Friday, 17 December 2010

Policy Fail? Simple Products And The UK Treasury

The UK's regulated financial services providers have failed to co-operate with various government initiatives to encourage the offering of simple financial products, according to a recent report by Professor James Devlin for the UK Treasury. He found that:
"The combination of a relatively low fee cap [1 to 1.5%], free movement in and out of products without penalty and the relatively low level of funds invested by many users together represented a formidable barrier to enthusiasm from the industry for previous “simple products” (Devlin, p.4)
The lack of simple regulated financial products affects virtually the entire UK population. The primary target may be those people earning low to medium incomes, and those with little financial services experience/expertise/interest and/or limited savings (Devlin, p.10). But people earning higher incomes (over £30k) include themselves in the target market because they would most welcome "standards which show when a financial service offers customers a reasonable deal" (Devlin, p.14). The Treasury also notes in the accompanying consultation on simple financial products, that 48% of UK households have less than a month's salary in savings, and 27% have none at all (para 2.13).

When launching the Retail Distribution Review of financial advice in 2006, the FSA claimed that "insufficient consumer trust and confidence in the products and services supplied by the market lie at the root of what we are seeking to address." And while Professor Devlin cites recent research to the effect that trust in financial service providers is "not significantly below" supermarkets, mobile phone providers and the NHS (Devlin, p.16), that's not saying very much. Investments, pensions and securities are the least trusted consumer services across the EU. Only 34% of consumers think they deliver what's promised, 26% of us are as likely to trust investment providers as used car salesmen, yet 76% of us don't bother to switch providers. What would be the point?

Faced with regulated financial services providers' continuing refusal to supply suitable investment, pension and savings products at reasonable prices, you'd think the government would directly question the structure of all the providers and their products. After all, similar proposals for 'vanilla products' are afoot in the US (and meeting strong resistance from providers, of course (Devlin, p.31)). Instead, however, the UK government has meekly decided to avoid simple investments altogether and focus solely on simplifying "deposit savings accounts" and income protection insurance:
"Although the Government believes that the principles of simple products are widely applicable, it also believes that, initially, simple products should focus on products that do not carry risk to capital, i.e. that are not investment products. Risk would add an extra level of complexity to the product design, as the design would have to weigh up how much risk individuals are willing to bear, both in terms of capital risk and risk to gains."

This astonishingly narrow focus fails on at least four counts. First, and most obviously, it shies away from the key challenge facing the consumer: the lack of simple investment products. Second, it means the government won't enable us to diversify at a reasonable cost. Third, it encourages us all to put our money in the banks for little or no interest, leaving us exposed to inflation that continues to hover well above base rates. Fourth, given the banks' reluctance to lend their deposits due to capital constraints, these proposals inhibit the efficient allocation of our surplus cash to creditworthy people and businesses.

While initiatives to improve financial advice are helpful, good advice does not equate to simple products. The glacial Retail Distribution Review, launched in 2006, will only alter compensation for financial advisers from the end of 2012. Full advice will be fee-based and beyond most people. While advisers are "considering" developing a simplified advice model that might provide a "limited sales route", they're worried that if the investments do not perform customers may claim they thought they were given full advice which proved to be wrong (Devlin, p.26). I wonder why?!

In response to the sound of dragging feet, the government recently commissioned the Consumer Financial Education Body to develop a "free and impartial national advice service":
"It will not give regulated advice, but it will provide people with information and advice on all major areas of money and personal finance. A key component of the national financial advice service will be a financial healthcheck, that will provide people with a holistic review of their finances, highlight areas to prioritise, and give people a personalised action plan to take forward. The service will move as close to the regulatory boundary as possible to ensure that people have a seamless journey between the national financial advice service and regulated advice, should they need it. To this end, CFEB is exploring the possibility of providing generic product recommendations, for example 'you should consider purchasing home contents insurance'." (HMT, para 4.3; see also Devlin, p.29))
You mean home contents insurance is an investment? In what, burglaries?

That little gem aside, the "Moneymadeclear" web site may help improve the knowledge of someone who already has a basic understanding of the various types of financial service. But it won't help anyone to actually decide on a suitable product, or render products 'simple'. Which is surely the point.

A little sunlight may penetrate via the "key investor information document" introduced at EU level to enable easier comparison of the key terms of multiple products. Professor Devlin also suggests that strong warnings on products that do not meet "simple product" criteria (Devlin, p.5) and a traffic light system to declare the risk associated with products (Devlin, p.27) would help people choose suitable products. He has urged the government to retain rule RU64 that obliges a financial advisor to explain why any alternative product being recommended is at least as suitable as a simple product. He found that this rule led product providers to reduce fees for more complex products to make them at least as suitable (Devlin, p.22).

For now, however, we're stuck with expensive, complex regulated financial products.

Like... the Kickout bond! ;-)


Thomas Barker said...

It's a pity the government hasn't at least tried, although the risk of being held liable for losses on "government approved" products must be unappealing. (And try to find a stakeholder pension that doesn't impose the maximum allowed charges.)

Sadly, I expect the lack of vanilla contracts in retail is here to stay for as long as retail buyers are unsophisticated.

Big lawyered organisations seems to have an easy time agreeing standard documentation, because they can't gouge each other in the small print. In retail, there are a lot of vendors with high markups and big advertising budgets :-(

Maybe if there was a website with every retail finance contract/product reviewed by a lawyer and summarised in a standard form? But then you have to pay the lawyer while keeping them unbiased... which was a hard problem with the rating agencies :-?

(Interfluidity has some interesting points on the US's experience of trying to introduce simple products.)

Pragmatist said...

Hi Thomas, thanks as always for the informative comment, and the link to Interfluidity.

You're right that a sophisticated market should demand simpler products - or at least plainly worded. Providers: if you want our money interest free for 5 years, just say so, instead of showering us with all the marketing crap describing the 'Kickout bond', for instance.

Failing that, the consumer lobby could agree ISDA-style standard docs with providers under a certain kite-mark. Of course, Zopa did this on its own - see the Zopa Principals ;-)

I like the idea of a site containing product summaries that cut through the crap - a sort of "Devil's Dictionary", with apologies to Ambrose Bierce. It would have to run off subscriptions/advisory fees under the new rules, since few may wish to buy what it summarised. But perhaps this is a job better done by the publicly-funded "MoneyMadeClear".

My one area of disagreement is that the government should find "the risk of being held liable for losses on 'government approved' products... unappealing". We're in this mess BECAUSE the products of the past decade were the product of the 'government approved' regulatory framework with the result that taxpayers ARE liable for losses and everyone lacks pension coverage. So the government should be pursuing every means of mitigating such liability in the future, including simplifying both regulated - and unregulated - retail investment products.

Thomas Barker said...

Yes, but we got here by just having state approved deposit accounts. (And the implicit bank bond guarantee. Basel 2, etc.) So I can understand the government not wanting state approved share funds/etc. It's very hard to shrug your shoulder at consumers/voters if your "brand" is on the product.

Consumers tend to be upset by losing money on an investment independently of it being cost effective or well administered. If the value goes up, they tend not to care.

It's sad, but then much of the mutual fund industry wouldn't exist if a lot people didn't think that way.

I think fear of blame is a selfish reason for the government not to try - but from a PR-aware ministry's point of view it is still a reason. Although the failure time for a retail financial product is probably longer than a single parliament, so who knows ;-)

(I had to sign a disclaimer to buy/sell covered warrants - a Kickout bond is much more complex derivative, you have to wonder why it doesn't get the same treatment.)

Pragmatist said...

I hear you. But inaction, where you have the power to act, counts as approval. New post in the works...

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