This talk was given at the Consumer Congress 10 December 2009
The text here may not be identical to the spoken text
Transforming financial services
I am here as a freelance financial journalist. Not to represent any of my clients. Specifically I am not here representing Money Box or still less the BBC.
In my fifteen minutes I want to introduce you to three radical ideas. Ideas that would transform financial services from an industry which is largely a money making machine for the financial services industry into one which serves and helps consumers to keep more of their own money and use it wisely.
I bought a car the other day. And I was faced with a choice. What colour would I like – maybe metallic paint? Did I want a sporty number with two seats or a family vehicle that could fit a table and a dog in the back. How about built in sat nav? And was I worried about the fuel efficiency of the car? If so I could reduce my road tax – and save the planet. These are all valid consumer choices.
But if this had been sold by a financial adviser I would have been asked what tensile strength glass did I want in the windscreen? It all depended on my risk reward ratio. Plain window glass was clear, you could see through it probably better than normal windscreen glass. And it would cost me a lot less. But there was an outside chance that a stone might hit it and then it would break and shower me with razorlike shards? What was my risk profile?
Luckily it was a car. I didn’t have to search the internet for information about the brake linings you needed for a 1.8 litre engine. I didn’t have to understand torsion bars or tensile strength. I didn’t have to decide how many and where I wanted air bags. Or check the mounting of the seat belts. All those things are laid down. In the law. The car I bought will be safe. It is illegal to sell one that isn’t. So I didn’t have to have to take a vehicle literacy course so that I could make rational choice about the car I bought. I was allowed to make the choices that a customer can make – colour, fuel consumption, upholstery. That’s about as active a consumer as I had to be.
But imagine if the sale of cars was regulated by the Forecourt Sales Association – FSA for short. it would be perfectly happy if I was sold a car with a windscreen made of window glass. As long as the risk was explained to me in paragraph 94 (b) (ii) blobby point five. ‘In some circumstances window glass can shatter.’ You were warned.
Because the FSA regulates not products but process. As long as an item is sold correctly and the risks explained then it does not have to fulfil any other standards.
Now I made up the Forecourt Sales Agency. But there is another FSA – no, not the Footballers Supporters Association. And it does regulate products. And it does tell us who is doing what.
17 August 2009 Shutki Raja Chutney Powder. The FSA has issued a Food Alert. Local authority food law enforcement officers must make sure the chutney is withdrawn from sale and destroyed.
No problem was found with Shutki Raja Chutney Powder. Except that it had been produced on unregistered, or possibly unapproved, premises. So the product was named and withdrawn and destroyed.
17 March 2009 Active brand peanut butter has been found to be contaminated with excess levels of aflatoxins. The Agency has issued a Food Alert. If any of these products are found, enforcement officers should ensure they are withdrawn from sale and detained.
Compare that with its namesake that regulates financial products. Aflatoxin in peanut butter. It would immediately swing into action and order a thematic study. And a spot of mystery shopping. After some months it would publish the results calling on the industry to take action to explain clearly to customers what aflatoxins were. After giving the industry several months it would order a second round of thematic work and a bit more mystery shopping. The next year it would publish a review and ask for comment. A few months later a Consultation Paper would appear on how these ingredients should be described and discuss whether they were ever completely inappropriate. A few months after that it would publish the results of the consultation paper setting out what it planned to do. Food manufacturers could object. It would then issue a feedback statement with a draft a timetable to make changes in the rules. And six months later decide that more time was needed as otherwise there was a real danger than peanut butter would not be available for everyone’s sandwiches and that changes would not be ordered until 2012.
Meanwhile the businesses that had been found to be selling food contaminated with aflatoxins would not be named. Their identity would be kept secret from consumers. So the FSA would know who was selling dangerous food and under what brand names. But it wouldn’t tell customers. That would take another long process of enforcement and eventually some retailers would be fined. But the amount would be reduced by 30% because they had co-operated with the investigation and taken the products off their shelves promptly – four years after they started selling them. And only at that point after they had stopped selling these dangerous products would the public finally know who they were.
