Firstly, let’s look at the reasons why the market is in a state of activity. I believe there are 4 main reasons:

>> The high average age of IFA’s is leading to principals retiring, and selling on the client base.

>> Firms are leaving networks, which are perceived to be expensive and inflexible. They then join others to set up a merged company.

>> Firms are merging to cut overall costs and obtain critical mass.

>> Firms are setting up Joint Ventures, often based on the fact that the ‘Professional Practice’ involved is struggling with regulation, often with a 1 or 2-person practice. Again, specialist skills and critical mass are at work here

.

Let’s take a typical firm involved. 3 Registered Individual’s (RI’s), a loyal client base, no real Compliance or Review issues. Call them ‘ABC Financial Services’, and assume that they are a partnership.

They decide that ‘Me2 Financial Services’ are a safe home, having 10 RI’s and, critically, just renewed their PI cover with no real issues. What are the steps involved?

1. First and foremost – Me2 should NOT buy the company. This would make them liable for past transactions. The purpose of the exercise is to allow the personnel involved at ABC to continue in business, and continue to look after the client base.

2. Me2 may or may not buy the client base. If they do, then a % split of the future renewals is the way to do it, sharing future success.

3. A simple view of the timeline is that:

ABC set up a new company, ABC Ltd (or similar)

This is registered as an AR of Me2.

The 3 RI’s are recruited into Me2.

ABC write to their client base, explaining the position, and allowing the clients the right NOT to go over to the new company. They give them time to ‘opt out’. This should allow them to comply with the Data Protection Act.

After a suitable period, ABC Ltd writes welcoming them as clients and providing them with new TOB.

Agencies are transferred.

If ABC can get ‘run-off’ cover, then they should do so.

ABC resigns as FSA members. They MUST fulfil all their Pension / FSAVC review obligations prior to departure.

4. Pardon the special pleading, but it is sensible for ABC to have someone independent look at their compliance and T&C, especially their ‘High risk cases’. The partners will essentially remain responsible for past advice, and should protect themselves. This process will also serve to set out ‘best practice’ for the future, possibly saving time and money.

5. Me2 may well want to do the same review! Whilst they are not responsible for past business, they are liable for new cases, and will want to ensure that everything is 110% right from day one. Why run risks?

The above is very much from the point of view of Me2. ABC will have a different agenda, and may well want Me2 to buy the company, for example.

To summarise, treat the transition as an opportunity to get in touch with all clients, offer reviews, clean up the database, and set out best practice for the future. It is also an opportunity for new ‘Host’ firms to REALLY see what is happening, and manage their own future risks.

Many of the points I made above apply to good old-fashioned mergers. Often, the driver here is to obtain critical mass, and cut costs. Taking the same companies as above, but assuming they are both directly regulated by the FSA, there are two main routes.

1. ABC simply takes on the business of EFG. This would usually NOT include liability for past business, for all the reasons we have explored above.

2. Both firms set up a ‘NewCo’, which then absorbs the client base from both ABC and EFG.

One point to be aware of here. If the FSA think for one minute that you are trying to walk away from past liabilities, and set up a ‘Phoenix’ company, they may well ask or require you to take on the liabilities for both ABC and EFG. This is where you DO need legal advice, and I’m not giving it!

The reasons for any ‘Due Diligence’ process are very similar to the points above.

However, I suggest that if NewCo DOES take on prior liability, then Due Diligence goes from a ‘Nice to do’ to a ‘Must Do’.

Let me tell you a story. Once, long, long ago, in a galaxy far, far away, I knew a company that had taken a short cut. It bought a dormant IFA that was still regulated, but did not trade and had sold its client base. This allowed them to be trading 3 or 6 months quicker than going through the process themselves. Eventually, they had a letter from SIB (I said it was a long time ago!). It turns out that the original firm had NOT finished its Pension Review! They ended up with about 30 cases, with no files or records, and no PI cover. Not nice!

But no one would do that now, you say. And I say, I wish that were true. We have seen a few lately, and there is no real way of putting Humpty Dumpty back together again, all you can do is react when it goes wrong. I am aware that there are tax benefits on buying the assets of the company, rather than just future income, BUT BE VERY AFRAID! Do the due diligence, and control your risks!

On a more positive note, what a great opportunity to offer reviews, and really start to work on the client base. It should, and can, be a good news story, or else why are we doing it?

Joint Ventures

Whilst I am aware that this could be a book in itself, I do want to cover some of the key areas involved in these scenarios, as we are seeing more and more of these, and they work!

Let’s outline the scenario. You are ‘ABC Financial Services’.

