of earnings. So probably the top tenth would get professional financial planning. The next four tenths would get general advice. And the bottom half – or some of them – would potentially just get something new called Primary advice. "Straightforward advice on more straightforward needs" – you know the sort of things poor people need.

The term ‘independent’ will take on a whole new meaning from that we have come to know and understand over nearly 20 years. Some advisers who offer products from the whole market will not be allowed to call themselves independent. Or perhaps some of those who don’t offer the whole market (whole of market, the whole of the market? Not clear) will be allowed to do so. They will have to be independent of commission bias or sales incentives. But as long as they use their professional planning abilities to recommend the best pension Barclays offers – even if the bank just offers one – they will be independent.

And all this change will only apply to investment advisers. So you will have a completely different system for the advice the same person gives you about insurance or a mortgage. I can’t do the arithmetic without knowing the numbers. But with new words for old activities and familiar old words taking on entirely new meanings it will be even harder for customer to know who is sitting there advising them to buy a particular pension or investment or policy or loan.

And then of course there will be a fourth level of advice. Perhaps we will finally find the west pole. Sitting below all of this will be GFA – that acronym is used to avoid calling it Generic Financial Advice. Because if Otto Thoresen’s paper is clear on one thing it is that Generic Financial Advice will not be called that Generic Financial Advice. Because as he puts it, "it is not a term that is easily understood".

Why not? ‘Financial advice’ is easily understood. It’s the word ‘generic’ that causes the problem. In medicine it is used to mean a drug that is not overpriced by the drugs industry – ‘paracetamol’ at 28p for twenty is generic rather than ‘panadol’ which is chemically identical but five times as expensive. So in a way it’s quite appropriate for cheap financial advice – but it’s not a commonly understood word.

But instead of just out leaving out the difficult word ‘generic’ and letting these new agents give ‘financial advice’ he proposes calling it something else to reflect what he says it really is "information and guidance to people, equipping them with the tools to make more-informed decisions".

But you know what the people who contact me and other journalists want is advice and it is about their finances. And as I said earlier they trust it because they know that the advice they get is free of the sales process.

• Mr E W G writes "I would appreciate your advice" – about income tax allowances in that case.
• Mary M writes "Can you give us any further advice?" About inheritance tax.
• "I am asking you for advice please" that from Mrs B W about a fuel bill.
• "Perhaps you would warn others of our experience" says Mr D W about his premium bonds.
• JM writes "Can you help?" about his pension.
• "I am a fan of your articles" from the excellent Mrs J M A – she didn’t want advice I just liked that one.

So here are people desperate for financial advice or help. Who can’t afford, or don’t trust, conventional financial advisers. And quite rightly as in most of those cases because a financial adviser could not help them with their enquiry. But when they go to the new – what shall I call them – Thoresen teams – they will be told that this new free service is not for them. They want advice. Advice a financial adviser can’t give them. But here they can only get "information and guidance, equipping them with the tools to make more-informed decisions." But people don’t want leaflets and web addresses, they don’t want homilies about budgeting and making ends meet. They want advice. From trained experts. To solve their problem.

The real reason why the term financial advice is not going to be part of the new service is not because it is not clear or doesn’t describe what people desperately want. It is a result of strong lobbying by the financial services industry. It says it will cause confusion with the term the industry has purloined to describe – wrongly inaccurately and misleadingly – the commission driven sales process.

So my solution to the problem is to stop calling the commission driven sales process ‘advice’ – it isn’t. It’s selling. And stop calling it ‘financial’ – it’s a small subset of financial – leaving out tax, benefits, budgeting, cash savings, redress, compensation, credit cards, direct debit, current accounts and so on. It is about pensions, investments, insurance, and mortgages. And that is it. So call it sales related guidance. And keep the normal English term financial advice for what the public yearns for – what the millions of people who read the newspapers and listen to the radio and television and surf the internet desperately want. Genuine impartial advice about their money – separated from the sales process.

Now there is a mistake that. The sharp-eared among you will know that cash savings are part of regulated advice. Deposits they are called and unhelpfully classed as a ‘specified investments’ in the FSMA 2000 (Regulated Activities) Order 2001 as amended para 74. Because of course cash savings are not investments. But then nor are shares ISAs savings accounts. Welcome to the world of non-English. But cash savings is a regulated activity. So advising about where to put your cash for the best return does take a regulated person. So why don’t they do it? Because there is no commission.

This raises a very difficult question for generic financial advice. Will those people be able to give advice about regulated products which pay no commission? And it’s not just cash deposits. It might be current accounts if the interest earned is an element of the advice. It is certainly National Savings. It is certainly gilts. And on the investment side it is certainly exchange traded funds – cheap trackers. Or indeed stakeholders. Or indeed the new personal accounts. Because if they can’t either financial advisers will have to start living up to their name. Or there will be a lot of products that no one – except us journalists – will be able to advise on.

Earlier I said commission was a conflict of interest between the advisor and their client. It is also anticompetitive – at least for customers. In a normal market when a business wants to attract more customers it cuts prices. So when a product it launched it is sold at a discount, maybe even at a loss. When it has a product which is in short supply it raises prices. Or in fact prices raise themselves because of supply and demand.

How different it is with financial products. When a product provider wants to limit the sale of an unprofitable or low profit item it doesn’t raise the price to customers, it cuts the commission paid to intermediaries. And when they want to promote a product on launch they do not offer it cheap to customers they raise the commission paid to intermediaries. All the time insisting in public of course that just as cigarette advertising doesn’t sell more cigarettes so levels of commission do not bias the recommendations of financial advisers.

So commission doesn’t just bias the sales process – either potentially or in fact – doesn’t just create a barrier of mistrust between the financial adviser and the client – it prevents competition working to keep prices for customers down.

At this point I am often asked at this point how do you get rid of commission? And I’m going to say now what I have said to meetings up and down the country for two years. I know the argument for commission – how do you motivate people without commission? Well it may come as a surprise but most people who work don’t get paid commission. What motivates consumer advocates, charity workers, teachers, plumbers, the people who run this hotel, even journalists.

I’ll tell you. If they do it well, they are valued, promoted, and yes maybe given a bonus at the end of the year. A fair wage for a worthwhile job. And if people don’t do their job well, then they are offered advice, perhaps some training, and if that doesn’t work they are disciplined, warned. And ultimately sacked. That’s what controls most of us at work.

It’s called management.

Are people who work in financial services so different from the rest of us that they can only be motivated to get out of bed by the thought of earning £2000 for selling a product that isn’t wanted, isn’t needed and may not even achieve the limited objectives it actually has? I don’t think so. Treat them like people, not like greedy bastards, they might behave that way.

I know at least two IFAs who don’t pay commission. They manage their staff as any other business does.

And away from financial services, in a highly competitive retail market, PC World scrapped commission across its 150 stores in March last year because the company realised that

"The previous commission-based selling scheme encouraged behaviour that was not necessarily in the customer’s interests"

So they piloted no commission. And stores where it was tried out – called One Team – showed a 5% better performance in converting visits to sales than the stores which still paid commission.

So it can be done. And the sooner financial services does it the better. Not just for customers but also for the reputation of product providers and for the financial sales staff whose job it is to sell those products to the public.

Thank you.