The Financial Conduct Authority (FCA) has made it clear: it wants a cultural shift across financial services – away from demonstrating that firms’ activities do not produce poor outcomes, to proactively proving that they consistently generate good outcomes.
Moreover, the FCA expects giving fair value to customers to be at the core of a firm’s purpose and strategy, and for firms to be able to demonstrate that this is the case.
Fair value is not just about the price a customer pays for a product. It's about firms being able to demonstrate that they have a clear, methodological and repeatable approach, based on sensible principles, to measure the relationship between the price of a product and the benefits received from it. As with measuring good outcomes, firms can't meaningfully measure value from a product unless they've articulated – with rationale relevant to the product’s purpose and target market – what constitutes this value.
The FCA has been clear that 'value' encompasses all monetary and non-monetary costs and benefits for the customer across the life cycle of the product. Having created the capability to articulate and measure value, the FCA requires firms to show that they're willing and able – by virtue of their product review and governance arrangements – to intervene to improve customer outcomes when this may not be the case.
The FCA has already been supervising assertively against the new standards. From our work with firms, it's clear that as well as its high-profile multi-firm review work, or examinations regarding particular products – whose outputs the FCA publishes on its website – the regulator now routinely approaches its interactions with firms within the context of the Duty rules.
So, while the prima facie reason for a firm’s interaction with the FCA may have little to do with the Duty, the FCA often uses the opportunity to explore how a firm has interpreted and applied the Duty’s rules. This includes those on price and value.
The FCA now expects firms to be able to provide to respond promptly and fulsomely to requests for information on all aspects of complying with the Duty, including its principles, approach and outputs regarding assessing value.
It's also become apparent that the regulator wants firms to be doing more to improve customer outcomes and experiences when they know – or, from the FCA’s perspective, should know – that a product doesn't offer fair value. High-profile examples of this include the FCA’s interventions regarding Guaranteed Asset Protection (GAP) insurance and ongoing adviser charges. We have previously set out our views on how this can be assessed in the mortgages market and published broader practical guidance for firms [ 1571 kb ].
Providing customers with fair value should be at the top of firms’ agendas. Not just because the FCA calls for it, but because, as Sheldon Mills, an executive director at the FCA puts it: “The prize is huge if we can get this right.” Firms and the wider UK economy can benefit from providing customers with better outcomes. Firms can see tangible benefits from ensuring their products offer fair value, and transparency and fairness builds customer trust and loyalty, as well as the firm’s reputation. It can also bring about innovation in product offerings and growth. In turn, these enhance the competitive position of firms in the market. The wider economy can benefit from increased trust in financial services, new innovative product offerings, and firms' growth.
Since the Duty came into force, firms have dedicated significant resource to ensuring that they assess and meet the fair value standard. The FCA has reviewed individual firms' fair value assessments (FVAs), and their supporting principles and methodologies, and provided insight on how firms have interpreted and assessed fair value.
Positively, the FCA indicates that it has seen the “green shoots of culture shift” across financial services. Moreover, in its recent multi-firm review of insurance firms, the FCA shared examples of good practices it had seen from firms:
Further, early indications across markets point to this FCA pressure increasing positive outcomes for customers. For example, in the GAP insurance market some firms have materially lowered the levels of commission being paid out to those selling GAP, increasing the level of value for customers. Likewise, in the cash savings market there has been greater responsiveness to base rate rises, with firms increasing the speed of pass through of financial benefits to customers using easy access accounts. The FCA has also described how some firms increase value for customers non-financially, for example by widening the definition of certain terms in policies to increase cover; including new benefits to products such as virtual medical care; and delivering training to staff to ensure better customer service levels.
Unsurprisingly however, fair value is one of the most challenging Duty outcomes for firms to meet. Ensuring FVAs are robust and effective has been among the most demanding aspects for firms. Particularly difficult elements include the following:
1 Defining what fair value is for firms with diverse product offerings.
2 Specifying the target market with the appropriate degree of granularity, defining the different customer groups within the target market, and showing why the product design is right for all customer groups.
3 Understanding and appropriately accounting for possible cross-subsidisation between different customer groups. Are some customers paying materially more for essentially the same product or service, in a way which supports the firm’s profitability but creates differences in value between customer groups?
