Excess baggage

Offering clients the complete package, whether they want commercial cover, a motor policy or a pension, appears to be a sound business model.

The broker has control over the account, can defend against poaching and earns maximum revenue.

However, financial services come with a sting in the tail. Some have been caught out over pensions mis-selling and, in the case of an acquired business, have even had to pay out compensation for cases in which they were not involved.

And there are other potential pitfalls, including discontent over endowments and now split capital trusts, which are subject to scrutiny by the regulator.

It is no surprise then that plenty of brokers currently have their independent financial adviser arms up for sale. Understandably, however, they do not want to go on record, for fear of jeopardising the deal. Finding buyers is far from easy.

Even though brokers face statutory regulation from January 2005, they are in for an easier ride compared to IFAs. Not least, their professional indemnity insurance is more affordable and IFAs have far higher excesses imposed.

Among the brokers that have disposed of their IFA divisions is Willis - its former Willis National operation is now owned by the Bank of Ireland.

The AA recently closed its IFA operation after only six months, citing unfavourable market conditions, and RK Harrison, one of the UK's most respected independent firms, decided around three years ago that its IFA division was surplus to requirements following its management buyout.

A year ago, Northamptonshire-based broker Clive King & Partners sold off its IFA division to the firm's management. It retains its thriving general insurance business and, according to managing director Clive King: "It was right for us to divest ourselves of the business. I have no regrets - brokers and IFAs are very different types of animal and I wish I had taken this decision years ago."

King is refreshingly honest about the problems faced by brokers in keeping an IFA business going. "We found it was dragging us down and I know many other brokers who have also experienced difficulties with problems over supposed mis-selling - often when this was part of an acquired firm - and who then had to eat into their reserves to pay the costs."

He says the annual cost of IFA PI cover was a massive burden. "For the last year we found it hard to obtain cover and, for a time, we were not compliant. I think the Financial Services Authority realised how serious matters were as it did try to step in and help, but we had gone through enough."

He explains that he always believed it was prudent to run the IFA operation as a separate division and is concerned about brokers who offer the full range of services under one company roof. "It can lead to problems and I also believe there is more danger in dealing with individuals, at least our dealings were all employee related."

Certainly, dealing with corporate clients appears more straightforward.

There is no doubt that many mis-selling cases are particularly difficult for an IFA to defend if they involve a convincing individual who feels they have been cheated with their endowment or been sold a high-risk product, which they believed was as safe as that of a building society.

David Slade, chief executive officer of Birmingham-based Perkins Slade, says he views retaining an IFA arm as 'margin business'. He argues it is virtually impossible for most brokers to make them profitable: "With an IFA firm, you are operating in the 1% world for many products. The whole financial services industry has been decimated by regulation and mis-selling and it is very hard to make money. The costs of compliance, PI and salaries for qualified financial services staff are high and, while some IFAs may be first-rate at advising clients, they may not be the best managers. This means opportunities are lost and there is insufficient focus."

He says that many clients do not expect their broker to offer financial services. "If it is a large corporate and you only have a small IFA division, then they will probably need to bring in one of the main employee benefit specialists. In theory, having an IFA seems a good cross-selling opportunity, but in reality it is not."

He adds that, if the IFA operation disappoints a client, there is also a risk this could sour the relationship with the general broker. "I'm not saying that it can not work, but it is difficult. You need highly professional staff to develop the client base and I think any broker looking to buy an IFA firm needs to be extremely careful. They don't know what skeletons are lurking in the cupboard."

But, brokers that have experience of owning an IFA division say it has provided some help in preparing for FSA regulation.

Steve White, who recently joined the British Insurance Brokers' Association as its regulation and compliance manager, formerly worked for the FSA and notes that such brokers are more 'switched on'. "They will know their way around the handbook and of the compulsory need for training and competence checks. In particular, they will realise how crucial accurate record-keeping is. This is something many general brokers have had a more relaxed approach towards in the past but they must now change before it is too late."

Slade adds: "Our IFA has proved a useful point of reference and we now have a full-time compliance officer working across the company."

King has better knowledge than most about future regulatory requirements since he is a BIBA board member and its regional director for training and competence. "I think we have always had high standards here but, with an IFA firm, there can be problems beyond your control. I think almost all IFAs will need to join a network, particularly to buy their PI cover, whereas it is easier for general brokers to be directly regulated."

He adds that not having an IFA operation means his firm can now focus on the future with confidence. "It was dragging us down. Now we can look at making acquisitions of general brokerages, but I would not consider financial services again, we do not want the extra baggage."

