CPD: Pricing advice for trust sustainability and loyalty (Part 2 – choosing and communicating fee model options)

The choice of fee model is one of the most important decisions an adviser can make.

Introduction

Advice fees – their quantum, and how they are charged – remain one of the most discussed, dissected, and debated topics within financial advice. They are at the heart of many issues fundamental to the future of financial advice – practice sustainability, affordability and take up of advice, and client trust.

In an earlier article, we explored questions around ‘what’ to charge for advice, examining critical considerations for advisers seeking to strike the right price for their service. In this follow-up article, we explore the ‘how’, examining the different fee methodologies and payment methods advisers can use. We will examine the topic from both sides, looking at the advantages and disadvantages of different fee models, usage trends for the different models, and client preferences. We also look at the often-vexed issue of how to communicate fees, and the value of advice, in a way that reinforces client trust in the individual adviser and the advice itself.

Different fee models

1. Flat or fixed fee

While different people interpret the concept of a fixed or flat fee differently, in essence it is the opposite of a fee linked to variable components, whether that be AUM, or hours spent with the client. A flat or fixed fee is generally taken to mean a set fee, agreed in advance, for the year ahead for all the work the adviser is likely to do for that client. It doesn’t mean you need to charge every client the same fee (a point explored in point 2 below)

2. Tiered fees

Really a variation on the flat or fixed fee, under the tiered fee option, clients are grouped into tiers based on the depth of the services provided to those tiers, and all the clients in that tier pay the same amount as each other. This approach might work well if clients can be fairly easily segmented based on complexity and workload. A fee pyramid (e.g., gold, silver, and bronze) and fee menus are commonly seen with this model.

3. Asset-based fee

The asset-based fee is typically charged as a percentage of funds/assets managed (AUM/FUM) by the adviser for that individual client. By its nature, it is a variable fee, the quantum of which is at the mercy of investment returns, and which therefore can’t be known in advance.

4. Hybrid fee

Typically a combination of a fixed fee and a percentage-based AUM fee.

5. Hourly rate

An approach used by many professions who provide services on a more episodic basis, such as accountants, doctors and lawyers. Under this model, the client is charged based on the amount of time the adviser spends working with/for each client. The hourly rate is usually a fixed rate, known in advance. In its purest form, the adviser is valuing an hour of his time at the same rate, regardless of the client. A variation on this model is that different employees working on that client may charge at a lower rate. So, an hour of a paraplanner or client services manager may be charged at a lower rate than the actual adviser.

6. Project-based fees or modular fees

In contrast to an hourly fee – where a simple hours worked x hourly rate calculation applies – project-based fees are set (and quoted up front) based on either a cumulative estimate of the time to complete the project for the client (working backwards from the value of an hour of the adviser’s time), or based on the perceived value of the project for the client (and what the time is worth to the client).

Typically, a project will be self-contained and on- off in nature, with common examples being advice around life insurance or estate planning. A variation of the project fee is the advice module fee, where the advice process is broken down into distinct – often linear – modules, which are undertaken individually (such as cash flow and budgeting, superannuation, saving for and buying a home, and so on). Another variation is breaking down the advice process into steps, such as initial advice, implementation, and ongoing care, with a different fee levied for each of those steps.

7. Commission

Although not strictly a fee model, advisers can still choose to be paid for their advice in relation to life insurance via commission, capped under law at 60% of the value of the first year’s premium, with a 20% commission payable on the premium at each subsequent annual renewal.

Payment methods and frequency can also vary

In addition to deciding a fee model, advisers also have a degree of discretion in how they collect those fees.

For example, advice fees may be charged up-front, in advance of the work, in arrears, or on a regular ongoing basis. The meaning of upfront can vary. For newer clients, where the client work is heavily front loaded, up-front typically means a fee is levied upon presentation of the advice. For existing clients, up-front may generally mean ‘paid in advance’ for the year ahead. In arrears means after the work has already been completed.

In addition to requiring fees to be paid in full, either upfront or arrears, advisers may also choose to break down fees into regular instalments, such as monthly, quarterly, or half yearly.

A major consideration for advisers is whether to offer clients the ability to pay from their superannuation balance. The appeal for clients and advisers alike is there is no strain on cash flow, making the fees more affordable. But this method also comes with strict guidelines and limitations, explained in more detail below.

Subscription models

At this point it is worth mentioning subscription models. Whether viewed as a fee model in its own right, or more of a payment frequency choice, subscription advice fee models generally involve clients paying a regular fee – typically monthly – for some pre-agreed service. That pre-agreed service could range from access to educational resources, a fixed amount of ‘face time’ with a financial adviser each month, through to advice modules and even the full advice service (in which case ‘subscription’ really means paying fees by instalments).