• ‘Grabit and Run Accountants’ decide that whilst there is scope for offering professional Financial Services Advice to their clients They do not wish to do it. Your letter / seminar on the provisions of the Trustee Investment Act / post A-day pension legislation may have contributed to this decision!
• However, they are aware that the ICAEW rules means that there are advantages in receiving any income as dividends / management fees, rather than as commission. They also feel they need some control.
• You set up a Limited Company as a joint venture, splitting the shareholding with the Accountants Practice, with at least one partner on the board. This is called ‘Grabit and Run Investment Services’ (or similar).
• This is set up as an Appointed Representative (AR) of ABC. Some / all of ABC‘s Registered Individual’s (RI’s) are made RI’s of the AR.
• Care is needed that ALL costs within the AR are accounted for within the AR. This will include:

• Printing
• Administration
• Compliance
• PI cover
• FSA fees.

There will be others – get your own accountant involved!!

So, if all this is as set out, what’s the problem?

Well, a number of issues come to mind. What about Data Protection, and Money Laundering. Who gives / gets the advice, and who is the client?

You need good procedures here BEFORE you start, and a look at current practice will help. Of course, you may find yourself also taking over a small existing department or firm at the same time. In which case, see above!

Summary

In this brief article, I have tried to make the following points:

1. Buy the Clients, and the income stream, not the Company.
2. Look at existing practice – it’s a guide to the future!
3. Manage and quantify your risks
4. Look for the positives – the more you know about the firm, and its clients, the easier it is
5. Try not to re-invent the wheel – ‘steal’ ideas and experience.

Good luck, and good hunting!

As always, it comes down to assessing and managing risk.

And that involves due diligence. And some intelligent due diligence at that.

Lets look at a ‘Normal’ investment. Lets say it is in a UK Growth fund, in a PEP or ISA ‘wrapper’. What are the risks?

1. There is a risk due to the Asset Class. We generally understand that as pure Equity market risk.

2. There is a risk due to the ‘Wrapper’. But we usually know when tax relief’s will be withdrawn – I said usually!

3. There are risks associated with the administration of the fund. But that is usually a major UK institution.

4. There are risks associated with the country you invest in. But the UK is pretty stable, and currency is not an issue.

5. There is a risk of maladministration or fraud. But the UK system is pretty well regulated, and there are monitoring mechanisms in place. Not perfect, but generally sound.

 

Let’s look at how this compares to an ‘Offshore’ investment.

Do we really understand the risks posed by the following factors?

• How sound is the Regulatory regime where the funds are invested?
• What exactly is the Asset class? Are there bells and whistles and extra risks?
• How sound is the Administrator? How are they monitored?
• How sound is the Investment Adviser? How are they regulated?
• How does the ‘Wrapper’ work? Does this increase or decrease risk?

Our point is simple. By choosing to place client money offshore, in sophisticated and often complex products, the IFA chooses to take on themselves the responsibility for any increased risk or weakness in any of the parties involved in the transaction. This increased risk comes at no increased risk ‘Premium’.

That is a commercial call for IFA’s to make. However, if it were my business at risk, I think I may be inclined to ensure that a very robust ‘Due Diligence’ process had been undertaken prior to making any investment. And no, reading the glossy marketing blurb does NOT constitute ‘Due Diligence’!

Whilst the Isle of Man (IOM) authorities are correct in saying that UK IFA’s carry the liability for any incompetence or fraud by any firm or person based on the IOM, it makes no sense to participate in their Job Creation programme - by continuing to channel large amounts of UK investments towards them - without a long hard look at the implications of doing so.

For what it is worth, my own judgment would be not to use the IOM until we see what the Authorities there actually do as a result of the closure of the Shepherds funds, and the apparent flaws in the system exposed by that closure.

To a very large extent, this means we are managers and protectors of wealth built up through other sources. And it is to the role of protector that I wish to turn.

I see many cases, covering a wide range of advice. I have to say that protection planning often seems to be the poor cousin, and can be viewed as either an add-on to Mortgage business, or is dismissed from the process with a ‘You didn’t want to discuss protection, but wanted to top up your pension / ISA’. Perhaps the raw truth that protection still requires some ‘Selling’ makes us reluctant. I wish we were not. Our squeamishness is not helping our clients!

So, getting back to the title, the Right Money, to the Right People at the Right Time.

Taking the title in reverse order, when is the Right Time?

Well, when they cannot work and support themselves. Our role should be to make money – especially income – available to our clients and their dependents:

>> On death. Every death is premature, every parent, spouse and business partner missed.

>> In sickness. In the United States – where they have no real Critical Illness market and poor healthcare provisions – sickness is a major cause of individual Bankruptcies. We have the opportunity to do much better here.

