This talk was given 8 June 2011
The text here may not be identical to the spoken text
COFUNDS INVESTMENT FORUM, HARROGATE
Thanks for asking me to talk to this gathering of – mainly – financial advisers.
You may wonder why a journalist is giving the keynote speech. I have been a
financial journalist for more than 25 years. I am not a trade journalist. I am a
consumer writer and my interest is in consumers of financial services not
providers. And consumers – and knowing what they want and need – is going to be
even more important in future. And it is that I hope to offer some insight into.
And
for every consumer there is a provider – or at least a way into the market. And
that is why I am talking to you today.
It’s been a difficult presentation to write. For ten years I have been talking
to meetings like this telling financial advisors – Polarised, depolarised,
independent and otherwise – about the evils of commission, about poor advice,
about mis-selling scandals, about the need to meet customers’ real needs. And I
will do a bit of that today – not just from habit. But I also want you to see
everything I say in the context of a wonderful real opportunity. Freed from
commission, freed from your past the world of real financial advice opens up.
I
was asked to talk about what you call ‘retirement solutions’. And, forgive me
if, as a writer – someone whose job is to explain highly complex things clearly,
unambiguously – if I quibble over the phrase ‘retirement solutions’. A solution
has to be the answer to a problem. And what problem do people have about
retirement?
Bill Deedes, at one time editor of The
Daily Telegraph and before that a Cabinet minister, born in 1913 who died at
the age of 94 in 2007 had a very neat solution to retirement – he didn’t do it.
During his final illness he wrote his Telegraph columns on his laptop in bed.
His final column was published just two weeks before he died – on Darfur being
as bad as Nazi Germany (he had been to both). His family reported that he was
writing another column as he died. And for myself that would be my wish – found
in bed with my laptop open and a half finished piece on the screen. To die doing
my job, earning my living. Not at the tedious end of a 30 year holiday paid for
by other people.
It’s a small example of how the industry uses words not to enlighten but
deceive. By calling it retirement
solutions you beg the question is there a problem in the first place? Maybe
there isn’t. And you may say well yes the problem is that most people don’t have
enough income in retirement. Which is true. But many of them won’t have had
enough income in their lives generally. And there is no reason to believe that
saving for a pension will solve that problem for them. Not having enough money
is the default state at any age for most of us.
CHANGE
We
are meeting at a time of immense, tremendous change in your industry. Three
things are on the horizon. The National Employment Savings Trust – yes its logo
is an egg and it is called NEST – the state sponsored pension scheme which
begins later this year. Automatic enrolment – not to be confused with NEST but
it frequently is, not least by journalists. And of course the Retail
Distribution Review – RDR – which will change fundamentally the way that
pensions are sold or at least the way the people who sell them – you – are paid.
And my thesis is it will also change the nature of your job fundamentally.
And
a fourth change is just below the horizon, the masts are sticking up and we’re
not quite sure what the vessel is beneath them, but it is sailing towards us and
if it avoids the rocks of politics and the dragons of the Treasury the good ship
high flat rate state pension may deliver its £140 a week cargo sometime in 2016.
Those four changes make this the biggest shake up in pensions for nearly a
quarter of a century.
Twenty five years ago the past was a foreign country. Margaret Thatcher was
Prime Minister, Nigel Lawson was Chancellor of the Exchequer, Norman Fowler was
S of S for Pensions. And in this foreign land called ‘the mid 1980s’ there were
no personal pensions. A few lucky professionals had a section 226 retirement
annuity plan and the even luckier ones did not put it with Equitable Life. But
there was no financial services industry as we understand it – there was the man
from the Pru and there were stockbrokers, and that was about it.
The
Thatcher Government came up with the idea that we should cast off the chains of
Government dependency. Official adverts showed a chained man setting himself
free. And the first thing he did, as you would after a long time in chains, he
bought himself a pension. One of the new personal pensions.
And there was a useful taxpayer subsidy
for those who took responsibility for themselves. Around 8% of your pay.
But
she also made another equally important change. Before 6 April 1988 if there was
a pension scheme at your job you had to join it – no choice. Margaret Thatcher
ended that and three weeks later (28 April) the first personal pensions went on
sale.
Commission
This history is important because it was the moment when the financial services
industry could have grown and developed into a popular, useful, worthwhile, and
much loved business. Instead it sent teams of poorly trained, commission driven
sales staff to descend on a hapless population who believed the adverts and
newspaper stories which said that for a few pounds a month everyone could buy
political and financial independence.
