In search of a workable model

With the RDR set to abolish commission, Gill Wadsworth investigates how new distribution models will develop

Any business operating in the corporate pensions space is used to drastic regulatory upheaval; even relative newcomers will remember the impact of A-Day and the forthcoming retail distribution review (RDR) looks set to create a game-changing new environment.

Irrespective of the frequency, severity or necessity of legislative change, any overhaul has a significant impact on how organisations are able to run their businesses and the impending RDR, coupled with auto-enrolment is no exception.

These sweeping reforms have huge ramifications for the way in which providers and advisers conduct their business in the corporate pensions market, and with both pieces of legislation scheduled to hit the industry in 2012, there are just 18 months to make sure systems and processes are fit for purpose.

Jim Smith, sales director at Scottish Life, says: “Like any of the big providers, we are used to dealing with huge pensions changes that cost millions in systems development, but every time there is a legislative change it impacts on your existing book and all your administration.”

Alongside a review of existing systems and processes, providers and advisers need to ensure their personnel are equipped to survive in a post-RDR environment, meeting the new training and qualification demands in an increasingly cost-conscious and competitive market.

No longer will firms with the biggest commission budget enjoy the largest share of the corporate pensions pie; instead it will be the firms offering the strongest proposition

Andrew Cheseldine, senior consultant in Hewitt’s retirement consulting team, says: “The biggest issue for us [with the RDR] is the process and compliance piece, and ensuring we have all the right qualifications and training in place. People come to Hewitt because we are more professionally qualified than smaller to medium-sized IFAs and we need to keep that clear blue water between us and not let them catch up.”

Although there are numerous considerations for providers and advisers attempting to comply with the RDR, the number one concern for many is the charging model. The abolition of upfront commission paid by providers has been welcomed by some but not all in the industry, as many life offices argue this approach is no longer sustainable. Many firms – advisers and providers alike – claim to have abandoned commission payments already and argue they are well placed to compete under the new legislative framework.

Scottish Life adopted its financial adviser fee model six years ago; an approach Smith says is as close to the FSA’s consultancy charging model as anything that already exists in the market. He adds: “Scottish Life is in a better place than others in terms of the RDR. It wouldn’t be fair to say [the legislation] will have no impact, but it is less for us than for others. We’ve been very close to [the FSA’s] thinking on the consultancy charging so we designed something that we thought would reflect the new model.”

Similarly, Standard Life says it is also well placed to tackle the RDR changes since it abolished upfront commission in 2004.

But Martin Palmer at Friends Provident says that no one provider is better placed than any other when it comes to complying with the new regulations.
“Everyone is equally well positioned; I am not convinced that Standard Life and Scottish Life have written that much business on that type of structure. The key is having a product structure that is up and ready for 2012 that advisers can use when the RDR comes in. It’s not about how long you have been in the market with a certain structure,” Palmer says.

And despite Standard Life’s confidence in its existing charging structure, John Lawson, head of pensions policy, concedes that some changes will have to be made, since the firm still uses factoring which is outlawed under RDR.

“We need some tweaks around the way we make payments out of products, because some of our methods could be seen as factoring. But they are quite minor so we don’t see the need to make an awful lot of changes to our business model,” Lawson says.

In spite of their upbeat attitude to the proposed changes in charging structure, providers are in no doubt that the new framework means that, in order to get any kind of recommendation, their products need to stand on their merits. No longer will firms with the biggest commission budget enjoy the largest share of the corporate pensions pie; instead it will be the firms offering the strongest proposition. So does that mean providers need to rethink their relationships with IFAs?

Business should be won by the best provider, not the one that pays the most commission

Palmer says: “One of the big debates between adviser and provider has been how much commission you pay on a scheme, and that debate will have to completely change. Post-2012 we will be competing on the quality of our proposition and the service we provide. We want to compete on products not on commission; we believe business should be won by the best provider, not the one that pays the most commission.”

However, Martin Bamford, managing director at advisory firm Informed Choice, says providers may find that post-RDR they are kept at arm’s length, and are viewed simply as a product provider rather than having any real influence on the scheme.

He says: “The implementation of RDR is likely to distance IFAs from providers to an even greater extent than they have already been. When providers no longer have a role to play in the pricing of adviser services their role will become restricted to being a third party administrator of products. Some may feel particularly disenfranchised in this new world, where they are no longer central to the value relationship.”

Like the providers, many advisers also claim to be ahead of the game when it comes to RDR compliance. Most of the employee benefits consultants have long favoured consultancy charging, with Cheseldine noting that his firm uses this model alone for its corporate pensions clients. However, he notes that the firm is looking at incorporating a fee based on the assets under advice.

