The details stated that: "The retail intermediaries sector plays an important role in helping consumers meet their financial needs. This sector faces huge challenge in adapting to current economic conditions. Mortgage intermediaries have been particularly affected by the weak property and lending markets, but firms across the sector are also being affected. Risk to the sustainability of the sector, improving management and control, and improving the quality of advice, will remain the key issues facing this sector for the foreseeable future.
Changing structure of the retail intermediary sector
Trends in the number of firms in the retail intermediary sector were relatively stable up until mid-2007. However, since then there has been a marked change in these trends. The total number of firms has increased strongly, with a net increase of over 1,300 firms through 2008, and this is mainly due to the growth in general insurance intermediaries. Previously, the mortgage intermediary sector grew in line with activity in the property market and the number of firms increased to levels that were (with hindsight) probably unsustainable. In 2008 there was a net fall of 769 mortgage firms (equivalent to 9% of the mortgage intermediary population) compared to growth of 13% in 2007. The number of financial advice firms continued to grow in 2008, although at 3%, this was half the rate of growth seen in 2007. Across all three sub-sectors, the number of directly authorised firms was static or declining, whereas the number of appointed representatives remained comparatively strong.
Sustainability
At the end of 2008, 80% of mortgage intermediaries reported that current economic conditions were having a negative impact on their cash-flow, with 65% reporting that they were seeing a negative impact on the level of capital reserves they hold.3 Those involved in the specialist and non-conforming areas of the mortgage market have been particularly affected by the slowdown in the property market and tightening credit standards. Lenders have greatly reduced their appetite to lend to consumers, with complex or more risky characteristics, an area that intermediaries have found profitable in the past. Even when the property market starts to recover, it is unlikely that intermediaries will be able to rely on this specialist area for revenue.
In addition, many lenders totally reliant on intermediary business have left the market, and mainstream lenders are likely to focus on direct distribution channels and key national intermediary relationships in the future. With the majority of mortgages yielding one-off commissions, advisers are reporting that on average only around half of their business now comes from mortgages. With firms struggling to maintain income and capital resources, it is likely that the number of firms in the sector will continue to contract significantly, reducing access to advice for consumers. Another consequence is that there is an emerging risk of ‘phoenix firms’, whereby directors of one firm try to close it and transfer all the business to a new entity, leaving only the liabilities behind.
The financial advice sector has seen strong growth in recent years, with the value of life and pensions sold through IFAs increasing by over 20% a year between 2003 and 2007. The number of firms has continued to grow and, despite market and economic conditions deteriorating, only around 20% of advisers say that their investment and pension business is declining. However, there are a number of threats to the ability of financial advice firms to maintain income levels, especially as many rely substantially on mortgage business.
Financial market turbulence means that many consumers have become cautious of investing in equity-based products, especially as many sectors that have been heavily recommended by advisers in recent years have seen falls in value. In addition, consumers looking for investment opportunities may be attracted by the security offered by bank deposits, despite current low interest rates. Global economic and financial market conditions mean that it will continue to be challenging for advisers to find opportunities that give their clients an attractive combination of risk and return. However, there are still many investors with existing portfolios who will continue to need good quality advice. Many advisers are already seeing the benefits of moving towards a holistic approach to providing financial planning and advice, based on ongoing customer relationships and a greater emphasis on recurring income streams.
Despite the fact that we have seen strong growth in the number of general insurance intermediaries over the last year, the sector still faces significant challenges. The current economic conditions mean that consumers will be looking to reduce their outgoings, including those relating to insurance and protection products. Most will continue to purchase core general insurance products, but demand for protection products could decrease, especially if the price of cover rises to reflect increasing risks. This will also impact on financial advice and mortgage firms who sell protection products.
In recent years the growth of insurance aggregator (or price comparison) websites has posed a particular threat to established intermediaries, particularly on home and motor business. Now firmly established in the UK market, they will continue to place the general insurance intermediary sector under competitive pressure. But the growth of aggregator businesses has moderated and the level of threat they pose appears to have stabilised.
Many intermediaries have made an explicit choice to exploit the opportunities available by joining aggregator panels. Others have chosen to avoid rying to compete directly, concentrating on higher value, specialist and non-conforming business, where they are well positioned to provide a good service to their clients. Many general insurance intermediaries serve both retail and commercial clients, so there is a risk that any deterioration in demand for commercial insurance could impact on the ability of their business. Small business clients are likely to be under particular pressure through the economic recession, and businesses of all sizes could look to reduce costs, including insurance costs, where possible. Additional competitive pressure could come from aggregator websites seeking to reproduce the success they have achieved in the retail markets, particularly targeting smaller businesses with relatively simple insurance needs.
Management and control
We continue to be concerned about the inadequate levels of oversight and control often seen in retail intermediary firms, particularly given the increased pressure firms are under in the current environment. Firms who rely heavily on maintaining volumes of transactions, with few recurring income streams, may suffer. Advisers who are remunerated wholly or partly based on sales volumes will have particularly large incentives to maintain business levels, and firms need to have the controls in place to ensure that products are sold appropriately. This environment also increases the risk that staff may be tempted to engage in a variety of frauds, either to meet sales targets or to supplement declining personal income. Firms need to maintain the checks they make against consumers, as consumers in financial difficulty may be more likely to make attempts at defrauding businesses.