Altogether the industry systematically mis-sold the new personal pensions to
millions of people keen to embrace the new world of freedom from the state and
personal responsibility. They were persuaded to leave good company schemes and
put their money at risk in personal pension plans. More than a decade later the
industry admitted its mistake and forked out £11.5bn in compensation plus
another £2bn to find and deliver the money to the two million people known to
have been mis-sold.
There were all sorts of things that contributed to that systematic mis-selling –
Government adverts, political interference, phrases like ‘personal
responsibility’, and articles by compliant newspaper columnists with little
understanding of risk or indeed of pensions– but the fuel which drove it to the
heights it achieved was commission.
It
is commission – not solutions to financial problems – which has driven the
growth in your industry.
I
am sure some of you are thinking ‘what’s wrong with commission? It’s how we earn
our living!’
For
the last ten years I have been giving talks like this saying that commission was
the cancer at the heart of the financial services industry. I did discover that
was a bit of a false claim as the heart is the one organ in the human body that
is just about immune from cancer. But you get my drift. And over the years that
view has moved from being completely dismissed and derided – I’ve been jeered,
shouted at, people have walked out – to being mainstream as the FSA has slowly
come round to my view on this as on many other things – such as regulating
products not processes.
And
commission is wrong because when I sit opposite someone who is recommending me
to invest my money in a product I don’t really understand and which will cost me
money every year regardless of whether it does what it should do or not, I want
to know why is that person recommending that to me? Is it because it is best for
me? Or best for them?
And
that conflict of interest lies at the heart of the problems of the financial
services industry. A conflict of interest does not mean someone deliberately
sells a rubbish product just to earn the commission. Undoubtedly some have. But
most don’t.
My
uncle was an IFA and he is the kindest, fairest, and, if it matters, most
Christian man you could imagine. I don’t believe for one moment he sold me an
endowment mortgage because of the commission he earned on it. He genuinely
believed it was a good idea. He had been told so by those clever people at
Standard Life who manufactured it and surely knew what they were talking about.
They had actuaries and everything. So it was win/win – by selling me the right
thing, he earned money.
The
insurers who made that crazy product promoted it through high rates of
commission because it was so profitable. The fact it was and always would be a
mis-match – an uncertain investment to meet a fixed and certain debt – was
ignored. Not by good honest salesmen like my uncle. But by the people who
devised it and sold the idea to him and gave him a cash incentive to sell it.
Mortgage endowments sold from the 1980s right up to the late 1990s left up to
five million people up to £40 billion short of the money they need to repay
their mortgage. Nearly £3 billion of compensation has been paid.
I
could go on – AVCs, SERPS opt-outs, precipice bonds, split capital investment
trusts, structured products – no lawful industry has been rocked by such a
succession of scandals. And all of them can be traced back to commission.
And
this isn’t just historical stuff.
In
January this year Hector Sants, Chief Executive of the FSA, told MPs that mis-selling
still cost the public up to £600 million a year. Such as in the FSA’s 2008
pension switching review of IFAs, multi-ties and tied advisers, the FSA judged
that 16 per cent of sales were unsuitable, costing £43m in annual consumer
detriment.
So
whatever you think of yourselves that is how you have been seen. Commission
driven sales staff, mis-selling financial products to a hapless population. And
that is why the Financial Services Authority has decided that commission has to
go – at least so far as pensions and investments are concerned. Because it
biases the sales process and gives you a different interest from that of your
client.
And
that applies even to the majority of IFAs who genuinely want to help us take
personal responsibility and save for our future.
So
be glad it is going. Because now, 2011 to 2013, is your chance to undo that
quarter century of mis-selling, misguiding, driven by commission. And replace it
with the financial services industry as it should be. Finding real financial
need and offer real financial solutions to those needs. And being paid to do so.
Now
I am sure many of you are thinking – the big mis-sellers are the banks, the tied
agents whose very structure leads to mis-selling because they cannot recommend
the best product unless they happen to sell it – which is unlikely. And you are
right. Don’t think I am against independent financial advice. Every piece I
write or broadcast about getting advice on pensions or investments end with the
words ‘go to a good independent financial adviser.’ And I always say never,
ever, ever go to your bank for financial advice. Because it is rubbish. And even
more commission driven than it is in the IFA sector. And thank goodness that the
RDR is intended to deal with that problem as strongly as it will deal with
commission paid to IFAs.
