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Out-Law Analysis 12 min. read

Consumer duty: the challenges in assessing fair value

The new consumer duty in UK financial services requires all firms who ‘manufacture’ ‘products’, meaning financial products in the traditional sense as well as services the firm provides, to assess their products for ‘fair value’. 

All products must provide fair value to retail customers in the target market for those products. If a product does not provide fair value, it must either be adapted before being distributed, or must be withdrawn.

Read more on the consumer duty

When the regulator starts talking about price and value, it can often feel like a push on firms to lower prices in a race to be the cheapest. However, as the FCA has made clear, price is only one aspect of value, and the value assessment is more than just a price comparison.

Products and services are covered

The extended scope to cover all ‘products’ as defined by the consumer duty draws in firms that may previously have thought that they did not need to be concerned about a value assessment, or that they only needed to be concerned to the extent that it was carried out and their charges did not adversely impact on value, like insurance distributors, for example. 

However, under the duty, anyone providing a service to a retail customer will need to assess the value of that service. This includes the insurance broker, the credit broker, the debt adjustment firm, the e-money firm, the financial adviser and platform provider. As a result, firms providing a distribution service will need to be assured that the financial products they distribute have been assessed as providing fair value, that their own charges do not impact on the value of those financial products, and that the service they provide is fair value for the retail customer. 

It can be easy to miss the expanded definition of ‘product’ used in the consumer duty. Firms should take care in ensuring they have identified all their obligations, especially when they do not create a product in the traditional sense but provide a service instead. 

Whilst there is likely to be quite a bit of overlap in assessments, especially when considering if your distribution costs impact on the value of products being distributed and when considering if your distribution service is fair value, firms should resist the temptation to bundle the assessments together or to rely on one as demonstrating the other is met. Setting up a clear process now that ensures each obligation in relation to a traditional product and to services provided is covered will put firms on their best foot going forward.

Timeline for engaging with distributors

As with every obligation in the consumer duty, timeframes are tight to meet the implementation deadline of 31 July 2023. For value assessments, the need to ensure distribution continues smoothly after the end of July compresses the timeline further for manufacturers since distributors need information on the value assessment ahead of the implementation deadline to be able to continue distributing the products. 

In the FCA’s implementation timeline, firms are required to complete fair value assessments for all their existing ‘open’ products – i.e. products still available to new customers or available for renewal – by 30 April 2023. The rules will require manufacturers to ensure their distributors have all the information they need to understand the value a product is intended to provide. 

The FCA has set out its expectation that the 30 April 2023 milestone is also when manufacturers should be telling distributors about the outcomes of their value assessments.

The FCA is keen to avoid the situation it had with insurance value assessments, where it granted an extension of time to address a similar problem in completing assessments. The clear expectation as to when assessments should be completed and made available to distributors will in theory lead to a smooth introduction and compliance with obligations. In reality, there is a significant amount of work for ‘manufacturers’ to complete, especially where they have a large portfolio of products. This is another example of where communication between manufacturers and distributors will help in ensuring compliance is achieved on time. 

Whilst we have seen a number of instances where product manufacturers have either reached out pro-actively to their distributors or have had their major distributors reach out to them, we regularly hear of instances where there has been no contact. Especially where firms may be concerned that their implementation timetable is under time pressure, reaching out to distributors or manufacturers may assist in planning out tasks to ensure that the whole chain is ready for 31 July 2023.

Some sectors will have experience, but not others

When it comes to what is involved in a value assessment, there are some firms that are already familiar with the concept. Insurance firms have already been grappling with similar requirements since October 2021, and the rules will also be familiar to asset managers that have a similar value assessment obligation under COLL 6.6.  Products within scope of PROD 4 and COLL 6, as well as PROD 7, which covers funeral plan providers, are excluded from the consumer duty fair value rules on grounds of their existing equivalent obligations. 

For many firms, however, in particular those in both secured and unsecured credit markets, e-money firms and sectors such as claims management companies, this is a new concept – with limited time available to understand and implement it. Additionally, even for the insurance and asset management sectors, PROD 4 and COLL 6 only cover the financial product in the traditional sense of the insurance policy or the fund. Services are not within scope of these rules and firms will still need to consider the services they provide for fair value. 

What is a significant adaptation?

