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Contingent fees can deliver the best outcomes for customers

31 July 2017

Criticism of advisers charging contingent fees is wholly misplaced and non-contingent fees can deliver worse outcomes for consumers, argues Peter Doherty, managing partner and CIO, Tideway Investment Partners LLP.

There has been plenty of criticism directed towards advisers who charge contingent fees. I believe that this criticism is wholly misplaced and that in fact for many transactions it is non-contingent fee structures that are more likely to deliver worse outcomes for customers as a whole.

Furthermore, it is easy to show that non-contingent fees generate a much higher total fee pool for advisers than contingent fees and with no additional benefit to customers.

The single most frequent and (sometimes only) criticism of contingent charging is that this creates an incentive structure whereby advisers entice customers to do something they otherwise would not and should not do.

Implied in this criticism is a degradation of the quality of advice in exchange for a fee. The narrative is: “Mr Smith should not have done XYZ. He would not have done so but he was pressured into it by his adviser who was only interested in getting the transaction fee. As a result, Mr Smith received poor and inappropriate advice”.

This criticism and related supposition are deeply flawed and here is why:

Commoditised activities

A fee for professional advice or a professional service can be thought of in two ways. The first and only way considered by contingent fee critics is as a payment for a process that ends immediately, at the point of transaction closure. There is no reasonable expectation of any future interaction with the customer and the probability of any future claim or challenge arising from the advice or service is negligible. These are what I call “Commoditised Activities”

Commoditised activities include high frequency, lower value tasks such as conveyancing and SME audits and fees for these activities have collapsed in recent years. Templates and software cover off a large part of the work.

Accountants, Solicitors, IFA’s and others are battling this commoditisation and many are losing. Some professions have been somewhat protected by oligopolies, where no one market participant breaks rank and materially lowers the fees charged. But the trend is clear for everyone: fees are collapsing for low value, routine activities.

Value-added activities

A fee can also be thought of as an insurance policy against future claims arising. Looking at a fee this way immediately neutralises the criticism that contingent fees drive poor advice. For high-value, higher risk, compliance-heavy complex advice, it is not an act of altruism to get the best outcome for the customer – it is the only way to rationally behave as an adviser. Of course, advisers who are not smart enough to work out that they are building up a stream of future liabilities by giving poor advice may continue to do so. But thoughtful, high quality advice is a way to deliver the best outcome for the customer and minimise the risk of future adverse claims. There is an alignment of interests, not a conflict, between the adviser and the customer.

Charging on a percentage basis is also entirely rational: the size of the fee is aligned to the size of the transaction.

Why non-contingent fees for DB Transfer are a terrible idea

Now that we better understand the breakdown of fees into “Commoditised” and “Value-added” components, it is obvious that for DB Transfers a non-contingent fee structure would simply increase the total fee pool for advisers.

In a world where everyone pays the same fee irrespective of transferring or not, the fee charged for completing a DB Transfer would not go down. That fee is paid for detailed and complex advice around an irreversible transaction and as described above represents an insurance policy against future claims. With flat, non-contingent fees the whole DB Transfer population – the scheme members – could only be worse off.

Under the logic of non-contingent charging, the fee for doing nothing must be the same as for doing something, otherwise there is an explicit subsidy and that is not allowed either. So, all that would happen with the introduction of non-contingent fees is that thousands of customers would be charged thousands of pounds for “not doing something”.

Does anyone think that equality and fairness comes from charging someone £ 10,000 to make no change to their financial circumstance? That cannot be right.

Over the past two years, Tideway estimates that:

  • About 30% of the people making an initial DB transfer enquiry to us have gone on to transfer out
  • Some 70 % of people making contact with us have had some combination of free guidance, a free initial appraisal and a free advice report and have not transferred through us. You have to ask yourself where the drive to charge people for doing nothing comes from.

One possibility is that some firms or professions are not prepared to do anything for free. Every hour, every phone call, every email must be accounted for and charged for.  What could be better than a high volume of low-risk “advice” via phone email and in person, all charged out to cover overheads and generate risk-free profit?  That is a real risk for customers.

If DB scheme members are going to be charged a fee for not doing a transaction, many of them will not bother to ask or find out what their options are. That cannot be in customers’ best interests.

 

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