>> At retirement. We have a long and honourable history here, but the problems in the occupational sector are degrading this historic success. Making sure that savings targeted at retirement are not eroded to pay for long term sickness may be the difference between comfort and poverty for some clients.

All the above is pretty well known - to us. Do we remind our clients and potential clients of the main economic fact of life?

For most people, everything depends on an income stream. Most of the time, that income stream is a salary / profits from a job or business. In other words, it needs to be worked for. If you have a recurring income stream, you can put some away to build a future income stream – pensions – or you can borrow to buy real, appreciating assets – mortgages. But take away the income stream, and it all falls over.

It follows that one of our roles is to protect this income stream from termination or interruption. These interruptions are perfectly foreseeable. People die. People get sick. 40 year olds have heart attacks. 35 year olds get cancer.

Sorry. But it happens. Nothing we can do about it.

But we can prevent temporary personal tragedy becoming a permanent economic catastrophe.

So, who are the Right People?

Clearly, it’s our clients, and their economic dependents.

Apart from their family, these include their employees, business partners and fellow shareholders.

What answer do we get to the question ‘If you had died 6 months ago, what would the situation be?’ Does that answer cover the effects on their business?

What about ‘What if you had quit work through illness 6 months ago?’ Again, how would their business be coping? If not well, then we really should be exploring the various business protection options with them, shouldn’t we?

The answers will give a clue to who the right people are, and what we should be doing about it.

What is the Right Money?

Well, in my eyes, that’s simple. It is enough to maintain a lifestyle. It’s the old question. If you die, do you want your family to live in the same house, eat the same food, and go to the same school? If yes, then how do you intend that to happen?

Take a client with a £40 000 salary. That gives us life cover of £160 000. If this is all invested for income on a fairly cautious basis, that means perhaps £8 000 pa. Even if we amortise the capital over say, 15 years, and work on a net to net basis, we are still looking at perhaps £16 000 pa, against a need for £30 000 plus. Bluntly, this is just not enough. Clients generally do not have 50% of the household budget ‘spare’. Lets be honest, we could double the figures above and they still would not have this degree of spare income. Running children is expensive!

And the above assumes that there is 4 times salary available, and that there are no debts to be paid, and that the mortgage is repaid separately at death.

Many of you will also spot that the above is based on the old cliché of ‘Husband working, Wife at home’. Life in 21st century Britain is not like that for almost all of us. That means that both partners, of whatever sex, need to be given the same economic value. In almost every case, the economic impact on the family / household is the same, whichever dies / becomes long term sick.

Since the demise of the Endowment Mortgage, there is a less likely to be comprehensive Life Cover and Critical Illness (CI) cover associated with the mortgage.  In real life, there will also be additional liabilities in the form of consumer debt which needs to be factored in.

So, guess what? I think the old figures of a rule of thumb of 10 times salary is about right – INCLUDING any existing provision. And that applies to CI as well.

In the example above, this gives £400 000, which would pay off mortgages and average debts (Say £150 000 in total) and leaves an amortised income of around £25 000pa, which is probably something like the net income prior to death. Better. Not excessive, but better. Clearly, I’ve ignored State Benefits. In real life, you will do a more complete analysis. But for most of our clients, the prospect of depending on state benefits is a very unpleasant thought.

The word debt keeps cropping up. We are told that we as a nation owe some simply silly amount to Barclaycard and MBNA et al. Trillions, we are told. Triple what we owed in the 90’s. And all on top of our mortgages.

Lots of this is owed by single people, and childless couples. These have not historically been a natural market for life assurance. But they should be for Critical Illness and PHI. Simply put, how will they continue to pay the bills if they / their partner cannot work for a period of more than a few months?

I realise that there are issues surrounding the terms and conditions of Critical Illness plans, but I will ignore these for now except to say that variations in the CI market is exactly why the role of the IFA is so critical.

How can we ethically recommend that our clients have anything short of enough?

OK, enough of the morbid thoughts about individuals. What about the business market?

Firstly, what is our role? I would argue in business terms we have 2 main roles. The first is to protect the business from economic disaster on the death or long term illness of a key person or principal.

The second is to allow firms, family firms in particular, to fund and plan for a dignified, commercial handover from one generation to another at times of premature death and illness.

To carry out the above role properly, means really getting to know a firm. It means doing proper scenario planning. It means using Trusts appropriately. It means understanding Partnership and Company law, to be able to work with Accountants, Finance Directors and Solicitors. In other words, it requires skill, expertise and credibility. None of this is, or should be cheap. It should mean that Advisers who deliver value in these areas are well remunerated, and have long term relationships with their Clients.