Under the consumer duty, firms need to establish a process for assessing value which they must follow for the initial development of any product and at any time they ‘significantly adapt’ a product. Firms must also regularly review their value assessments. 

Jackson Venetia

Venetia Jackson

Senior Associate

As the FCA has made clear, price is only one aspect of value, and the value assessment is more than just a price comparison

The rules do not set out any parameters for what adaptations should be considered significant, but the FCA’s finalised guidance at point 6.15 (121-page / 1.17MB PDF) indicates that it is the impact on the customer that is important, not the impact on the firm. Allowing customers to invest in a wider range of potentially more risky products would be a significant adaptation, as would similarly restricting what they can do with a product they hold. 

For example, removing benefits from a packaged bank account would be likely to be viewed as significant. Importantly, the FCA highlights that a number of small changes may cumulatively amount to a significant adaptation, even if each change on its own was not significant.

Given the requirement to carry out a value assessment at every significant adaptation, firms should consider making and recording an assessment of significance from the customer perspective with every change to a product, also noting whether cumulatively since the last value assessment there has been a significant adaptation.

Fair value is not about benchmarking

The FCA’s definition of ‘fair value’ does not specify a range of prices or even a numerical approach as to how it should be calculated. Fair value is defined in the rules as being where the amount paid for a product is reasonable relative to the benefits provided by a product. It is a holistic assessment that requires firms to look at all the benefits a product provides and compare them to all the costs, both financial and non-financial, that the customer is expected to pay. 

The rules set out that firms must consider the nature of the product, its limitations, the expected total price to be paid by the customer – including all fees and charges and non-financial costs – and any characteristics of vulnerability in the target market. Notably, this list of mandatory considerations does not include any costs of the firm itself. The firm’s own costs along with comparable market prices come in the list of factors that a firm may consider. 

Of some assistance to firms, especially those looking to provide premium products, is the guidance that a consideration of the benefits the product is intended to provide may include non-financial benefits such as enhanced levels of customer service.

In a recent podcast on the price and value outcome, the FCA highlighted concerns around firms taking advantage of customers’ natural inertia to keep savings rates low, using unnecessary add-on products to entice customers to purchase a product, or using high profile initial discounts that hide the true cost of the product for the customer. All of these are said by the FCA to be examples of where a product may not be providing fair value. 

However, the price and value outcome does not prevent firms from offering initial discounts, offering add-ons, or supplying products that can be held for a long period. The challenge to firms is to ensure that in all these cases the product or service continues to provide fair value. 

Firms should be mindful that each consumer duty outcome does not operate entirely on its own. At all times firms are also required to comply with the cross-cutting rules and the other outcomes where these apply. Delivering good outcomes for customers and ensuring their products provide fair value in situations such as those highlighted by the FCA is likely to also involve considerations of how much the retail customer understands the pricing of the product and the impact on them and a careful selection of add-ons that are likely to be relevant for and useful for the target market. The regular value assessment reviews and the monitoring expectation will provide an opportunity for firms to consider their approach on an ongoing basis.

Assessing from the customer’s point of view

Both benefits and costs should be considered from the view of the target market, not from the view of the firm. 

The financial return expected from a product is the most obvious benefit and reason for a customer taking out a product, but it will not necessarily be the only benefit to consider in the value assessment. 

Features such as the number of channels a customer can access to obtain support with their product may be considered a benefit for customers. This could include the ability to have an online chat at any time, or the ability to speak to someone in a UK-based call centre. Similarly in banking, some customers may value the ability to go to a branch for assistance with their banking needs, whilst others value the ability to do all their banking on the move via a mobile app. 

The ability to access money when needed may be an important feature of a savings or investment product. Customers may perceive value in regular newsletters or other communications in long-term products such as pensions or investment-based life insurance which draw their attention to developments or factors to consider. 

Benefits such as these come at a cost to the firm providing them. It is important to bear in mind that a fair value assessment is not all about being the cheapest product available or driving prices down to this point. A product perceived to be of higher quality and providing more support may still be fair value even though it costs more than a ‘no frills’ basic online-only product.

It is also important to be mindful of the different groups of customers in the target market and assess benefits from the perspective of those different groups. A benefit is, in the FCA’s view, only truly a benefit that provides value if groups of customers in the target market use it. Even where there are groups that don’t use the benefit, such as free key cover on their motor insurance, the product overall still needs to provide good value for those customers. 