4 Avoiding the aggregation of products, perhaps to reduce the number of FVAs a firm needs to produce, but whereby the features of individual products that are material to their value are not identified, or even misunderstood.
5 Using a suite of metrics to assess fair value, not just price benchmarking against the market. Particularly, ensuring that they include non-financial measures of value that go further than complaints data. The quantification of benefits and costs for products with intangible or long-term aspects has also been demanding.
6 Accurately quantifying ‘cost to serve’, ie, the total cost of all aspects of designing, manufacturing, distributing, operating and servicing a product, and comparing this with the firm’s profit margin.
7 Taking advantage of the capacity within the Duty to use outputs and indicators related to the other three Duty outcomes – on Products and Services, Consumer Understanding and Consumer Support – as inputs into FVAs. For example, firms can use the outputs of periodic product reviews and FVAs to inform each other. And when conducting FVAs, firms can, in principle, justify higher charges or profit margins than those of comparable products if they have information – perhaps including outcomes testing results – that demonstrates that the product only reaches its intended target market, and that customers understand what they need to at key points in the customer journey, and receive high-quality support.
8 Understanding and quantifying their own contribution to the value of the product, in the context of the overall value proposition to a customer, once the contributions of other counterparties in a distribution chain have been considered. The Duty effectively asks firms to interact with other counterparties in a way, and to an extent ,that wasn't the case before the rules came into force.
9 Ensuring data quality and integrity. Firms recognise the real risk of poor data leading to inaccurate assessments and conclusions about product value.
The FCA has expressed dissatisfaction with some aspects of FVAs. The greatest concern surrounds the lack of solid data and credible evidence to justify how the product is giving fair value to customers. This can be the result of a firm failing to consider a full suite of fair value metrics, for example if a firm simply compares similar product offerings in a market and doesn't create metrics that dig deeper into the costs and benefits of the product to a customer. This fails to capture if the customer is getting fair value as the nature of the product, including product specific benefits and limitations, is not assessed.
More deeply, the FCA is concerned that some firms are approaching FVAs as a ‘compliance exercise’ – a mindset whereby the aim appears, from the regulator’s perspective, to be to conclude that a product offers value without designing and applying a sufficiently detailed and objective approach. The FCA has described how some firms have made unevidenced assertations about the value of a product. For example, that their distribution chain represents fair value, without considering fees that are added along the distribution chain. Furthermore, some firms have provided data without any accompanying analysis or explanations. This is crucial for enabling scrutiny and challenge on FVAs.
The FCA has stressed that a crucial element of FVAs is differential outcome assessments for different customer segments. However some firms have shown limited monitoring of fair value across different customer groups, including for vulnerable customers. Firms need to be able to demonstrate that vulnerable customers do not receive materially worse outcomes to follow the Duty. They need to be mindful that costs and benefits may differ between vulnerable and non-vulnerable customers. For example, vulnerable customers may need a higher level of support to understand the risks of a product they buy – just putting a warning statement on a website is unlikely to be enough.
The conclusions from the insurance multi-firm review underscore that the FCA expects firms to be able to measure the extent to which good outcomes are being delivered for customers, rather than inferring that this must be the case by virtue of processes simply being followed and controls applied. For example, firms shouldn't focus on the number or percentage of product reviews and FVAs completed, but the level of fair value being given to customers. Firms could go further to create the well-evidenced and robust FVAs that the FCA expect to see.
We are experienced in the design and production of effective and proportionate FVAs. Our economists and financial services regulatory specialists employ a range of appropriate metrics and techniques to both design and undertake FVAs for firms, and assess FVAs for how they could be improved.
We have advised a range of firms across the financial services industry to ensure their products, services and operations are in line with the Consumer Duty’s wider requirements. We can also provide planning and implementation remediation where poor value becomes apparent.
To discuss the Consumer Duty rules or FVAs further, get in touch with Emma Wilson or Schellion Horn.
What should firms do to demonstrate fair treatment and the avoidance of poor customer outcomes, to a world in which detailed rules require firms to proactively demonstrate good customer outcomes?
