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.
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.
I would implore the FCA to try to see the balance of probabilities say the markets tend to be right and this post-RDR marketplace is one that is working well.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.
This could be as simple as that they have come in to discuss an unfunded public sector scheme and they have no other advice requirements.
A risk premium is incurred at the ‘recommendation’ stage. If half of those that take the adviser up on provision of a recommendation take options 1 or 2 below or their case may mean that it is simply inadvisable for the client to move their pension then, again, this extra work must be recouped elsewhere.
There are thousands of pounds of work that will likely go unpaid for if only the assessment fee is paid.
The client that proceeds to business must pay the business risk premia identified above or else the IFA business will go bust. This liquidation event is a poor outcome for all, and to be avoided.
Do advisers operate to this level of cross-subsidy? almost certainly not.
Former FCA staff member Rory Percival’s comments are pertinent here, he seems to feel for the IFA profession to behave in a more professional manner, all the fees should be explained and charged at the appropriate juncture.
Returning to behavioural economics, not only must a client overcome status quo bias and the endowment effect, they also must overcome the negative way the regulator makes us frame and anchor our advice.
In conjunction with the effects of hyperbolic discounting and subsequent tendencies to procrastinate these psychological nudges mean all clients are in favour of doing nothing.
The psychological basis and the business risk premia identified above mean transferring a pension is very difficult indeed, and such difficulties comes at great cost to the public.
I hope that Keith Richards, chief executive of the Personal Finance Society (PFS), is right that we should not fear a price review from the regulator, although from recent comments from our illustrious regulator, perhaps we should?
The FCA is staffed, and properly so, by many those from a legal background. I would implore the FCA to try to see the balance of probabilities say the markets tend to be right and this post-RDR marketplace is one that is working well.
Our businesses are strong, our customer base has never been more loyal, and complaints about our service are the lowest they have ever been.
I welcomed the clearer consumer communications papers, but I had to redraft my client engagement documents the day after this was announced, as the old FSA tick-box form was a nonsense.
I urge the regulator to see contingency charging as being what it is; a valid business model. There will always be those that abuse it but removing it will have negative consequences.
Daniel Elkington is an IFA for Chattertons Solicitors