“We’d like to build in ad valorem fees but we need to make sure that is compliant [with the RDR]. There is nothing to stop us taking 0.5 per cent on all the assets under advice, except that it sounds quite high and, under the RDR, if any IFA did that they would need to prove they were providing value for money.”

Cheseldine adds: “We want as much business as we can get in this sector, but we want to make sure we are fireproof so that we are not only compliant with the letter of the law but also with the spirit.”

For some IFAs the move away from commission payments was a matter of survival rather than sticking on the right side of the law. Bamford says Informed Choice moved to an adviser-charging model several years ago; a decision which was in no way motivated by the RDR.

“We were experiencing falling margins for the provision of corporate pensions advice and increasing clawbacks as businesses fell victim to financial difficulties. These factors meant we were not being adequately rewarded for the work we were doing and that we were exposed to a lot of financial risk by working in this market. Instead, we started invoicing the employer for consultancy fees and charging any implementation fees directly to the pension funds, so there was no claw back liability,” Bamford says.

Clarity on the National Endowment Savings Trust (Nest) charging structure will also influence how advisers charge for their services. In particular, commentators believe the upfront charge of 2 per cent on Nest member’s contributions may drive advisers to consider a similar route.

Palmer says: “I would expect advisers to start talking about that concept since the RDR allows them to take a contribution charge out of premium. We have not seen a huge number of advisers quoting fees with a contribution charge but I think that might happen over time.”

Bamford: Post-RDR, providers may be kept at arm’s length
Bamford: Post-RDR, providers may be kept at arm’s length

The final impact of Nest on charging structures will not be seen for some time, but it has already renewed employers’ focus on cost just when advisers need attention to centre on value.

To best counter this, Smith says IFAs simply need to find a market where employers do appreciate independent advice and are willing to pay for it. He argues that four group pensions markets will emerge in the post-RDR and Nest worlds, and it is up to IFAs to shape their business proposition to suit the most profitable one.

“The first market is the ’box ticker’ where the employer puts in a pension scheme simply to comply with the law. The next market is a bit more than box ticker, but the employer won’t spend effort on getting the best scheme.”

Smith continues: “Then you get into the more interesting places where people don’t buy brand, but they buy value and quality through advice, and that is where the IFA and EBC will want to play. The fourth market is at the top end, where you have extremely specialist high net worth group Sipp and group wrap which also requires advice.”

For IFAs to compete effectively in the potentially profitable third market, it boils down to their ability to demonstrate the value of independent advice. For many employers, while cost is undoubtedly a consideration, if they are able to recognise the difference an IFA can make, they are more willing to pay the fees.

Bamford says: “Employers are prepared to pay for advice and other services as long as they understand the value of what they are paying for. If an IFA struggles to articulate this value, it is unlikely that an employer will be prepared to pay for advice on any basis where the cost of that advice is explicit.”

For any companies that remain particularly anxious about relinquishing their commission-based income stream, schemes set up before the end of December 2012 are still permitted to retain the old style charging structure. For providers and advisers that still favour commission, this situation may well provide a much-needed lifeline as they adapt to new business models, but for Lawson it smacks of double standards.

“One issue in the corporate space is the continued payment of commission on schemes sold before the RDR comes into force. That is an issue because advisers in the commission-based world in the run up to 2012 will just churn as much as possible and set up as many new schemes on a commission basis.

“The whole purpose of RDR was to open up the market and make sure products are sold for the right reasons, so it goes against the grain that they are allowing a market that still relies on commission,” Lawson says.

However, Scottish Widows argues that allowing commission to remain on schemes set up pre-December 2012 allows for continuity, and the firm disputes that it will benefit from so called ’churning’.

The firm states: “It is important that existing commission arrangements for increments and new members are honoured by providers and that the new rules are not used as a ’regulatory excuse’ for providers to renegotiate their current obligations. We understand the FSA concern over the potential rush for new business while commission is available. However, we do not believe this to be a significant risk due to the length of the lead time from initial employer enquiry to any scheme reconstruction.”

It adds: “We may see a slight acceleration of business that would have been written in 2013 moving into 2012, but do not believe that this will be a material amount.”

Although there are still a few months to wait until the FSA releases its final paper on the rules governing the corporate pensions space, providers and advisers can be fairly sure they know how the final regulations will look.

Providers need to make sure their business models are driven by robust product offerings that work in a world dictated by advisers’ charging structures, while IFAs and EBCs need to ensure their services offer demonstrable value for money.

Undoubtedly for some firms this is easier said than done but for those that manage the transition, they will be well placed to prosper from a workable business model in the commision- free world.