PensionsFeb 26 2015

Making the case for commission

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In a recent article I suggested a blueprint for investment advice, using the approach used to manage pensions funds and life companies. There is a snag.

Giving such advice requires a combination of skills: actuarial, legal, investment, tax and regulatory expertise. A life company or a pension fund can call upon a range of experts, but how can an individual customer afford them all? He needs all these skills in one person who must also have excellent communication and selling skills. Do not underestimate the latter, as faced with uncertainty the client will just postpone decision.

This might suggest that advice can only be affordable for the well-off. You could be right. The do-gooders have thrown the baby out with the bath water. Commission has now become a taboo word. Ros Altmann said the other day that it ought to be banned on annuities without bothering to find out how much it was. It is a concern that such shallow views are taken seriously.

In fact there is nothing wrong with commission per se. Ask any HR manager and they will talk about performance-related pay or payment by results. Is not that what commission is? The problem was – well there were two: it was paid by the provider not the client. That should not matter so long as it was disclosed at the point of sale and the rate did not vary from provider to provider. That was where we were before the Office of Fair Trading said commission agreements were anti-competitive. The other problem was that the wrong criterion was used to measure success.

By killing commission and introducing complex and dense stuff such as the retail distribution review and the fancy stuff that former director general of the ABI Otto Thoresen created, we may be all right in the future; but in the meantime, savings rates have declined and many are set to retire with inadequate pensions. What is more, by saving less they are spending more and enjoying a higher standard of living than they should, so will therefore fall farther when they retire.

People said that commissions and charges were excessive, but failed to recognise that at least they made people save. There is an opportunity cost to inaction, which is greater than the charges inherent in action.

We are where we are. We do not want to overhaul RDR and have more uncertainty. We have built a mechanism for giving proper advice to those who can afford it. People should be prepared to pay £300 an hour, with perhaps five hours’ worth of advice as a minimum. That prices out those who can only save, say, £50 a month. I think for them a simple suite of products should be created:

1 You choose a target date, say 65

2 You choose whether to receive a lump sum or an income from that date

3 You specify your attitude to risk (cautious, normal, aggressive)

You then set up a series of funds to deliver those objectives. Instead of linking it to an individual’s birthday, it would be calendar-year based. There is nothing magical about a birthday. So you would have two funds for each of the years 2025, 2026, 2027 and so on; one providing a lump sum and the other income. They would vest on a prescribed date, maybe 1 Jan or 1 July or 31 December. The income fund would require some thought. It would still be priced as if it was a lump sum fund but could only be cashed as income – which might be an annuity, guaranteed or variable, or income drawdown. The asset mix would aim to reduce volatility as the maturity date approached and would have regard to the risk-preference chosen.

For want of a better description, they would be with profits funds run on a mutual basis. There would be a fixed charge, which is all the provider would receive as revenue and out of which commission would be paid. There would in addition be a ‘guarantee reserve’, the purpose of which would be to ensure stability of price. It would be run down by the maturity date.

That should have been the basis of stakeholder pensions when they were originally launched at the turn of the century – if only the product providers had had the imagination.

The key to successful financial planning is discipline. In the past quarter of a century consumer champions have insisted on flexibility and choice. The product providers have delivered. But at what price? They have struggled to provide the systems that deliver what they have been asked to provide. All the recent talk about administration errors have been as a result of this. It is all very well for consumer champions to bleat, but who created the chaos in the first place?

Unlimited flexibility and choice is a recipe for inaction. What is needed is a simple set of products addressing genuine needs. With profits still has a role to play– if it stuck to its original purpose. Providers have tweaked and twisted it, particularly in the pensions version, to be all singing, all dancing – but it has ended up being a camel.

Icki Iqbal is a former director of Deloitte