Charging into the unknown

With just six months to go before commission disappears completely it is far from clear how consultancy charging models will work. Gill Wadsworth investigates

Corporate advisers have had more than a year to digest good practice guidance on implementing consultancy charges under the Retail Distribution Review (RDR), but 15 months on there is little clarity on how this new remuneration structure will be applied.

Providers and advisers have accused each other of holding up progress in developing effective consultancy charging structures, and with just six months to go until the RDR comes into force, both sides are feeling the pressure.

As with the rules governing adviser charging in the retail market, consultancy charging sees commission outlawed in the corporate space, meaning consultants must unbundle advisory fees from product charges.

In March 2011 the Consultancy Charging Working Group issued good practice guidance aimed at assisting advisers with a framework under which they could formulate an RDR compliant remuneration strategy (see box overleaf).

Then in January this year a group of five providers – Aegon, Friends Life, Legal & General, Scottish Life, and Scottish Widows – agreed a ’shared approach to consultancy charging’ which set out the core remuneration structures they would be willing to support.

However, advisers claim they are still awaiting more detail on how their insurance company counterparts will facilitate consultancy charging above and beyond the basic structures laid out in the ’shared approach’.

Mike Whitfield, Thomsons Online Benefits’ chief executive, says: “Most of the providers are running around at a great pace trying to work out what their final solutions will be. Some of them do have a plan, but we still need to confirm whether they are allowing a flat contribution or percentage of the fund to be paid as the consultancy charge.”

“Where the consultancy charge comes from doesn’t make any difference in terms of member outcomes; it’s more psychological than numerical”

Providers, meanwhile, claim it is the advisers who are unclear on consultancy charging strategies, leaving insurance companies to second-guess what structures they will need to support.

Steven Cameron, head of regulatory strategy at Aegon, says: “From a provider perspective, consultancy charging has not been left to the last minute. We appreciated early on that while adviser charging was complicated, consultancy charging included even more complexity and we have been taking it along the same timeline as adviser charging.”

Cameron adds: “Where that last minute argument might be more valid is in terms of how advisers are thinking about how they are going to structure consultancy charging with their clients. Maybe that is something that will emerge from them on a slower timeline than adviser charging.”

Advisers appear to fall into two distinct camps on consultancy charging: those that are ahead of the curve and those yet to formulate a strategy.

Whitfield says Thomsons would like to implement consultancy charging ahead of the RDR deadline, claiming it is providers that are preventing his firm from moving forward.

However, there are many more EBCs and corporate IFAs that are still to formulate a compliant consultancy charging strategy.

Fiona Tait, business development manager at Scottish Life, says: “There will be adviser firms out there that already have a fairly robust fee structure, and for them consultancy charging is not quite as big an issue. But advisers who are used to remuneration via commission will have to think very carefully about how they are going to cover their costs from the client. They will need to think about the shape of remuneration and when they should charge, which is not something they have had to tackle before.”

Where advisers are yet to decide on a consultancy charging strategy, Cameron says they should avoid attempting anything which strays too far from the core structures agreed by providers in the ’shared approach’ document.

He says advisers may find any unusual charging agreements cannot be supported by providers.

“We would encourage advisers to look at the shared approach. If they agree shapes with their clients that are slightly unusual, what is likely to happen is that they will agree a consultancy charge with the employer and then find that the selected provider doesn’t support that structure.”

Cameron adds: “We are encouraging advisers to stick with straightforward shapes that would ideally be within the core range that the shared approach identified.”

Fellow insurer Friends Life shares this unwillingness to venture too far from the core structures dictated by the shared approach. The insurer argues that since advisers are still unsure what charges will be favoured by their corporate clients, providers cannot be expected to build technology to support a vast array of strategies.

“In many cases advisers are still trying to get their heads around the types of charging structure they want to apply”

Martin Palmer, head of corporate benefits marketing at Friends Life, says: “In many cases advisers are still trying to get their heads around the types of charging structure they want to apply. We don’t want to offer a massive range of structures that will never get used, and that is reflected in our build. We are going to have a range of options that we think will meet adviser requirements but we are not going to build every possible variation.”

Palmer says Friends Life will watch how the market develops and include any additional consultancy charges as they emerge and prove popular with corporate clients.
While Friends Life and Aegon are still finalising their approaches to consultancy charging, rival Aviva says it will be ready to operate under the RDR rules from July.

Aviva will allow charges to be deducted as a percentage of the funds under management and will be able to take fixed amounts from both employer and employee contributions.

The charge may be applied to regular contributions, single premiums and transfer values, and can be done on an initial or ongoing basis, or for set periods as defined between adviser and employer.

