FOOL'S EYE VIEW
Fair Savings Industry Moves A Step Closer

By James Carlisle
August 1, 2001

The recent publication of a Review of Medium and Long-Term Retail Savings – A Consultation Document is a leap forward in the battle for a fair and efficient savings market. It's being referred to as the rather more snappy "Sandler Report", after the man in charge and, though it may not yet have all the answers, it is certainly asking the right questions.

The report starts by noting that "there are grounds for concern as to whether the competitive process in the industry is necessarily producing efficient investment and an appropriate range of products that deliver to the consumer an efficient risk-return trade-off at the lowest possible cost." Hear, hear! It goes on to cite five main reasons for this:

• many consumers lack the time for or expertise in investment and savings issues and there is limited shopping around;
• as a result products are usually distributed through intermediaries, who are subject to their own commercial incentives;
• costs and charges are poorly understood by consumers and exhibit very wide variations across the various product markets;
• high distribution costs generally create substantial disincentives for the consumer to switch products or providers even where it might be in their best long-term interests to do so; and
• in certain products, such as with-profits policies, competition is based on proxies that are only indirectly related to the underlying investment performance.

All of these concerns will be familiar to regular readers of the Motley Fool and it's wonderful that they're beginning to be taken seriously by the powers that be. The report goes on to look at the three main links in the value chain of the retail savings market -- consumers, distribution and product providers.

Consumers

Consumers, it appears (not surprisingly), have a poor understanding of investment and savings issues. This has meant that their influence is weak in driving the structure of the market. In particular, it means that they place great weight on financial advisers.

The report notes that "to the extent that advisers' incentives are not aligned with those of their clients, competition within the industry may not lead to optimal outcomes." Or, in plainer English, if a financial adviser stands to get a large wedge of commission from selling you particular products, then there's a fair chance you'll end up with the wrong ones.

The reality is, in fact, worse than this since, other things being equal, the products with the highest commission rates are, by definition, unlikely to represent the best value. The other problem with the reliance on advice is that it all needs to be paid for and that represents an inefficiency in the system.

So, if consumers were more knowledgeable about financial matters, then they'd be more likely to get the right products and the system, as a whole, would be more efficient. The solution would seem to be to find ways of educating the consumer. The Financial Services Authority (FSA) has already started to take steps in this regard with a range of leaflets and pages on its website explaining the ins and outs of various products. But more is needed and, as the Motley Fool has said time and again, the place to start is in school.

Distribution

Perhaps the most revealing thing about this section of the report is that it seems to talk almost exclusively about the remuneration of those distributing financial products. As noted above, the commission structure is inherently flawed as it puts the distributor's interests at odds with those of the consumer, but there are other problems.

The regulatory regime relies heavily on the disclosure of commissions and fees as the basis for safeguarding consumers' interests, but the "complexities of commission structures and indirect benefits with which the product providers can reward the distribution channel may mitigate the effectiveness of this regime."

Call me a cynic, but to me this sounds as though the savings industry has worked out that since it has to disclose its remuneration, it had better make it as complicated as possible if it's to get the most out of us. The most obvious solution to this seems to be one of direct Government intervention. Some first steps have already been made though CAT standards and restrictions on Stakeholder pensions, but again more is needed.

Product Providers

"In principle", the report states, "since retail savings products are being sold in a competitive market, product providers should be motivated by competitive pressure to obtain the best risk-adjusted investment returns." However, "the way in which the market functions means that competitive interaction is governed by factors other than investment performance. For example, it has been suggested that marketing expertise and effectiveness of channel strategy are far more significant determinants of competitive success."

Again putting my translator's hat on, this sounds like a product's success in the market depends far more on how effectively it is sold than on how good it actually is. The problems here derive from the lack of consumer understanding, but also from the way in which product providers are able to manipulate the available information.

The FSA has already taken some steps to address these problems, for instance by calling into question the relevance of past performance data. But, again, more is needed. Here the solution would seem lie in a combination of education and intervention. Consumers need to be more aware of the real factors that affect future investment performance, like the risk/reward nature of different product types and the importance of charges. On top of this, the way in which providers are able to market their products needs greater control.

Have your say

So, the Sandler Report is to be applauded in almost every respect. Whisper it – we're beginning to make some ground! The deadline for responses to the consultation document is 28th September, 2001, and the Motley Fool, as ever, will be putting in its tuppence worth. Let us know on the Fool's Eye View discussion board if there's anything in particular you think we should bring up.