So
at the risk of sounding like one of those awful books on business you see at
airports, I am here to say you should see this change not as a threat but as an
opportunity. The IFAs consumers want is one who will work for fees and build a
business around that.
Some IFAs who want to embrace the change say if we charge £100 or £200 an hour
then that will exclude the mass market. What about the guy who wants to start
saving £20 or £50 a month – he isn’t going to pay me £400 for advising him. And
I say ‘good’. He probably doesn’t need financial advice of the product-based
sort. The mass market should not be risking their small amounts on the stock
market. Should not paying fees of 1% or 1.5% or 2% of their money every year for
the hope of unachievable growth.
A
good IFA when asked about a pension or an investment will say do you have debts?
And if the answer is ‘yes’ will reply ‘then use any spare cash to pay them off
and come back and see me when that is done.’ Indeed a good IFA will reject as
many or more customers as he or she serves.
But
I am sure these changes are an opportunity for those who genuinely want to give
independent, financial, advice.
I
am sure many of you agree with me about commission but are still wondering how –
or indeed whether – you can make a living. Problem is that people who come to
meetings tend to be among the good guys. The ones who don’t think that Ethics is
a county to the east of London.
And
that is where another danger lurks. Because although commission is going for
investments and for pensions, it is not going for insurance or for mortgages, at
the moment anyway.
The
understandable temptation will be to seek the comfort blanket of selling those
commission-based products. Because as the FSA says it will not be ‘reading
across’ as it calls it, from the RDR to the insurance industry, though mortgages
are of course being reviewed.
The
view is that there may be product bias with investment products but not with
insurance. But that misses the point. There may not be significant product bias
between life policies or indeed car insurance policies. But there is a bias to
recommend insurance that is not needed in order to earn the commission.
I
mentioned some major mis-selling scandals of the past. And as I was moving
towards the present I am sure some of you were thinking – PPI. Because it is
looking likely that Payment Protection Insurance is going to be the second
biggest mis-selling scandal – I was going to say of all time, but I mean,
actually. PPI redress won’t cost the £13.5bn of pensions mis-selling. But we
already know that four High St banks and credit card provider MBNA have set
aside nearly £6 billion to pay compensation and admin costs. And industry
estimates suggest the final total could be £8bn to £10bn including
administration costs. And that was insurance. Commission driven insurance. And
not generally sold by IFAs. Mainly sold by lenders and particularly by the banks
and the commission driven staff that work there.
Now
I am not suggesting you might start selling PPI – there isn’t much of a market
for it now. But for insurance – or as the industry likes to call it now
‘protection’ – there is a big market.
I
am not a great fan of insurance. In many cases it buys you peace of mind – until
you claim. Then it is a nightmare. When Larry Silverstein bought the world Trade
Centre in New York in 2011 he insured the buildings with a cap of $3.5bn for
each claim. On September 11th the twin towers were destroyed and he
asked his insurer for the maximum $3.5bn for each of them – two towers, two
planes, two events, two $3.5bn caps – so
$7bn. Insurers said ‘no’ it was one event so the cap was $3.5bn. Now, the risk
was spread among several insurers so several lawsuits ensued and eventually the
courts decided it was one event for some insurers and two for others.
On
a smaller scale, 200 people are still waiting for payouts following the volcanic
ash cloud which closed down European airspace a year ago. Some insurers are
arguing that the ash cloud was ‘weather’ which the policies excluded. Others,
whose policies insure against weather, are arguing it was not weather but a
natural disaster which their small print excludes.
Far
too often insurance gives peace of mind to the vast majority of people who do
not claim, but anything but to the minority who do.
And
even good insurance can be mis-sold. Life insurance – yes. But only to someone
who has a financial dependant such as a child in education – in that case term
assurance is what is needed, insurance that runs out as the child gets older and
disappears when it reaches an age when it will – or should – be out of education
and independent.
A
spouse or partner might be financially dependent – and a key example of that is
a partner with whom you have a joint mortgage – always insure that debt. But
often not otherwise. Many couples are genuinely independent of each other
financially.
And
any policy should take account of life insurance that is available through work
– some jobs pay three times salary – or a pension arrangement. And always write
the policy in trust to avoid Inheritance Tax problems. So sometimes good advice
about life insurance is – don’t buy it. But commission can still drive those
inappropriate sales.
Don’t touch critical illness insurance with a bargepole. Consider income
replacement if you want – but ditto all of the above.