This FSA is of course is not the Food Standards Agency it is the other FSA – the Fundamentally Secretive Association. Which began investigating Payment Protection Insurance in 2005, found problems and two years later referred it to the OFT which passed it onto the Competition Commission which did more research, published draft proposals then a draft order and still has not imposed a two week period between the sale of the food and the sale of the aflatoxin. Sorry, the sale of the loan and the sale of the insurance.
Much better to be like the Food Standards Agency – ban them. Issue a notice and destroy them. ‘My goodness’ I am told ‘we can’t work like in the finace business! If we went round banning things it might destroy confidence in the industry. Then no-one would buy pensions or investments. And that would be a bad thing – wouldn’t it?’
Among that list of products reported by the Food Standards Agency recently there was this
20 November 2009 Tesco has withdrawn two batches of its own-brand wholegrain brown rice because they might be contaminated with insects. The Agency has issued a Food Alert for Information.
12 November 2009 Coca Cola Hellenic Bottling Company has withdraw certain batches of Dr Pepper in Nothern Ireland, because of high levels of benzoic acid.
Big brands. Does it stop people shopping at Tesco? No evidence of that from their recent sales results. Does it make Dr Pepper less popular as a drink? No evidence that it does.
Indeed we buy food with confidence because we know that the Food Standards Agency is there, naming products, withdrawing products, and ultimately banning and destroying products.
And to its credit on one form of PPI the FSA has stepped in and banned it – even though it doesn’t regulate products. Single Premium PPI was banned on 29 May. And from some time in 2010 the Competition Commission will ban the sale of PPI with the loan. Five years after the FSA became concerned and seven years after journalists began to point out the dangers.
So radical idea number one: regulate products not process. And while you're at it end the secrecy that surrounds the current process of investigation. Give customers the information so they can make rational choices for themselves.
And that brings me on to my second radical idea. Choice is a bad thing. At least when there is too much of it. Try this experiment at home. Throw a handful of Smarties or coins on to a table. Without counting them how many are there? I can tell you if there are three or four or five or six you can tell me that without counting. If there are seven you probably can. But 8 or more and the brain gives up. A dozen and we are completely lost.
And similar numbers applies to choices. Take your washing machine – how many programmes does it have? Probably 20 or more. How many do you use? Nevermore than seven. Probably 2 or 3. You go to your favourite restaurant. How many items on the menu? Again 20 or 30. How many do you really choose between – a handful.
But when it comes to financial services you are faced with what is normally called – what I think I first called – a bewildering array of choice.
Mortgages. I used to do a slide of the rise and rise of choice in mortgages. According to MoneyFacts in July 2007 there were 11,951 different retail residential mortgage products. Today the number is far lower. But there are still 1,629. No-one can choose between 1,629 mortgage products.
Standard Life sells personal pensions through what it is called a SIPP a self-invested personal pension. And there is a choice of funds you can invest your money in. 1,666 funds. The human brain cannot choose between 1,666 things.
It’s a process I call complexification. Giving customers so much choice that they cannot make a rational decision between the products available. And making products so complicated that no-one can really understand the choices they are being offered.
You might think at that point – I’ll get advice, go to an advisor. They will use their computer programmes and find the best product for me. And to help you choose they will ask impossible questions. What is your attitude to risk? Do you want to be exposed to emerging markets? What proportion do you want in commodity funds? And if you ask for a recommendation and it goes wrong then the advisor takes no responsibility for the advice at all.
Because the advisor is actually a sales person. So although you may think you are getting advice, all you are getting is guided sales – choices between one commission paying product and another. Because in fact they make their money by selling you stuff. And that creates a conflict of interest between the advisor and their client. The customer never knows why the advisor has recommended a particular course of action. And within that course of action why he or she recommends a particular product to fulfil it. That is not to say that there aren.t good honest financial advisers most of them are. But they are in a system that fails its customers. Would we have had any of the mis-selling scandals of the last twenty years if there ad not been commission? No. Of course we wouldn’t.