Industry trends on fees

In line with overseas trends showing a gradual decline in the use of asset-based fees, Australian advisers have been shifting towards fixed fee models, a trend which accelerated after the Hayne Royal Commission in 2018.

Indeed, Adviser Ratings analysis^[1] showed that between 2018 and 2019, advisers using:

• fixed fees increased from 50% to 69% (a figure almost certainly higher now)
• asset-based fees decreased from 13% to 7%, and
• hybrid fees decreased from 37% to 24%.

Considerations when choosing a fee model

The choice of fee model is one of the most important decisions an adviser can make, a choice which can literally make or break a practice. There are many considerations an adviser must weigh up when making this decision, including internal business-related factors, regulatory factors, and of course client factors.

Fixed v percentage: What are you actually charging for?

One of the most fundamental questions for advisers to ponder is what they are charging their clients for. This is almost an existential question, which is really about asking yourself whether you are charging clients for advice, or to manage their investments.

If – like the majority of advisers – you are charging clients for the advice you provide (rather than for investing their money), then an asset-based approach may drive a disconnect between the work you are doing and the fees you charge them.

The simplest example of this can be seen in a market downturn, when the work you are doing for, and the time you are spending with, your client is likely increasing, while the percentage fee is being levied on a shrinking AUM base, meaning your remuneration is decreasing.

A related disadvantage of the asset-based fee from an adviser perspective (the regulator and client perspectives on this will be explored below) is that the adviser is essentially tying their value to investment performance, which, by extension, means when markets underperform, the adviser – in the eyes of the client – has also underperformed, putting their willingness to pay fees, and indeed the entire advice relationship, at risk. Charging a fixed fee breaks this nexus between the value of advice (which an adviser can control) and investment returns (which they cannot).

Client and advice homogeneity

The extent to which clients can be grouped into similar work, will determine how to apply a fixed fee model. Where the services provided don’t vary appreciably from one client to the next, perhaps because the adviser is serving a well-defined niche, or providing a highly rigid service offering, then a pure flat/fixed fee, where every client pays the same, may work.

On the other hand, if different clients need different needs, a tiered approach, with pre-defined fees and service levels, may be more appropriate.

The adviser’s business model is also an important input into this decision. Ad-hoc, episodic advice may be better suited to a project fee, or even an hourly rate.

Special considerations about life insurance advice

While Quality of Advice Review recommended the retention of the life insurance commission system – having considered a general appetite among consumers to pay for life insurance advice – the review also recommended the 60% cap on up-front commissions be retained. Increasingly, this is creating a situation where the cost to provide that advice far exceeds the commission amount payable (especially for younger people with low average premiums). For this reason, advisers remaining active in this space are increasingly looking at augmenting those commissions with fees. These can include a fixed advice preparation fee (paid regardless of whether the client proceeds with cover), a gap fee which covers the difference between the commission amount and some pre-agreed advice fee, and claims management fee.

Regulatory considerations

Setting aside the various disclosure requirements relating to fee consents, there are also some ‘big picture’ regulatory matters advisers must consider when choosing a fee route.

FASEA

One of these is FASEA Standard 7, which mandates:

“Any fees and charges that the client must pay to your or your principal, and any benefits that you or your principal receive, in connection with acting for the client, are fair and reasonable, and represent value for money for the client.”^[2]

Implicit in this is the idea that fees charged without providing a related benefit (fees for no service) is unethical, which does throw into question the idea of retainer fees, or indeed any sort of fee levied where the adviser has done little or no work to justify that fee (regardless of whether the client has agreed).

There is much less clarity around the concept of ‘value for money’. Some commentators advocate that – to the extent ‘value’ is a measure which is determined by, and varies between, each individual client – each client should be charged a bespoke fixed fee, based on the value they receive. While this is notionally true (a client with a larger portfolio can theoretically benefit more than a client with a smaller portfolio acting on the same advice), this can be seen as a variation on the idea that people who can afford more, get charged more, which many would find unethical.

Sole purpose test

Another major regulatory consideration relates to the collection of fees from a client’s superannuation fund(s).

Under the sole purpose test, superannuation funds to be maintained ‘solely’ for the core purposes of providing benefits to members on retirement and death, and certain ancillary purposes, such as disability benefits.

Any advice fee deductions from members’ superannuation accounts can only be used to cover the cost of financial advice about superannuation investments. Examples include

• consolidation of superannuation accounts
• selection of superannuation funds
• selection of superannuation investment options
• asset allocations within a fund
• taking pensions and/or lump sums
• contribution strategies.

