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The Waterbed effect

Panacea comment

21 Jan 2014

The Waterbed effect is a phenomenon that should increasingly cause concern to those who regulate the industry and those it regulates in regard to pricing and the detriment the post RDR world has wrought upon the intended beneficiary- the consumer.

The Waterbed effect is the natural but not necessarily intended potential to squeeze one part of a complicated and complex regulated business model (and the attendant regulatory processes) to cause a serious bulge elsewhere in the process.

As an owner in the 70’s of a waterbed (with the attendant fond memories) the metaphor of the water-filled mattress seems to be a common sense albeit simplistic description supported by a little known mathematical formula called Bode’s Sensitivity Integral.

The Waterbed effect is already well illustrated in the mobile phone and utilities industries where regulation and political interference fixes or manipulates the prices of basic products and services only for consumers to see complicated pricing structures ensue by way of significant increases in the price of peripherals and additional services as a direct consequence.

So, the Waterbed effect theory in RDR dictates that in achieving:

  • the elimination of bias in the market
  • ensuring the adviser is the true agent of the consumer
  • clarity over the costs of advice
  • and various other factors,

We will no doubt see the bulge appear somewhere else.

And this will be seen in costs in every conceivable way and particularly for consumers. Cost is something that the FCA incurs for firms, often with little thought of logic or affordability and with little benefit analysis being done on the consumer impact and detriment it created. And none is being considered politically at least until 2015.

So how else will the Water Bed effect manifest itself?

In ensuring the adviser is the true agent of the consumer, the result is that the mass-market consumer will not, does not want to pay for advice that has previously been seen as free. Why do you think the banks bailed out of the crashing plane, much to the annoyance of Martin Wheatley, who felt they had 5 years to prepare?

For clarity over the costs of advice, sadly that clarity will be that for the mass market, cost equals no advice sought if they have to be seen to pay for it, even indirectly by way of fund deduction. 

Consider an investment in an ISA. The fee costs of advising could be a couple of hours work. The average hourly rate is around £150 based on our recent research. This could equate to say £300. I suspect that in the current market this cost, together with other management costs would mean no client return of any significance in year one. Similar to the days of commission in both amount and effect, you really could not make this up if you tried?

So clarity is achieved, but as for savings to the client or the cost impact to the client by way of fee rather than commission, what is the outcome?  Also consider this example of the Waterbed effect.

When a consumer is able to obtain lower prices from an adviser, is it possible that other consumers will have to pay more for the same input from another adviser firm as a result? Is this bad for consumers?

The asymmetric exercise of consumer power can lead to consumer detriment through raising other consumers’ advice charges- the Waterbed effect. 

While a large and powerful firm or distribution channel improves its own terms of advice supply by exercising its market power in getting cost reductions, the terms of its lesser resourced competitors can deteriorate sufficiently so as ultimately to increase the average price of advice - the Waterbed effect.

Even the recent FCA paper on inducements will have little effect now for smaller firms, but it will later on networks- in extreme cases the reduction of cash flow resulting in network failure- the Waterbed effect.

Such consumer detriment is more likely very soon if adversely affected firms are already sufficiently squeezed, due to relatively higher regulatory and other operating costs and a lower market share. They will close leaving orphan clients - the Waterbed effect..

So while we lay in our Waterbed, what should we wear to prevent a bulge getting the better of us?

Chanel No. 5, of course was Marilyn Monroe's choice, what is yours?

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Comments (3)

Why is it that often when I read articles in this forum I get the impression that the writer is firmly stuck in the past?

Now I’m no youngster, but I do understand that the world has moved on and that our industry no longer flogs policies to the unwary.

There seems to be an unquestioning acceptance of perceived reality that says that the less well-off were/are keen purchasers of financial products (which incidentally it seems they all thought they were getting for free). I question this wisdom. I ask whether these people were in effect ‘force fed’ and that the retention rates were in the end pretty abysmal.

In the example it seems to indicate that these people bought an ISA. (And I take this to mean a one off transaction). If so what a waste of time. What will one ISA – even presuming it was the maximum amount) do? How will it change a life? Indeed what sort of a business model is this?

Now when clients buy the maximum investment ISA every year – or at least regularly - (both husband and wife) then this is a worthwhile undertaking. In this case I contend that these people are not of the coterie under discussion. Furthermore on this basis I see no reason why advising on this couldn’t fall within a £150 fee (assuming a funds under management charge in addition) – after all the groundwork has been done as the client is a regular – not just a one off stranger.

Even then these article constantly bemoan another perceived fact – that these people don’t want (or can afford) to pay a fee.

I would make two comments on this:
1. Adviser charging is facilitated by most providers – so that the fee can be taken from the product with the prior agreements (and documentary proof) of the client.
2. The client can (say) contribute a little less to his ISA and the remainder can be paid as a fee. Thereby not costing one penny more.

I can only surmise that the above is not on most advisers menus because they are reluctant to be explicit as to exactly what they charge and why many still relish the meaty returns on annuities and life products which regrettably still do not fall under current rules.

Harry Katz   27/01/2014   09:31
Clarity of costs - what is the difference between a quote stating I receive £300 commission and one saying I receive a fee of £300? Commission has been disclosed compulsorily for many years.

Elimination of bias? Little or nothing still to stop the unscrupulous from milking a client.

Ensuring the adviser is the true agent of the customer? (Why does the regulator still insist on calling a client a customer? Is it because most of them are from banking?) It's been in the rules for many years that proper disclosure of status is required, long after any decent adviser would have declared it in any event.

Richard Brown   27/01/2014   10:56
Richard I'm afraid there are a few flaws in your argument.

1. Too often commission disclosure is buried. A recent example - commission on an annuity disclosed on page 17 of a 19 page document - ridiculous!
2. Commission relies on a product being sold – thereby putting you to an extent in the thrall of the product provider. Fees allow proper financial advice which may not include a product or may include a non-commission paying product.
3. The unscrupulous may well try to milk a client, but the charges have to be stated upfront – not after execution (like so often with commission). So the customer does have a get out. (I have never been in banking and am not so ‘precious’ about the terms customer and client)
As for disclosure of status. Try doing a mystery buying exercise with an SJP agent. (Oops, partner).

Harry Katz   31/01/2014   09:26


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