Car, house, and contents of course. Travel insurance when you travel or annual
if you travel a lot. And change your provider each year to keep costs down.
And, err, that’s it. Mobile phone insurance? It’s with the contents. ID theft
insurance? It doesn’t cost you anything, the bank picks up the bill. So why
spend money on it? And so on.
And
IFA should never tie themselves to one company for insurance. One of the most
confusing things for customers today is how IFAs move seamlessly from being
independent for investments or pensions but then suddenly not independent for
insurance. – choose the best deal for your client in that as you do with other
things.
Let’s get back to pensions. And what is wrong with how they are sold – even by
good financial advisers.
Persistency
Every Autumn the FSA publishes a little noticed report called
Survey of the Persistency of Life and
Pensions Policies. The series was due to be axed in 2007 but after the then
chairman Calum McCarthy said poor persistency was evidence for how the market
was not working it was reprieved.
There are a lot of figures in this report and I recommend it – you can download
it from the FSA website. Let me concentrate just on pensions
and
on two sets of figures.
The
first set show show how many personal pensions taken out are still live after 1,
2, 3, and 4 years. The latest year we have four year figures for are policies
sold in 2005 and how many were still in force in 2006, 2007, 2008, 2009.
Here is how they change year by year. After one year 81.5%, after 2 yrs 66%, two
out of three, after 3 years just over half and after four years 44%. In other
words after four years most personal pensions sold by IFAs 56% have been
abandoned.
The
only comfort from these figures for you IFAs is that they are slightly worse for
personal pensions sold by company representatives where only 41% in force – so
nearly 6/10 are abandoned.
And
there are two more damning things about theses figures. Over time the record of
persistency has got worse.
These figures show the persistency after four years of pensions sold each year
since 1993 to 2005. Pensions sold by company representatives have declined from
57% to about 41%. In the case of IFAs persistency has declined from 70% of 1993
pensions to 44% for those sold in 2005. And there was a slight improvement a
couple of years ago.
And
these figures look even worse if we look at persistency of whole of life
policies. Those show a rise in persistency over the years 1993 to 2005 both for
company reps in green and IFAs in purple.
And
here are the figures for regular premium personal pensions in force after four
years tracked from those sold in 1993 to 2005 so in force from 1997 to 2009.
The
report is not terribly helpful or insightful about why policies are abandoned.
But it does say
“If
investors buy policies on the basis of good advice, they would not normally be
expected to give them up.” (para 3.3).
So
if more than half are giving up these long term, life-time products within four
years we can conclude that something is going wrong. And that is something for
you to sort out. Mis-selling, mis-buying, misunderstanding?
Auto-enrolment
Some attempt to tackle the lack of persistency is behind envisaged by the new
system of auto-enrolment which will start now in July 2012 and which will come
in slowly starting with very large employers down through medium and small
employers in a process known as staging in which will be fully in place by 1
October 2016.
The
Government hopes that “Automatic enrolment into workplace pensions will see
millions of individuals newly saving for their retirement.” (press release
24/5/2011). So everyone earning enough to pay tax aged 22 or more and under 75
and in a job at least three months will have to be automatically enrolled by
their employer into a pension scheme. And those just outside those limits can
opt in if they choose.
People who are enrolled can opt out but after three years they will be
automatically opted back in and so on and it will be an offence for an employer
to encourage people to opt out.
Until staging-in is ended in October 2016, the contributions paid by employees
and employers will be a minimum of 1% each. Then a second process, known as
phasing in, will start increasing the minimum contributions to 2% and 3% from
October 2016 and then to their final level of what is being called 3% employer
and 5% employee from October 2017 – actually being called 3% employer and 4%
employee plus 1% tax relief. That is not true, as we shall see.
Even if it was these are pathetic amounts of money to put into a pension.
The
average amount going into a salary related pension – a defined benefit scheme –
is not 8% but 21.5% split 16.6% employer and 4.9% employee. The average amounts
put into money purchase pensions – defined contribution as the industry likes to
label them now – is much less but is still 9.1% split 6.1% employer to 3%
employee. So 2:1 employer and employee.
Source:
ONS, Pensions Trends, Chapter 8 April 2010; DWP data and Paul
Lewis calculations
Under auto-enrolment the amounts are a lot less than that. The 8% figure is
simply misleading. The percentage will only apply to a band of earnings. Those
bands have changed and as far as we know now will run from £5715 to about
£38,185 – though both may be different when they are announced in January 2012.
