On June 27, the Financial Services Authority will publish its conclusions on how financial products should be sold. Its Re-tail Distribution Review will look at the role of commission and how it affects the advice independent financial advisers and brokers give to their customers.
We already know that commission does have an impact on advice because it affects sales. When providers want to sell more of a particular product or draw a new one to the attention of advisers, they raise the commission on that item. When they want to sell less of an unprofitable line – such as some stakeholder pensions – they cut the commission. Such is business.
The fact that commission levels affect overall sales does not mean that any individual adviser will always be influenced more by the commission they will earn than the interests of their clients.
But the presence of commission creates a conflict of interest – the best mortgage deal for clients may not be the best one for advisers to sell.
This is a conflict that brokers will resolve in their own way. The best will ignore the commission, others will not.
So customers buying mortgages – or investing in cars or computers – faced with those who make their livings from commission on sales should be cautious.
At least part of an adviser’s motivation when recommending products could be the commission they will earn.
This was the point I made in answer to a question at the Building Societies Association’s annual conference in Bournemouth last month. If I’d said ‘close your windows when you go out or you might get burgled’, the 99% of passers-by who are honest would not be offended.
And the 99% of decent, hard-working and modestly remunerated brokers should not be upset when someone says you cannot fully trust advice that is given in a commission environment. It is common sense.
There’s another danger that commission brings. Two years ago, I investigated its role in the financial sales process for Radio 4.
A broker told me that the commission paid on mortgage products was so low that he had to sell other products, main-ly insurance, to make ends meet.
In that sense, he agreed that mortgage sales were loss-leaders for selling life, critical illness and payment protection insurance, even home and contents insurance.
Sales of some of these products have been criticised by the FSA as inappropriate. So again, customers have to be wary of what is being sold alongside their mortgages.
Since that programme was made, a new danger has emerged. Many brokers who are whole of market for mortgages – which under the regulator’s confusing rules does not mean they have to cover the whole of the market – are tied agents when it comes to insurance sales. So even when the type of insurance is appropriate, the particular product sold by brokers might not be the best value to cover that risk.
Customers may do better buying their mortgages from brokers but also checking independently what insurance they need and shopping around for it. And of course, some brokers are not whole of market even for mortgage products. Their advice will always be partial and they should be avoided.
The mortgage broking profession is relatively new – 20 years ago, people who wanted to buy property went to their local bank or building society and took one of the few products available. There were no best buy tables and no discount, fixed or capped deals. Buying mortgages was simple, if poor value for money. Today there is far more choice – perhaps too much.
Two weeks ago, Moneyfacts. co.uk told me it had 10,665 mortgage products on its database, compared with just a year ago when it had 6,437.
In one sense, this in-crease shows that competition is working. It is creating choice and driving down prices.
But in another way, it is not. It is presenting the public with a choice of products so baffling that it is impossible for individual consumers to say which is the best one for their needs.
Unable to choose rationally from this bewildering array, they turn to the experts for help. Recent estimates suggest that three-quarters of all mortgage sales are made through brokers. In the market as it exists today, brokers are essential.
But they have to be paid. And even if their pay is disguised as commission from lenders, and many brokers take fees as well as commission, ultimately customers will pay higher prices for their mortgages.
In many cases, the commission that providers pay to brokers is taken from customers directly as part of arrangement fees. So mortgage broking has become an additional cost when buying homes. It may be small compared with estate agent fees, the cost of removal firms and Stamp Duty. But unlike them it is repeated every few years when property is remortgaged to get another deal.
In such a complex market, paying for good mortgage brokers is the one expense of moving that can save borrowers money in the long run. Which is why it is so important for them to treat that advice cautiously and to be sure it is given in their interests, not in the interest of earning commission.
Paul Lewis is a freelance financial journalist who presents Money Box on Radio 4