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In case you didn’t know, the world of financial services is going through a major change over the next few years as the Retail Distribution Review (RDR) does away with commissions and imposes higher educational standards on advisers. For many IFA’s, the RDR represents yet another bureaucratic headache getting in the way of the everyday business of helping their clients. However, here are three reasons why even the most resistant adviser should welcome the enforced changes to adviser knowledge and commission.
The growth of Financial DIY
Compeer’s March 2009 Financial DIY report suggests that for those resistant to change, the RDR is a blessing in disguise.
Some of Compeer’s findings include:
- 29% of adults believe their knowledge is as good as financial advisers’ – uniformly spread across age and socio-economic groups
- 28% of adults believe advice is just disguised sales of investment products – A&Bs (39%) and 40-49 year olds (34%).
- 26% of adults believe financial advisors add insufficient value to justify their fees (A&Bs 38%)
It’s about time therefore that IFA’s upped their game for their own sake.
They also found that:
- Overall use of IFAs fell in 2008 – 7% fewer respondents regard a commission based IFA as their main financial advisor compared to 12 months earlier.
- 6% of adults cite a fee based IFA as their main financial advisor, up 33% on the previous year.
- A growing proportion of people (67%) taking professional advice now seem to have accepted a fee based model.
And when you take into account the trend from 2003 onwards the picture doesn’t get any better:
- 44% of adults view the internet as an essential source of financial information and advice.
- 42% of A&Bs unadvised in 2008 (26% in 2003) and 44% of C1s (27% in 2003).
- Of those with over £1m of liquid assets, 61% make all or most of their investment decisions with professional advice.
The growth of financial DIY is powerful. Nails are already being hammered into the coffin of the traditional IFA.
Life insurers are going bust
There’s the other small issue that life insurers are going bust. Life insurers often report rosey results on a European Embedded Value basis to satisfy the markets. However, these results include future premium income on policies sold but not yet collected. With less than half of policies in force after five years, the International Financial Reporting Standards measure which does not include future income but includes investment losses have been showing unsustainable losses for some time. Up front commissions funded by the illusion of long term contracts are therefore unsustainable.
The loss of indemnified commissions under the RDR is therefore insignificant. They were already on the way out.
Bear markets badly expose the transactional, commission based adviser
Traditional commission based advisers often sell themselves on their ability to pick funds, find the best product – little more than a personal shopper in some ways. When the focus is on the transaction rather than the long term plan, the indemnified commission based adviser’s credibility and business model tends to sink as fast as their client’s funds. By focusing on working with clients on their plans and charging explicitly for the life enhancing work, advisers’ business models are far more sustainable.
Be thankful for the RDR. For the transactional IFA, it was a wake up call. For those financial planners already prepared, the industry is better for it.
Not a week goes by at the moment without a news reference to the demise of private sector final salary pension schemes. The reasons for their demise are not always conveyed well. Here are 13 good reasons:
1. We are living longer and so scheme liabilities are increasing well beyond original expectations.
2. There is no way to accurately predict the liabilities of the scheme so they are actually a danger to the parent company.
3. Underfunding in the past (and present) by the employer has led to deficits so it is clear that the costs are higher than many employers would like or can afford.
4. Poor investment returns have created or increased deficits.
5. Misguided and risky investment strategies formulated during boom years have created deficits and a lack of correlation between liabilities and investments.
6. 1997 Budget imposed a draining tax credit on dividends.
7. FRS 17 rules which made employers put (burgeoning) pension liabilities on the balance sheet for all to see.
8. Three-yearly statutory funding statements were valued at the end of March 2009 when both the stock market and gilt yields were low (the latter encouraged by Quantitative Easing) brought the scale of the problem to everybody’s attention.
9. The difficult economic environment has resulted in companies choosing to pay down liabilities and remove risks such as final salary pensions.
10. Cheaper alternatives exist – money purchase schemes are cheaper to run and the risk is all on the side of the employee rather than the company.
11. It’s not fair to have a scheme which is closed to new members but still subsidised by non-members of the scheme.
12. There is a growing trend of closing final salary schemes and this makes it easier for others to follow suit without losing staff or gaining bad publicity.
13. If a lot of schemes go bust there’s every chance the Pension Protection Fund will not be able to compensate all of the members, resulting in a huge lack of faith in this type of pension.
Don’t mourn for the death of final salary pensions – they are a huge and unpredictable liability that has been shown not to work. And don’t get me started on public sector pensions…n
Talk about rising interest rates to the man on the street and he may find this difficult to understand.
The economy is still battered, jobs are still being lost, there’s no sign of inflation (yet), the banks won’t lend and here we are talking about the prospect of an increase in interest rates.
Rather than inflation, what’s creating this fuss has been the recent sell-off in the government bond markets largely due to growing concerns over the amount of debt UK government is taking on. The concerns revolve around the increased yield the government is likely to have to offer future investors in gilts in order to successfully sell their large issues. And so with the prospect of an increase in the yield reducing the price of gilts for existing holders, they are being sold off. The sell-off forces down the price of gilts and increases yields still further.