And
8% of that band equals at most a percentage of 6.8% of earnings. For someone on
average pay of about £25,000 it is around 6.2% and for someone on minimum wage –
about half average pay – it is around 4.4% of total pay. And that is when it is
fully phased in from October 2017. Before that – when auto-enrolment will be new
and it is important to persuade people of its value – it will be a lot less.
And
note that the auto-enrolment figures are biased to contributions from the
employee. While the employee will pay much what they pay on average into a DC
scheme – a bit less – the employer will pay well under half the average
contribution into a money purchase scheme. Instead of 2:1 employer employee it
is almost the opposite 2:1 employee to employer.
So
contribution levels are to be scandalously low especially among the very people
auto-enrolment was supposed to help – the low paid.
But
there is hope. Auto-enrolment percentages are a minimum. If the employer enrols
employee into a better scheme that is fine. There is no maximum. And even those
employers who are afraid of the big bad – and sometimes expensive – world of
pensions can stick with NEST and put up to £4200 per employee into that. For
someone on average pay that is about 17% of their wages which could provide a
decent pension – especially for younger people – at the low NEST charges 0.3% a
year (plus 2% upfront).
So
auto-enrolment brings immense opportunities for IFAs – millions of people with
no pension suddenly need advice – crucial advice like should I stay in? YES. How
much should I pay AS MUCH AS POSSIBLE. And yes you have to charge a fee – paid
by the employee or better still their employer – but this kind of
straightforward advice can be done quite easily – and if it can’t then the FSA
should ensure it can.
Financial advice
And
let me mention another great opportunity for you. How many of you are financial
advisers?
Forgive me but I doubt it. I doubt if many people here really are financial
advisers. Not in the sense of giving people advice about their finances.
Here is a list of ten common financial topics I get asked about.
1.
Income tax
2.
Benefits
3.
National Insurance
4.
State pension
5.
Credit cards
6.
Current accounts
7.
Foreign currency
8.
Inheritance Tax
9.
Care home fees
10.
Fuel bills
How
many feel comfortable giving advice on those topics?
Let
me help with ten common questions I might be asked.
1.
Income tax – is my tax code wrong?
2.
Benefits – what can a widow claim?
3.
National Insurance – Do I need to pay it on my earnings?
4.
State pension – how much will SERPS rise by this year?
5.
Credit cards – how do I cancel a regular payment I agreed to?
6.
Current accounts – which is the cheapest bank for an overdraft
7.
Foreign currency – where will I get the best rate for euros?
8.
Inheritance Tax – What allowance will my heirs get?
9.
Care home fees – does my daughter have to help with the cost?
10.
Fuel bills – how can I reduce the cost?
Those are all financial questions that need advice. Can anyone here answer them
with confidence? Or even tell people where to go to get the answers? And that is
without mentioning debt, or budgeting, or student loans, or tax credits, or cash
savings…I could go on. So in what sense are you financial advisers if you can’t
advise on basic financial questions?
The
trouble is financial advice is trammelled by its commission driven past. Now if
I had put this up
1.
Pensions
2.
Investment
and
perhaps
3.
Insurance
4.
Mortgages
there would have been a forest of hands. And what do they all have in common?
They all earn you commission. At the moment!
So
you have to be able to advise on those other things. And it is not very hard.
After all, journalists do it all the time. But it is what people want. And if
you are charging a fee, there just might be a model where you can make some
money – or at least break even or perhaps have a loss leader – advising on those
aspects of financial advice which the public really needs.
And
now you are – or will be free from commission other opportunities open up.
Equity release for example. A vital thing to explain. But often the best way of
releasing equity is downsizing – selling and buying somewhere smaller. It is
difficult and mistakes are easy. It can be costly. But freed from the need to
earn commission on a product, you can do that job too. Become an expert in the
problems – financial and psychological – and where the best choices are.
And
annuity choice. One of the most vital things there is – and for 95% of people an
annuity is still a much better choice than drawdown. And freed from the need to
balance the commission paid, sell the best annuity – ignore drawdown for most.
The advantages are an expensive profit generating illusion. For most people the
advice to get the best annuity would be a few hundred pounds in fees well spent.
A lot less than the commission in many cases. But money you have earned well.
So
25 years after the financial services industry began, auto-enrolment and
especially RDR are your chance to change and to turn your industry into one that
is valued, trusted and genuinely helps people meet their financial needs. Please
don’t mess it up again.
e-mail Paul Lewis