And the answer is to take commission out of the process. I have often called commission the cancer at the heart of the financial services industry. An unfortunate metaphor because the heart is one of the few organs in the body that is almost immune to cancer but you know what I mean.
There are moves to do that – at least for independent advice. But whether the retail distribution review will ever happen, or be extended to mortgage and insurance sales, or indeed to the staff at High Street banks – all of whom are allowed to call themselves financial advisers – remains unclear.
So that’s the second radical idea. Reduce choice. Make products simpler. And get rid of commission. Completely.
Of course the retail Distribution Review is supposed to ban for independent financial advisors. Fees will be the only way they can charge. But many of them are now asking ‘what about those who can’t afford £100 an hour for an advisor? How will they get pensions and investments?’ My answer is very simple. If you cannot afford an advisor you probably shouldn’t invest. There is no point in putting £20 a month into a pension. The minimum is about £100 a month and if you can afford that each month you can afford to pay an advisor. And if you can’t write a check pay for it on your credit card and pay it off over a few months.
Now people say to me ‘but commission exists throughout the sales process. What about the car salesperson who sold that car? They were on commission.’ That’s true. But they didn’t persuade me to do anything dangerous. They could praise my choice of red as the colour. They could commend the luxury of the leather seats. They might encourage me to buy the more expensive model. That is consumer choice, they are guiding it, and I know what they are doing. But suppose they got more commission for recommending a car without seat belts. Or enhanced pay for encouraging me to have the cheaper but clearer cheaper window glass in the windscreen? Or the model that saved a bit of money on manufacture by having two wheel nuts instead of four? Would that be acceptable? I don’t think so. But we accept in financial products.
The answer that the industry has come up and has persuaded consumer groups and politicians alike is that customers should all know more. Financial education or as it is often called financial literacy. This is a cunning move. Because an educated knowledgeably consumer can be expected to make rational choices. And so what was mis-selling to the ignorant becomes misbuying by the wise.
But that is like saying that we should scrap the Food Standards Agency and make sure that every child studies food toxicology at school. Was warned about the effects of aflotoxins on the human body. So they would know that it was sensible to avoid them.
And we are now encouraged to believe that the end to financial mis-selling will be a national network of ‘money guidance’.
You know I get hundreds of emails every week at home and at Saga Magazine and at the BBC. I don’t think a single one has ever begun ‘Dear Paul, I’d like some money guidance.’ People have asked for help, for advice, for information, but never as far as I can recall for guidance. Advice is what they want. But that term is not allowed because it has been hijacked by the financial sales industry. So if sales are called advice then advice has to be called something else. Guidance.
Now there is a need for some forms of financial education. All the things financial advisors won’t or can’t tell you. Question one from any advisor face with someone wanting to invest is – do you have debt? If yes, then tell them to go away and pay it off then come back and see them. There is no point in saving or investing if you have debt. Debt will always cost more than investment or saving will always guarantee to bring in.
Very few advisors will tell you that. Nor will they give advice about tax, about benefits, about credit cards, about current accounts, about tax credits, about personal loans, about budgeting, about grants, or in most cases about cash savings. Because none of those pays commission.
So someone has to do it. Or do they? Why pick on financial services as the one area that we all have to be taught about in school, and guided on in adulthood? Do we go on vehicle literacy courses before we buy a car? Do we take an evening course in apparel education before we buy clothes? No. The answer to financial literacy is to make the products that are sold safe, simple and clear. And then anyone with a general education can buy them without being conned.
So my third radical idea is that financial education is a diversion from the changes needed in the financial services industry. And in any case it is not concentrating on the right skills. Many children leave our schools unable to read. Even well educated people are proud of the fact that they don’t do numbers. Improve literacy and numeracy and people could see for themselves that the financial services industry is a vast money making machine – not for its customers but for itself.