We recognise that many firms will be considering how they can reduce costs and will see customer-facing functions as the areas of their business where they want to maintain resources, if at all possible. As is usual in any industry, firms will be taking a close look at back-office functions that can be reduced in size or made more efficient. However, it is important that resources dedicated to oversight and compliance activities are maintained at a level appropriate to the risks and conflicts inherent in the business. Arguably with the current challenges and changes in the sector, firms should be thinking about whether they actually need to increase resource in this area as part of their strategy for building a strong, sustainable and compliant business.
Increasing numbers of firms are becoming appointed representatives, including some directly authorised firms who have migrated across to this business model. This is leading to an increase in the size of some network firms at a time when they too are under significant pressure. We have previously reported our concerns that some firms with appointed representatives rely too heavily on remote monitoring, with inadequate consideration given to overall monitoring procedures. Not only do principal firms need to improve their approach, they may also need to increase the level of resource they dedicate to oversight and compliance functions to cope with increasing numbers of advisers. This includes carrying out appropriate due diligence to ensure the quality and sustainability of new member firms, and avoiding inadvertently taking on a ‘phoenixing’ firm.
Quality of advice
Low levels of consumer trust in financial advisers has been a long-running issue in the sector, partly driven by concerns over the quality of advice and service given to consumers in the past. This is a significant concern as it could deter consumers from seeking advice, resulting in inadequate provision for their needs. The implementation of the Retail Distribution Review (RDR) and related proposals will be a major challenge for the financial advice market for the foreseeable future, requiring the whole retail distribution market to implement proposals that will: improve the clarity of the service they offer; remove product provider influence over adviser remuneration; increase professional standards; and improve the sustainability of the sector. Many financial advisers have already taken steps towards enhancing their professionalism, partly in anticipation of the outcome of the RDR, but also as a way of improving their customer proposition. This includes attaining the higher qualification standards that may be required, but also offering improved service-based propositions that build ongoing relationships with clients. There is a risk that some advisers and firms will choose to exit the market rather than implement these proposals, but over time the result will be a stronger, more sustainable sector, with greater access to good quality advice for consumers.
There are now few specialist and non-conforming mortgage products being sold by intermediaries. In these areas in particular, but also in the wider market, we have previously had significant concerns about the quality of advice, which has often resulted in consumers entering into potentially unaffordable mortgages. Too many firms failed to adequately establish consumers’ needs, with senior management failing to ensure that customers were treated fairly. We have not seen any substantial evidence that quality of advice has improved, meaning that there is a risk that when the mortgage market recovers, problems of consumers being sold unaffordable and unsuitable mortgages will re-emerge.
Regulatory action taken over the last year demonstrates our ongoing concerns about the quality of advice given to consumers on payment protection insurance products, particularly where they are supplementary to the primary business of the firm. Poor sales practices too often result in consumers purchasing cover that is not suitable for their needs.
Across all three sectors, as current economic and financial conditions cause firms to come under pressure, they may look to diversify and build income streams in new areas to ensure the sustainability of their business. Where this is the case, they must ensure that their advisers are competent to offer advice on this broader range, having the appropriate knowledge and experience.
Key messages for retail intermediaries
• Measures need to be taken to ensure the sustainability of their business model, particularly in terms of ensuring that they have the financial resources that will enable them to withstand the current economic and financial climate, while still ensuring that they treat their customers fairly.
• Robust management and systems and controls must be in place. Firms should resist the temptation to reduce expenditure on compliance given that pressure on income and profitability could tempt advisers to treat customers unfairly or act fraudulently. Firms with appointed representatives should ensure that they continue to have compliance resources in place that reflect the risks inherent in their business.
• Advisers need to do more to ensure the quality of the advice they give, collecting sufficient information from consumers so that advisers can properly assess their needs and recommend suitable products. If firms do wish to diversify into new areas as a response to difficult market conditions, they should ensure that their advisers are competent, and have appropriate knowledge and experience.
Chris Cummings, Director General, AIFA, commented: "It is pleasing to see FSA acknowledge the important role IFAs play in helping people meet their financial needs.
"IFA firms have not escaped the financial turmoil brought on by the banking crisis. We have actively sought to help members diversify their businesses while continuing to invest in their people and their firms. We support the view that advisers must be competent to advise in any new areas. To facilitate this development we ran a series of business diversification workshops in autumn 2008 to help equip members with the knowledge and skills to do so professionally.
"However, we seriously question the assertion in the report that there are low levels of consumer trust in the IFA profession. We challenge FSA to provide solid irrefutable evidence to support this opinion. Independent academic research demonstrates that IFAs are the most trusted out of all Financial Services Institutions (FSIs). In addition further research published in the report ‘Consumer Trust' showed that 98% of consumers who already have an IFA state that it is their IFA who they trust most to offer financial advice. The FSA is again behind the times.
"In the current climate access to independent advice is more important than ever for consumers. FSA should be doing all it can to increase access to this advice. We look forward to continuing our discussions about the implementation of the Retail Distribution Review to ensure a favourable outcome for consumers."
