Clash of Two Paradigms: Commissioned-based Vs Fee-based Advisory

Today we feel like dragging out one of the most thorny issues ever to plague the Insurance industry: Its compensation model.

More specifically, a commission based system vs a fee based system. (These are the two most well known in the market, with pure salaried advisers being rare to come by)

Of course we don’t mind dragging this out into the open, because we’ve written about it previously.

Now it is about letting some one else weigh in on the issue, and that someone being an active and successful industry practitioner.

Shawn Yap shares his thoughts on the highs and lows of each model – as well as how consumers can learn to safeguard their own interests.

Commission-Based Advisory

The model that we know and love to hate

This is the most traditional form of compensation for advisers. Consumers have long gotten used to “free” advice. However, free advice can sometimes be the most expensive advice. A 2002 study on the effect of commission-based remuneration on financial advice in Britain, submitted to the UK Financial Services Authority, found that financial advisers exhibited significant commission bias – recommending products or providers that pay them the largest commissions, for a small number of single-premium products.

On the local front, the situation is described as “particularly disturbing”. According to a mystery shopping survey conducted by the Monetary Authority of Singapore (MAS) in 2011, 30% of the recommendations were unsuitable, 40% “may be suitable” and only 30% were suitable. This means that the recommendations are only reliable 30% of the time! Is it a coincidence that most advisers in Singapore are commission-based?

But it is not without its merits

It is not to say that the commission-based system is all bad. The commission from product implementation does help to pay for part or whole of the planning process leading to lower cost of advice for consumers, provided that the right and suitable product is recommended.

The financial institute that the adviser represents also make a difference. If the adviser only represents a sole product supplier such as a single insurer or bank, your choices are obviously limited. If the adviser has access to multiple insurers and fund managers, comparisons of similar products can be made to find the best deal for clients. With quantity comes value.

Protect yourself as a consumer

Always be on the look out for a product recommendation that is given before any advisory process is given. The advisory process is meant for the adviser to have a greater understanding of your needs and situation – you wouldn’t trust a doctor who starts a prescription without even understanding your symptoms!

Fee-Based Advisory

Slowly gaining popularity

At the moment, this is more common in developed countries like US and UK than in Singapore. A fee-based compensation has always been used by professionals. When you visit a doctor, you pay a consultation fee. When you consult a lawyer, you pay an hourly fee. When you engage an accountant, you pay a retainer.

With this model, you can expect to get more instead of a sales process. Interestingly, some advisers think that they are fee-based advisers just because they receive an annual investment fee. A fee-based adviser is different from an adviser who charges an investment advisory or management fee. The latter can still be a commission-based adviser.

The litmus test for a true blue fee-based adviser: He charges a fee for planning and advice. (usually nothing more)

But there are still potential flaws to be fixed

Although the fee-based model is touted to be the more transparent model, the fees can even exceed those of the commission based model. While those with larger sized transactions may benefit, the initial cost of $3,000 to $5,000 for a comprehensive financial plan and an annual retainer of $1,200 to $2,000 might be a hard pill to swallow for some.

(Editor: These seem to be a mid to high range of fees to be charged. The lower cost ones could be less than about half the amounts stated above)

Specific needs like insurance, investment, retirement or estate planning cost about $1,500. Some fee-based advisers either refund the commission or waive the fee. But others charge both a fee and collect the commission!

In a triple whammy, some advisers receive a separate commission for insurance plans and a sales charge for investments on top of a paid financial plan! Slapping a “fee-based” tag on someone does not automatically guarantee any additional value to be had.

Protect yourself as a consumer

Nothing against higher fees if they are charged, as long as the advice provides good value. But look out for exorbitant upfront fees that have to be paid in a lump sum, regardless of advice given. (or yet to be given)

And always be on the look out for multi-layered compensation – you only need to pay for a cake once, not thrice!

Conclusion

The quality of financial advice cannot be determined solely by the mode of compensation. No single model can be the best for every client.

The most important factor to consider is the advisory process in planning for your wealth. A proper financial planning process can save clients tens of thousands of dollars. It is not the price but the value that counts!