Bruce Stevenson, a broker with offices in Glasgow and Edinburgh, was among those who bought an IFA 'with baggage'. Marketing and development director Alan Russell comments: "We inherited some pension problems and we did not examine the IFA closely enough. Although it met the Financial Intermediaries, Managers and Brokers Regulatory Association requirements, which were in place at the time, the goalposts were later moved and we paid the price. It is essential to be aware of long-tail liabilities."

But, he says the problems have now been sorted, although he agrees with most other brokers holding IFA arms that the two operations need to be kept separately.

After a costly experience, Russell says his firm is now committed to its IFA arm going forward to the extent that it has recently recruited a senior professional - Les Stewart from Aon - to develop the business.

"Part of his job will be to ensure all staff are working together, so that we can boost cross-selling," he says.

Broker/IFA compatibility

Although they may be reluctant to admit it, there is no doubt that IFAs and brokers do not always make the best associates. "There can be an element of distrust and it is vital that each understands what the other does. Too often they can be working in isolation," says Russell.

Most general brokers will have a smaller IFA arm and, in recent years, the proportion of revenue earned by the financial services side is likely to have diminished because of falling investment returns - in contrast, profits from general broking have soared.

"There are valuable ways in which we can work together and, apart from pensions, I think that products such as key man cover and shareholder protection are undersold and yet have the potential to be appreciated by corporate clients. Our IFA division currently accounts for about 15% of our turnover and we are now in a position to market it strongly - I see it growing," Russell states.

The Jelf Group, which has its head office in Yate, near Bristol, is atypical in that its three divisions are of roughly equal size. Group commercial director Phil Barton explains: "We operate three divisions - general insurance, healthcare and financial services - which are similar in the amount of revenue they produce - around £3m each. We are committed to our IFA company and it is growing steadily."

Separate divisions

He points out that a key benefit of having separate divisions is that they balance each other out and diversity is healthy.

There is talk of the general market softening right now and this will mean lower premiums and commission. But, on the financial services side, there are clear signs that the investment market is improving, which will lead to increased earnings.

"While there may be some brokers looking to sell off their IFA divisions, in my view, an holistic, client-centric service can not be offered if you are purely general insurance. It also has defensive benefits - if you can only service part of a company, there is always a danger that a rival firm will offer to take on the entire company's needs," says Barton.

He agrees that, in terms of forthcoming FSA regulation, having an IFA does help. "It means you put the right mechanisms in place and we have a group compliance team. Regulation also costs and having the three divisions brings economies of scale and learning."

Barton is a firm believer in general and financial services staff working together and says: "Over the last nine months we have restructured to offer our clients multiskilled teams - something our research showed our clients wanted. This means our people from the broking arm, healthcare and an IFA would be able to offer the client an integrated approach and this team would have regular meetings in the office."

Rowett Insurance Brokers, with its head office in St Austell and a number of branches across the West Country, is committed to its IFA arm, a view held forthrightly by its principal Glyn Rowett, who is a broker, a member of the Chartered Insurance Institute and also holds the Financial Planning Certificate qualification.

"We have considered creating a different company for financial services as, in the past, financial services has been perceived as a burden. Pension transfers and endowment policies proved onerous as lots of work brought no return," he declares.

He now feels that the position is improving for those who wish to remain a single company, "By remaining combined and independent, with the proprietor registered individually with the FSA, it has at times seemed that the system has worked against us. It is only now that the scope of FSA regulation is being widened to encompass mortgages and general insurance that we seem to have any advantage in terms of varying our existing permission rather than starting from scratch."

He adds that financial services provides the potential to maintain his firm's shopfront offices. "With a possible decline in the personal lines sector looming, we have identified a need to diversify. Personal lines business can no longer be relied upon and we can see the opportunity to grow in terms of financial services and, in particular, mortgages."

His advice to other brokers looking to move into the IFA market is: "To budget carefully and pay a salary for the position rather than a commission-based agreement. This would reduce the pressure to sell that would otherwise be a factor, thus avoiding the danger of incorrect selling."

And, as a typically entrepreneurial broker, he explains that by streamlining the business to three centres in Devon and Cornwall, Rowett has the vision of creating one-stop centres, each offering general insurance and financial services leading to business solutions for small to medium-sized business.

He adds that mortgage business leads to valuable cross-selling opportunities in the shape of life assurance, critical illness cover, accident, sickness and unemployment insurance and household cover.

"In the past we have viewed our IFA division as a service to clients providing little if any profit, with some benefit in preventing the competition from muscling in and further attacking the general insurances. Our view has changed somewhat as evidenced in our current business plan and we are now in the process of developing our IFA arm. Due to regulation we feel that the public has a greater confidence in the financial services industry as a whole."

This is 'fighting talk' from a broker determined to make his IFA division succeed - the question is, will those who left the sector, in the years to come, feel they acted too hastily, or be relieved that they bailed out when they did?