Increasing government bond yields could well bring even higher mortgage rates on the high street with the first signs of this appearing in the fixed rate market. Why? Rates are calculated using swap rates, which move around with government bond yields. With yields rising the swap rates have been creeping up with them. Swap rates allow lenders to borrow funds to lend on to the public. The swap rates available to lenders are like trade prices that drive the eventual price of fixed rate mortgages.
I have previously argued that banks would continue to buy gilts rather than lend money to you and I so the demand for gilts should remain strong (keeping prices high and yields low). But people are getting anxious. And it’s perception that drives markets. We cannot for example rule out future problems with UK plc that could weaken sterling which in itself could trigger a rise in interest rates in order to protect the currency. In sum, the market is getting jittery over the bottom falling out somewhere else.
The impact of higher interest rates would be disastrous. It would be the final nail in the coffin for those homeowners in negative equity or unable to secure a fixed rate deal for lack of equity. This is where the “W” shaped “recovery” would become a reality.
There exists a wonderful opportunity to consider a fixed rate while you still have enough equity – it might be prudent to at least look into the options available to you before the window of opportunity closes.
It’s worth going back to basics to understand what all the fuss has been about this week with regard to final salary pensions, a subject which has already been discussed in technical detail on this blog.
A final salary scheme is a “defined benefit” scheme where what goes into the pension is undefined but what comes out is defined. I know that if I work in a company providing a 1/60th final salary scheme that after 40 years service, at retirement I will receive 40/60th times my final salary as a pension for the rest of my life. At the very least, if the scheme changes, my entitlement to the years accrued to date will be protected.
The alternative is a money purchase “defined contribution scheme”. What goes into the pension is defined but what comes out is undefined. I know that at the retirement, I will receive a pension income dependent on how much went in, how much growth the fund achieved and what annuity rates are available at that time. This outcome cannot be predetermined or even accurately predicted at the outset.
The big difference between the two therefore is who bears the risk. In a final salary scheme, the employer bears the risk. In a money purchase scheme, the scheme member bears the risk.
Until recently this risk has slid past quietly like a vague shape beneath the waves but as the economic high water of boom times drains away the monster is taking shape.
Final salary pension schemes are simply becoming more and more expensive to run. We’re living longer and changes in legislation have meant they are simply not viable for businesses in the private sector.
The first notable problems were the effects of the 10% tax on dividends earned by pension schemes, which was imposed by the “iron chancellor” shortly after the Labour government was elected in 1997. This £5bn a year stealth winner for the government has been quietly leaving corpses in its wake.
Then there was the introduction of FRS 17 rules which meant that private companies had to show pension liabilities on their balance sheets. Whilst this may have made transparent the failings of past funding, problems that were being stored up for now, it meant that continuing to provide final salary pensions was just not viable. What’s more, we are admist a balance sheet recession where firms are seeking to pay down their debts.
So what has the effect been in practice?
Five years ago, around 40% of companies offered final salary pensions to new employees. Today just four FTSE 100 firms continue to do so. They are Shell, Tesco, Cadbury and Diageo.
This week BP announced is was closing its scheme to new members and Barclays is closing its scheme to new and existing members. Others, such as Morrisons, are taking the less cold turkey approach by moving to a career average earnings calculation of final salary. These are the big firms. Smaller firms, bearing the biggest brunt of this recession, have huge problems.
What’s more, around half of the UKs final salary schemes will soon be releasing their three-yearly statutory funding statements which were valued at end March 2009. The stock market was at five year lows and with the effect of Quantitative Easing artificially depressing gilt yields thereby increasing pension liabilities, it is almost inevitable that there will be close after close after close.
Meanwhile, public sector pensions remain untouched. Public sector pensions are paid for out of the tax that we pay today. They are “unfunded”. They don’t have FRS 17 requirements despite the huge future liability of the public sector pension. This became painfully obvious during the recent Dick Turpin efforts to privatise the Post Office. The Post Office could not be privatised without the debt-laden final salary scheme remaining under goverment ownership. The scheme would show up as a huge, expensive liability in the private sector. Kept under the ownership of 10 Downing Street, the liability is hidden and will be borne by the tax payer, who’s already paying out hand over fist for things they don’t know about. This of course includes the private sector tax payer whose pension is being reduced.
This all comes on top of a recent survey commissioned by the BBC suggesting that half of UK adults aged between 20 and 60 are not putting aside any funds into a pension.
If the government is so keen on public sector pensions, then it should be a public sector pension for all. Look to Europe where the maximum state pension in Germany is over €26,400 compared with just over €5,100 in the UK (at current exchange rates).
Bankers pay, MP expenses and pyramid selling have all come under the spotlight in this recession. Public sector pensions, a monster ponzi scheme built for one sector of society, will inevitably be the next.
