Very few employers would argue they need specialist independent advice to guide them in establishing and managing their work-based pension scheme.
But when it comes to paying for advice the market is polarised. Larger companies tend to engage consultants and pay fees for their services. Smaller businesses, on the other hand, appoint a financial adviser who receives commission payments from the pension product provider.
The DC pensions market has operated these models for many years and Friends Provident has written business through both consultants and financial advisers.
Yet against this distribution background, the numbers of employees in work-based schemes has declined. For those in schemes, average employee and employer contribution rates are falling.
Reasons for the decline are complex and varied. Here we consider the remuneration of advisers and the links to consumer attitudes in saving for retirement through a work-based pension scheme.
The FSA launched its Retail Distribution Review (RDR) in 2006. Its terms of reference include payment for advice, levels of commission and the influence on product recommendations.
It is widely accepted that commission is an imperfect remuneration system. Payments rarely match the costs of the services performed by the adviser. On any individual scheme, commission could over or under reward the adviser. Unsurprisingly, press comment focuses on cases where high up-front commission payments are received. The calculation of commission is not understood by either employers or scheme members.
Where commission is paid to an adviser the provider’s reputation can be tarnished where payments are viewed by others as excessive. Where no commission is payable, the scheme is simpler to operate.
Since the introduction of stakeholder pensions in 2001, product charges have been rationalized to a single annual fund charge, with no early exit charges. This has proved to be good for most scheme members, but exposed providers to potential financial losses on poor quality schemes.
Schemes paying initial commission in our experience will not prove commercially attractive because the cost of commission payments cannot be recovered from the product charges levied within an acceptable time frame. There is also a risk to providers that the adviser switches the scheme after a period, once initial commission has been paid and earned. The adviser could justify this by achieving better charge terms for his client, say on a non-commission basis. With 100% of funds available for transfer the provider is left completely exposed.
In our opinion, more employers and advisers should grasp the nettle and operate fee agreements. This would remove any questions about the choice of provider being linked to the level of commission paid to the adviser.
Perceptions are important to encourage more employees to join their employer’s scheme. Gaining consumer trust is vital. Fairly or unfairly, a fee-based arrangement suggests a high level of integrity and professionalism.
The absence of commission simplifies the product terms and charges are more transparent. Product charges are lower as no commission has to be recovered.
The employer agrees the fee terms with the adviser at the outset. This could prove a challenge with some smaller employers. Where the employer will not accept fees as an additional expense of operating the scheme, the employer contribution rate can be adjusted to broadly offset the fees and stay within the overall pension scheme budget.
From the members’ perspective, slightly lower contributions are paid into their account as a consequence of funding the fees. However, this is broadly balanced by lower fund charges being applied to accounts. Fee-based business ticks the right boxes for all parties involved and we expect the market to move increasingly in this direction.