With our example of the general bank account, a mobile banking app comes at a cost for the bank to develop. So whilst a cohort of customers may use the mobile banking app and be happy to do so, in doing its price and value assessment, the bank needs to be mindful of the cohorts of customers who for whatever reason, whether it is security concerns, or lack of capacity with the technology, do not use and do not want to use the mobile banking app and ensure that the bank account continues to provide fair value to those customers even though they do not use that benefit. 

Assessment to be based on the lifetime cost of the product

The cost side of the equation is also wider than the initial fee paid by the customer or even any agreed regular fee, such as the monthly management charges on a SIPP, or monthly interest paid on an unsecured loan or mortgage. It includes costs such as contingent fees that a customer will only pay if they fall into default or arrears, as well as charges that may be levied for making changes during the lifetime of a product.

The FCA expects firms to be aware of their customer behaviour patterns and what customers may end up paying to ensure that, overall, the cost has a reasonable relationship to the benefits provided. 

The FCA’s guidance provides an example of a 0% interest product with default fees sold to a target market including customers on low incomes/with poor credit ratings and an operating model that derives a significant income from the default fees. The FCA notes that the whole pricing structure including the default fees needs to be considered as well as the possibility that customers do not pay sufficient attention to the risks and likelihood of incurring default fees when they take out the product. 

The value assessment needs to be seen as a holistic assessment of the likely life of the product, not just the initial cost to the customer of the product. In carrying out their assessments, firms will need to make sure they have to hand data on the typical customer lifecycle in the product and what they pay over the course of the product alongside the benefits they receive over the lifetime of the product.

Non-financial costs

In an interesting development to its thinking, the FCA’s podcast also highlighted the need to consider opportunity costs especially where a product is otherwise ‘free’ for the customer, subject to any administrative or default charges that may be incurred. 

The FCA views aspects such as foregone interest on a current account as being a cost to the customer, which the bank benefits from through the ability to lend out the money. There are also benefits to a customer in that a current account is easy access compared to a savings account, and at least until recent times, the very low savings rates on easy access savings accounts may have led some customers to conclude the ‘cost’ to them of keeping money in a current account is marginal over the benefit that might be gained from using a savings account.

It is also important, particularly in a digital age where sales of products often include a request to agree to further marketing, not to forget the FCA’s inclusion of ‘non-financial costs’ in the value assessment. The most obvious non-financial cost is the provision of data and the consent of the individual to use of that data. The FCA is aware that data has a value of its own, and firms should be mindful of this when considering the overall value of their product. 

In a link to the customer support outcome, the FCA has also referenced time costs in the category of non-financial costs, citing time taken to be able to switch products or to use the product. As firms tackle the FCA’s concern about ‘sludge practices’, it may be expected that these type of time costs will reduce, but it is a reminder of how the different elements of the consumer duty can interact with each other.

Time horizon of the assessment

The rules require a product to offer fair value for a reasonably foreseeable period. Interpretation of this concept is left to firms, based on the nature of their product. 

For fixed-term products such as a structured investment product, a fixed-term bond, or a fixed-term loan, firms are likely to be looking at the duration of the product in question. Where the product is open-ended or subject to renewal, however, what amounts to a reasonable period involves a greater degree of judgment.

Factors such as the typical length of time a customer holds a product before switching, or the average number of times a customer renews a product, will be useful information in informing what the reasonably foreseeable period for that product is. Firms should also bear in mind the requirement to regularly review the value assessment and ensure that the reasonably foreseeable period is at least as long as the gap between their regular review cycles.

The emphasis on price and value is coming at the same time as a cost of living crisis. The FCA has emphasised in its recent podcast that the cost of living crisis highlights the importance of the price and value outcome and their expectation that firms are challenging themselves on their value assessments and ensuring their support mechanisms are in place for customers who are hit hard by the cost of living crisis. 

In its recent guidance for individual sectors and in its speeches, the FCA has highlighted some factors such as the passing on of base rate increases and the offering of fair and competitive rates where it is expecting firms to take action. Through the price and value outcome and the records that will need to be kept to demonstrate compliance with it, the FCA has a framework within which to engage with firms on these areas.

Co-written by Daniela Ivanova of Pinsent Masons.

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