Incentive Driven Miss-Selling

The practice of incentivising independent financial advisors (IFAs) to shift their investment and risk books is possibly the single biggest driver of churning, and is likely to be addressed as part of the review of retail distribution.

A recent article in Personal Finance gave the rationale for the payment of an “establishment fee” as:

  • set-up and infrastructure costs to become a mandated agent
  • loss of earnings from selling policies of other financial services companies
  • a restraint fee to ensure that the IFA remains a tied agent

I am personally aware of one IFA who was paid R1 million rand to become such a tied agent. The fact that he already did all his business with the same product provider meant that the only set-up costs he incurred involved changing his e-mail address.

Other advisors were financially incentivised, over and above the commission on new business, to shift their entire life cover book to certain product providers. The lip service paid to the required replacement agreement documentation made this farce possible. It was nothing other than institutionalised churning, and is still going on.

A broker recently shared with me details of how a product house, without his knowledge, contacted his client to convert his existing life cover to a new generation policy. Given the client’s particular circumstances, it would not have been in his best interests at all. Had he not called the broker to discuss it, he may well have been worse off, following the advice from the call centre.

No doubt, all these “conversions” are shown in the balance sheet as “new business” which makes shareholders very happy. They do not necessarily have the best interest of clients at heart.

In a recent presentation, Mr Jonathan Dixon, DEO Insurance at the FSB, and the driving force behind the Retail Distribution Review (RDR), commented:

“Inappropriate incentive structures expose intermediaries to regulatory risk – particularly the consequences arising from incentive-driven miss-selling or unlawful fee arrangements.”

Commission on replacement business is specifically earmarked for attention as part of the RDR. Tragically, this will lead to clients not receiving appropriate advice where a product is in their best interests.

In an ideal world, and if the applicable legislation is applied correctly, this should not be a problem, but the current reality is far from ideal. This means that honest advisors may be punished for the sins of those who place their own interests above that of their clients.

While many fear the consequences of the RDR, there are clear signs that the focus is shifting from advisors, whose actions are only the tip of the iceberg, to policies and practices which entice them to do things which are not to the advantage of their clients.

This will be extended as the fair treatment of customer starts making its presence felt. TCF will cover every aspect of the relationship between the client, his advisor and the product house, from product development right up to the end of the contract.

On 27 September 2007, Warren Buffett ordered top management in his Berkshire Hathaway group to expedite efforts to weed out unethical behaviour.

“…we can have a huge effect in minimizing such activities by jumping on anything immediately when there is the slightest odour of impropriety. Berkshire’s reputation is in your hands,” said the memo.

“The five most dangerous words in business may be: ‘everybody else is doing it'” wrote Buffett.

“A lot of banks and insurance companies have suffered earnings disasters after relying on that rationale. Even worse have been the consequences from using that phrase to justify the morality of proposed actions,” the memo continues.

A resetting of the moral compass in the financial services industry is long overdue. Putting the interests of clients first, as it used to be, will be a huge step in the right direction.

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