Benefits advisers can be remunerated in various ways, so employers should check the cost-effectiveness of how they pay for their services, says Sam Barrett
The advice and support required to implement a well-designed benefits package that fits an organisation’s business strategy, meets the needs of its employees and offers value for money is worth paying for. But, with a variety of commissions and fees on offer, it can be difficult for employers to know exactly what they are paying for and whether the service they get justifies the adviser’s remuneration.
Pan Andreas, head of corporate clients at Towry Law, says: “Many employers don’t think about how their benefits consultant is paid and simply let the commission take care of the cost of advice. But it is worth checking what your consultant is receiving, especially as the cost to you and your employees could be significant.”
Confusing matters further, there are several ways in which a benefits consultant can be remunerated. Commission is the traditional method, with the provider paying the adviser a percentage of the premium for selling their product. This could be paid as a lump sum once the product is sold, or as a level commission paid annually while the product is in force.
Alternative commission options
Alternatively, an adviser can be paid a fee for the work they do. Not surprisingly, there are several methods to levy a fee, including hourly rates, set fees for the job and a fixed amount to cover the consultancy required, as well as performance-related fees. Simon Bailey, head of marketing for employee benefits at Aegon Scottish Equitable, says: “We are seeing a lot of employers moving to a fixed fee rather than an hourly charge. It is easier to budget for.”
Some advisers will also combine the two forms of remuneration, perhaps charging a fee for the initial research, then taking commission for arranging the product. How much commission is paid, and when, is often determined by the product provider.
However they are paid, all advisers must abide by the Financial Services Authority’s rules. FSA spokesman David Whitely says: “Advisers can charge a fee or take commission, but they must make sure their client understands this, so there are no surprises.”
Before any charge is incurred, advisers must disclose the services they will provide and how much they will be paid for them.
When it comes to the amount of commission paid on products, the simplest rate structures are for group risk products such as group life and income protection. Pete Cole, customer relationship director for direct clients at Canada Life, explains: “Historically, industry-wide levels have been agreed for commission on group risk products. Insurers pay 4% for group life and 12% for group income protection and group critical illness cover. There is no front-end loading, so the adviser receives the same percentage of commission each year that the contract is renewed.”
Although there are industry standards, a group risk adviser can vary the commission they receive, from zero up to 20%. “The commission is reflected directly in the premium rate,” says Cole. “This means an adviser who takes nil commission and charges a fee will be able to offer a lower premium rate to their client, although from the client’s perspective, the overall product cost will include both the premium and the adviser fees.”
It is fairly common for advisers to charge a fee for their work on group risk insurance, rather than take commission. Glenn Laming, group protection sales director at Legal & General, says many intermediaries take this approach.
“We do have a lot of advisers asking for nil commission quotations,” he says. “For group life, 4% of the premium isn’t much but an adviser will look to win this area of the business as a way into other areas of an organisation’s benefits.”
Healthcare products are a little more complicated when it comes to commission. Medical insurance generally involves an initial commission payment when the policy is taken out, followed by a lower level of renewal commission each year the policy remains in force.
Rates can vary enormously too, especially when an insurer is looking to win market share. Mike Blake, group sales manager at PMI Health Group, says: “For smaller groups, the typical rate for initial commission is 10%, but I have often seen it as high as 40% of the premium. Likewise, the standard rate for renewal commission is 5%, but this can go as high as 12%.”
Blake says commission tends to be lower, at between 2% and 5% of premium, for larger groups where the premium is based on claims experience.
As with group risk, there is some room for movement on the commission an insurer pays. Aware that higher levels of initial commission could be seen as influencing an adviser’s decision to place the business with a particular insurer, Blake tries to negotiate level commission where possible, so there can be no claims of bias.
Although there is a lot of variance in commission rates for medical insurance, the situation gets even murkier when you look at commission on pension schemes. David Abbis, principal consultant for wealth management at research company Defaqto, says: “The amount that an adviser can take as commission varies greatly. It can depend on the number of members and the size of the premium, as well as the pension company’s commission rates.”
Also, several different commission structures are available. Advisers can take an initial commission, which could be up to 25% of the first year’s premium, or a level commission, which is about 3% or 4% of the annual premium and will be paid every year for the life of the policy.
There is also the issue of fees to consider, says Towry Law’s Andreas. “A commission-based adviser can end up taking a much higher payment than a fee-based one (see box, page 37) and there is no real incentive to come back and offer further advice,” he says. “[Also], the adviser could receive further commission payments if new members join the scheme or employees get a pay rise and pension contributions increase.”
A growing number of pension firms have ditched initial commission in favour of fees or a level commission structure. Among those taking this step are Standard Life and, more recently, Friends Provident. Martin Palmer, head of corporate pensions marketing at Friends Provident, says: “There is very little margin in a stakeholder pension-style charging structure, so a scheme has to stay with the pension provider for many years to cover the initial commission. Other charging structures are more appropriate.”
Andy Tully, senior pensions policy manager at Standard Life, agrees. His company scrapped initial commission on its pension schemes at the end of 2004. “It was unsustainable to offer initial commission,” he says. “Also, while we believe advisers should be paid for what they do, we didn’t want high levels of initial commission to be seen as unduly influencing an adviser’s choice of pension scheme.”
Fall in business
Although independent advisers are supposed to search the entire market for the most appropriate product, anecdotal evidence suggests that, in some cases, when a company cuts commission, they go elsewhere. Friends Provident’s Palmer says: “We have seen our pension business fall off since changing our commission structure. The vast majority of advisers that took initial commission still are, but from the pension providers that still offer it.”