Advice provided outside these topics would not meet the sole purpose test, and the client would need to pay the fees from another non-super source^[3].

Client considerations

Arguably the most important considerations of all are those relating to clients, with affordability, transparency, and value for money as much a priority with financial advice as they are with other product and service categories.

Extensive research, including the 2019 Global Wealth Management Research Report^[4] by EY, has found that financial advice clients are largely dissatisfied with asset-based fees specifically, and with the overall perceived complexity and opaqueness of advice fees generally.

While advocates for the asset-based approach argue that clients appreciate the ‘skin in the game’ that this approach theoretically embodies, the vast majority of clients dislike this approach, with dissatisfaction higher amongst higher wealth levels (which amplifies the size of the fee), and younger clients, who have become more accustomed to clear, simple, and predictable pricing for everything from taxi fares to financial products.

Indeed, EY found 60% of Millennials desired a different fee model to their current one. Fixed and hourly fees were the two most preferred fee options, with asset fees being favoured by less than one in five respondents overall, and the remainder favouring other options.

Another source of dissatisfaction among clients relates to their perceived complexity and opaqueness.

According to EY – which surveyed 2,000 advice clients around the world, including Australia:

• 45% of clients do not trust their adviser or wealth manager to charge them fairly, and
• only 56% of clients say they fully understand the fees they pay.

This is a longstanding theme, with Australian research⁵ also finding that advice fees were seen as complex and confusing, and that client trust in advisers was being eroded as a result. (That same research found that clients who understood fees were more likely to refer their adviser to a friend or family member.)

Fee affordability is obviously critical, with the nature of the target client, and their capacity to pay fees, also a critical consideration for advisers.

Fee equity is also an important consideration for clients, most of whom would be uncomfortable with the idea that different clients were paying different amounts for the same service (which can make clients feel they aren’t as important, or their bargaining skills aren’t as strong).

4 tips for confidently communicating fees to clients

Understanding the importance of fee transparency to clients, it is important to communicate fee schedules clearly and early.

Indeed, the first tip is to proactively communicate fees, at the first meeting, rather than doing a slow reveal later in the process because you think you will have greater ‘buy-in’ by then. In the words of an adviser interviewed for this article,

“Unless you deal with the topics of fees early in the very first meeting, the clients will be anxious and distracted, sitting there thinking ‘how much is all this going to cost me?’. They won’t be paying attention to what you are saying before then. Once you get that topic out of the way, they are more relaxed, more forthcoming, and pay more attention, which leads to better advice outcomes.”

The second tip to confidently talk about the value for your fees is to describe your fees with absolute clarity and make sure clients understand your value proposition.

This means doing a detailed breakdown of what the size of fees, the basis of their calculation, and the work that is covered by those fees. The mechanisms to pay those fees should also be discussed, positioned as offering them more flexibility and convenience in how they are paid. Phrases like ‘most clients prefer to pay to pay fees from their superannuation’ provide important social proof and help put them at ease about their ability to pay.

Tip three is to ensure simple, jargon free language is used in any fee documents and conversations. Clients can feel distrustful of advisers who use overly technical terminology, fearing they are hiding something.

Finally, advisers should talk about fees regularly with clients. This could be done during regular reviews and framed from the perspective of making sure the client understands them, and also that they are representing value for money. This not only demonstrates transparency, and a willingness to hear client feedback, but it can also help advisers build their own confidence that fee discussions are not something to be feared.

Conclusion

The choice of fee model is one of the most important decisions an adviser can make. As well as being a key driver of both advice affordability and practice sustainability, fee models, and the way they are communicated, can greatly influence a client’s trust in their adviser. The trend towards more fixed and flat fee arrangements reflects a growing client preference for more transparency, clarity, and equity in advice fees, while also enabling advisers to break the nexus between investment market performance, and the perceived value of their advice.

Read part 1 – CPD: Pricing advice for trust, sustainability and loyalty (Part 1 – pricing framework and context).

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References:
[1] https://www.afr.com/wealth/personal-finance/how-to-pick-the-right-financial-advice-fee-model-20200206-p53y9f
[2] https://faaa.au/wp-content/uploads/2019/07/FPA-Understanding-the-FASEA-Code-of-Ethics-Version-1.pdf
[3] https://www.moneyandlife.com.au/professionals/insight/five-things-to-know-about-the-approach-of-regulated-superannuation-trustees-to-advice-fees/
[4] https://assets.ey.com/content/dam/ey-sites/ey-com/en_gl/topics/wealth-and-asset-management/wealth-asset-management-pdfs/ey-global-wealth-management-research-report-2019.pdf
[5] https://www.ifa.com.au/news/16810-adviser-investor-confusion-driving-trust-issues