Iain Oliver, head of workplace savings development at Aviva, says: “We have tried to make it as flexible as we can. The difficulty for all providers with consultancy charging is that we know there are parts of consultancy charging that will get used an awful lot and parts that won’t be used much at all.”

For the past three months Aviva has provided advisers with modelling tools to simulate how consultancy charging will impact cash flows over the long and short term. From the data input into the models, the insurer has garnered some indication of the more popular consultancy charging approaches favoured by advisers.

Typically, advisers are avoiding applying charges to employee contributions since this is widely seen as deterring individuals from saving into a workplace pension if they believe their benefits are being eroded by fees.

Oliver says: “The structures we are seeing advisers set up apply the charge to the employer contribution only so that it doesn’t undermine the employees’ trust and confidence in the scheme itself. It’s considered fairer that it comes from the employer contribution because 99 times out of 100 it is the corporate receiving the advice, not the member.”

However, Aegon argues that distinguishing between the employer and employee contribution is a red herring since the overall impact on the member’s pot is the same.

Cameron concedes that members may perceive taking consultancy charges from the employer contribution to be fairer, but says it makes no difference to the actual value of the pension fund. Consequently, Aegon is yet to decide on whether it will allow charges to be deducted from both employer and employee contributions.

Cameron says: “Where the consultancy charge comes from doesn’t make any difference in terms of member outcomes; it’s more psychological than numerical. There are complications to building the functionality to allow consultancy charges to come out of either part of the contributions so it’s one area that we’ve not yet concluded on which options we will allow.”

Whether or not consultancy charges are genuinely fair, or simply appear so, it is down to advisers to manage their clients’ expectations and ensure they find sustainable structures post-RDR.

In particular, advisers must ensure they avoid cross-subsidies where certain sectors of the membership find they are unfairly footing the bill. For example, where scheme set-up costs are borne by initial members only, leaving subsequent joiners unaffected by the charges.

Roger Mattingly, head of client relationship management at JLT Employee Benefits, says: “The Consultancy Charging Working Group homes in on cross-subsidies and calls on advisers to mitigate those where possible. We need to identify where they exist and ensure the charging is as fair, customised and transparent as possible.”

Under the Working Group good practice guidance, the fairness stipulation extends to ensuring members do not receive an ’adverse outcome’ as a result of consultancy charging.

For many advisers this means opting for structures based on percentages rather than flat fees since these represent a greater imposition on lower paid employees.

Whitfield says Thomsons will eschew flat fees in favour of charging a percentage of contributions.

He says: “What is fair and egalitarian across a workforce is to pay a percentage of the contributions. If a flat fee is charged then the lower-paid employees could proportionately pay more than a higher-paid one. If it’s a percentage then it is fair across the board”

Advisers also need to confirm the stability of their existing, usually commission-based remuneration strategies, when setting up RDR-compliant arrangements. While commission-based structures are still allowed for corporate pension schemes set up pre-RDR, there is no guarantee that insurers will maintain current contracts, particularly where schemes’ circumstances change.

Mattingly says: “We are making sure we get our modelling correct by establishing with insurers what guarantees there are in respect to existing revenue streams and whether there is a fragility to that. If so, we will need to factor that into the ongoing consultancy charge.”

At the same time as devising a whole new remuneration strategy, corporate advisers must also be cognisant of auto-enrolment. The sweeping pension reform sees all eligible employees enrolled into their company scheme unless they choose to opt out. Where employers do not offer a compliant scheme they must set one up and make a minimum 3 per cent contribution.

“The difficulty with consultancy charging is it’s coming in at the same time as auto-enrolment and Nest will be launched, so there will be a direct cost comparison with Nest. This means an additional pressure on advisers to keep charges down”

The government’s default workplace saving scheme, the National Employment Savings Trust (Nest), has confirmed it will not allow consultancy charging. This begs the question as to whether employers setting up new schemes will be able to justify paying additional consultancy charges if they opt for an alternative to the Government scheme. Palmer says: “The difficulty with consultancy charging is it is coming in at the same time as auto-enrolment and Nest will be launched, so there will be a direct cost comparison with Nest. This means an additional pressure on advisers to keep charges down.”

When it comes to consultancy charging, advisers and providers are caught in something of a chicken-and-egg scenario. Insurers only want to facilitate new structures they are sure advisers will use, yet advisers are unwilling to put arrangements in place unless they know providers can support them.

It will take something of a leap of faith on both sides to start the ball rolling, and advisers and providers will need to remain flexible in their approach. All parties must be willing to co-operate to find the best models that meet employers’ immediate needs and that can adapt to changing circumstances once the RDR is bedded in.