But he believes the days of initial commission in the pensions arena are numbered. “The situation where some providers pay initial commission and some don’t is only temporary,” he says. “Through the Retail Distribution Review, the Financial Services Authority is looking at how advisers should be remunerated and this will bring about change.”
The Retail Distribution Review has so far focused on reducing the potential for independent advisers’ remuneration to influence their decisions around investments for the individual market, with the aim of removing the possibility of bias. The FSA wants tighter controls to be put in place through adviser charging, but has shied away from imposing a complete ban on payments passing from providers to advisers.
Although its proposals are almost wholly related to the individual market, the FSA, in its feedback statement published in November, said that it would explore the scope for applying adviser charging in the group personal pension (GPP) market in the coming months.
While there may be a bit of a shake-up going on in the market, Michael Whitfield, chief executive of Thomsons Online Benefits, believes that all methods of remuneration are valid. “People have preferences about how they pay for advice,” he says. “Providing you explain the cost of the service, then it is fair to give them the choice of paying by fee, commission, or a combination of the two.”
The way an organisation chooses to pay for advice can often come down to the way it operates, says Whitfield. For example, a company that is making a very small margin might prefer to pay for advice through commission, but a professional services firm is more likely to choose a fee-based remuneration package.
Many observers also expect new ways of remuneration to evolve as commission levels wither on pension plans. For example, rather than charging the employer a fee or taking commission through higher charges, it may become more normal to levy a fee on the employee for advice.
Towry Law’s Andreas says: “We do need to be more creative about how we are remunerated. Fees could come from a higher charge on the employees’ fund in the first year and then the charge could drop down again.”
Whether or not this type of charging structure becomes commonplace, advisers are keen to ensure that employers are confident about what they are paying when they use their services.
Blake adds: “If [employers] are not sure what their adviser is getting for the advice they receive, [they should] ask. An adviser has to disclose this information and be able to justify what they get. If they can not, then [employers] don’t have to use them.”
Example of difference between fee and commission
Whether an adviser is paid by fee or commission can make a significant difference to how much they receive and how it affects the product the employee receives.
As an example, Pan Andreas, head of corporate clients at Towry Law, uses a model scheme of 100 male employees, all aged 40 years and earning £25,000 a year. “If the employer asked an adviser to set up a pension scheme into which it would pay 10% of the employees’ salary, the adviser could take a one-off payment of as much as £55,000 as initial commission,” he says.
Working this through, the salaries for the 100 staff add up to £2.5m, 10% of which equates to £250,000. The commission pegged at 22% of this annual contribution comes to £55,000. This commission would be paid for through a higher annual management charge being levied on the pension scheme. This means that by the time the employees come to retire, in Andreas’ example, each of their pension funds would be reduced by £12,000, using a retirement age of 65 years, growth projections of 7% and an annual management charge of 1%. This equates to an overall cost to the scheme of £1.2m.
By comparison, Andreas says a typical fee for advising and arranging this scheme would be £2,500 for the initial analysis and report, followed by a further £7,500 for arranging and communicating the scheme to members, while the annual management charge would be as low as 0.45%. “Employers need to be aware of the options and how they affect the overall cost,” he says. “Commission can seem invisible but, in this example, the employer may prefer to pay the £10,000 fee and see the employees benefit from larger pension funds.”
Pension commission examples
Pension provider Product Example of commission Aegon Scottish GPP Level: 4.5%. To qualify for commission, the scheme’s Equitable average monthly contribution must be £100 or more.
Axa GPP Agreed on a scheme-by-scheme basis.
Legal & General GPP Scheme Initial commission: One times the monthly contribution 2000 plus 0.2%. Level: up to 2.5% plus override.
Norwich Union Designer Pension Agreed on a scheme-by-scheme basis. @Norwich Union Scottish Life Retirement Initial commission: up to 15% (of first year’s premiums for (Royal London) Solutions GPP regular premium contracts). Level: up to 4% through an annual management charge adjustment or up to 5% through a reduction in allocation rate.
Scottish Widows GPP Agreed on a scheme-by-scheme basis, with the scheme profile, the company and the industry all taken into account.
Skandia GPP Regular contributions: between 0% and 7% of each contribution for the term of the plan or up to 25% of each contribution paid during the first two years.
Standard Life Group Flexible All schemes are individually priced.
Voluntary and flexible benefits
Not all perks are suited to commission charging by advisers because the level of business can depend on employee take-up. For that reason, providers of voluntary and flexible benefits schemes often charge a fee.
Simon Bailey, head of marketing for employee benefits at Aegon Scottish Equitable, says: “When take-up rates [of voluntary benefits] are unknown, it is more common for the adviser to charge a fee. A significant amount of work will be needed to identify the products required, put them in place and communicate [them] to employees, so it makes sense to charge a fee rather than rely on the possibility of take-up.” Commission can still be paid in some instances, however. For example, where a flexible benefits scheme is in place, the adviser may collect commission based on the benefits taken out.
Given the fee-based structure often associated with voluntary benefits, some advisers are also looking at ways to add value. For example, Thomsons Online Benefits has developed tools to measure and analyse take-up of voluntary benefits and it charges a fee for this element of its service.
Chief executive Michael Whitfield explains: “It is one thing offering staff a voluntary benefits plan, but it is another having evidence of their effectiveness. Most providers supply limited management information, [but some] analyse [data] to show trends and enable employers to deploy their packages [effectively].”