The market is massive. We regularly hear that only 4% of businesses have Key Man cover. And I bet this is high compared to properly written out, funded Partnership Protection Programmes and Share Buy Out schemes.

It all comes back to the title of this article. How can we get the Right Money, to the Right People, at the Right Time? It simply extends the principle to the business market. Which is logical.

These markets are not for all of us, any more than all of us will be Discretionary Wealth Managers. The IFA profession is a diverse one.

But for those that seek to protect individuals, families and firms from economic catastrophe, I believe the rewards can be substantial. And only some of these rewards are financial.

Let’s go back to first principles. What do we mean by ‘Risk’? And here lies the core of the issue. We use Risk to mean two things:

We use the word ‘Risk’ to mean the chances of something happening. So we discuss the risk of a meteor hitting the earth, or of developing a disease, or being knocked down. Of course, what we mean here is Probability, the odds of an event occurring. I’ll return to this theme in a minute.

The second way we use the word ‘Risk’ is to discuss the Impact of a potential event. Think about it. Most of us would very happily walk across a plank of wood that was 6 inches above the floor. Fewer would walk if the plank were at 6 feet, and fewer again at 60 feet. Why? The odds of an event occurring are the same (not allowing for Vertigo!), but the Impact, or consequence, of any problem is much greater as we gain height.

The true measure of ‘Risk’ is the probability of an event, multiplied by the impact.

We can summarise this in the table below.

 

 

Increasing  Impact	Medium Risk	High risk
	Low risk	Medium risk
	Increasing Probability

 

So how does the public view things?

There are two real approaches here. In terms of Probability, clients overestimate the probability of high impact events, and underestimate the probability of low impact events. And I bet you do too. Go on, test yourself. Below is a table giving the annual number of deaths in the UK from certain sources. What is your guess? (Answers are shown at the end of this Article)

Heart disease
Lung Cancer
Measles
Car Accidents
Train Accidents
Salmonella
Flu

So, in financial services terms, there is lots of worry about fraud – which is rare, and less about what really loses money – the natural movement of markets. This also translates into an assumption – especially by the press - that when clients lose money, it MUST be because of fraud. That then leads to cries of misselling!

If we then move onto the other component part of Risk, we move onto Impact. There is plenty of evidence that the public is often very risk adverse in terms of impact. For example they would rather NOT take a chance on an investment with a potential gain of 50%, if it could also result in a loss of 10%. Now, whilst not logical, that’s real life.

If we now think of the main issues with both ‘Zeros’ and the High Income Bonds, it was that Advisers usually correctly identified and explained that the chances of a loss were low, but usually failed to identify and explain that the potential impact was fairly high.

How does all this affect how we will assess, record and explain risk in the future?

At present, many advisers still use the rather discredited ‘Adventurous – Balanced – Cautious’ approach. I’m not sure why – it really does not work. What do these words mean? Surely Risk is a relative term? If the client has money, it has to be somewhere. So how much more risk is a Distribution fund than a Building Society? Or a UK Tracker fund?

Another approach is the 1 to 5 scale, or 1 to 10. Well used, these CAN be useful, especially when the have examples of the types of investment at each point. So UK shares may be a 7, for example.

The missing element here is TIME. Over 6 months a Tracker fund is much more risky than a Cash account, both in terms of the probability of a fall in value, and in terms of the scale (impact) of any fall. We all remember October 1987, don’t we?

But take a 15 year time horizon, and the situation is different. Here the Tracker fund WILL (almost certainly!) have outgrown the Cash fund. The difficulty is that it will also have underperformed the Cash fund at a number of points. But as long as the client holds on to the investment for an appropriate time period, the actual chances of a capital loss are low.

Ok, we all know that. So what do we do about it? Here is my 5 point plan.

1. We should start to discuss risk in terms of both chances / Probability and Impact. A questionnaire type approach to pick out clients inconsistencies will be a real help here and identify the ‘Greedy but Cautious’ who wants 20% returns with NO risk at all!

2. We should give examples of each point on a scale

3. We should relate risk to the Clients’ investment time horizons

4. We should be VERY careful about mixing higher and lower risk products together to get a medium. Clients will only focus on the losses. Sorry.

5.We should refocus on the fact that it is the asset class that determines both risk and reward, not really the fund / manager / share, or market timing. This may discourage advisers and clients from chasing last years top performing sectors. Anyone remember technology funds?

 

Hope this helps to concentrate some thoughts!

(answers to the mortality table are shown below)

 

So let’s see how close you were, the answers are : 

Heart disease	270 000
Lung Cancer	35 000
Measles	16
Car Accidents	5 000
Train Accidents	100
Salmonella	50
Flu	25 000