The case for contingency charging

Daniel Elkington

The fundamental principle revolves around behavioural economics or transactional economics as the field is sometimes known.

Transactional economics answers the question: 'How do people behave when they are making a transaction?'

Classical economists try to identify macro patterns, whereas behavioural economists argue that the economy is made up of billions of transactions and therefore it is important to look at transaction behaviour and scale it up.

Article continues after advert

Ultimately, and perhaps obviously, the truth lies somewhere between the two.

When a prospective client comes to see an IFA they need help, if regarding pensions they have decided they need to talk to an expert as their knowledge may be lacking in some area, be that investment selection, flexible access and the legal requirements therewith or whether they can afford their retirement plans with the assets they have.

They may be willing to pay a fee for this initial service, but to get them through the door; the industry model is a free first appointment.

If we were starting from scratch then obviously, we would charge the first hour out at the usual hourly rate, but we cannot as the industry model is that the first hour is free – this represents great value for the client and business risk for the business.

Then, the IFA undergoes a fact-finding process and often completes letters of authority requesting the information pack from the life company – often on multiple occasions as these firms frequently misunderstand the requirements of the adviser and send the wrong pack.

Then a recommendation is compiled, perhaps even with a suitability report to be issued at the stage the recommendation is made.

Most IFAs have in place a ‘minimum fee’ that is charged for this process, somewhere between £500 - £1,500. This fee will almost certainly not cover the cost of this initial process, unless said process is very simple.

The client then receives the recommendation and does one of the following:

1.    Accepts it

2.    Rejects it

3.    Accepts it and instructs the adviser to execute it.

If option three  is chosen the adviser executes the instruction to follow through with the advice and the full fat fee is charged, often this is many multiples of the ‘minimum’ fee. This is where the contingency charge comes into play.

The regulator may consider why the contingency charge is often many multiples of what an hourly rate might come to, they are justified in asking; why is it so much?

The simple answer is the risk premium. I’ll use a simple probabilistic model below to calculate this.

There has been a business risk attached to the initial appointment, if half of the initial conversations do not eventuate in business then this hour must be recouped elsewhere in the business model.