UK FCA Consumer Duty: Price and value outcome - good and poor practice update

The FCA update will be of particular interest to: All firms within scope of the Consumer Duty.

Key takeaways

• The FCA’s publication builds on its findings from May 2023 (see our previous Engage article) and seeks to help firms improve the way they think about fair value assessments.
• The update provides insights from the FCA’s supervisory activity on price and value in the three areas that it has prioritised since the Consumer Duty came into force and where it has longstanding concerns about value and effective competition in the interests of consumers, namely:

1. Cash savings;
2. GAP insurance; and
3. Cash on investment platforms.

• The FCA states that the findings apply generally and all sectors should take them into consideration, but acknowledges that there might be sector-specific challenges which may not apply to other areas. The FCA separately notes how its findings might apply to smaller firms.
• The key messages from the FCA are:

1. Outcomes of the Consumer Duty should be considered holistically – The price and value outcome should be considered alongside the other outcomes and cross-cutting obligations under the Consumer Duty.
2. Effectively identifying target markets helps in assessing impacts on different customers - Defining the product group and the target market for a product are important for a good fair value assessment. If different products or services have different features or target markets, they should be considered separately. Broad target market definitions risk not meeting the FCA’s requirements.
3. Analysis of cross-subsidies (where relevant) can be helpful in identifying where different consumer groups may be at risk of not receiving fair value – Firms should be particularly alert to risks that cross-subsidies may disadvantage vulnerable customers.
4. Evidence is vital in fair value assessments, but firms should adopt a proportionate approach - The extent or level of detail of the supporting evidence should be proportionate to the size of the firm and complexity of the factors being considered.
5. Prompt mitigating action is required if fair value assessments show consumers are at risk of not receiving fair value - The actions should be specific, and their success and impact should be monitored.
6. Importance of effective governance in ensuring senior-level challenge on whether fair value is being delivered – Fair value assessments are an opportunity to provide the Board (or other governing body) with thorough management information demonstrating good outcomes for price and value.

What should firms be thinking about and how can Hogan Lovells help?

• All firms within the scope of the Consumer Duty should consider the examples of good and poor practice outlined by the FCA in this update. Some key actions for firms coming out of the FCA’s findings include:
  • Holistic consideration across the Consumer Duty outcomes: Depending on the nature and severity of the fair value concern, a firm may consider adjusting the core features of a product, ensuring there are alternatives available, effectively communicating with and supporting consumers so they are using the right products, and monitoring how these actions are cumulatively working together to ensure consumers are receiving fair value. A reasonable option for smaller firms with fewer resources could be to gauge consumer understanding and support through the nature and volume of complaints, feedback or enquiries, or an assessment of whether consumers are engaging with their products in unexpected ways.
  • Assessing fair value: Defining the product group and the target market for a product are the basic building blocks of a good fair value assessment. Products that have distinct features, fee structures or yield different benefits need a separate fair value assessment drawing out the combination of price and benefit for each product and assessing its fair value. Target markets should be defined accurately to ensure they only capture intended customer groups for whom the product or service provides fair value. It may not be practical for smaller firms to do a complete cross-market benchmarking exercise, and the pricing of alternative products may not be available. Here, smaller firms should use judgement to benchmark against a relevant sample of products including a range of different value propositions.
  • Differential outcomes: Firms should identify and analyse varying outcomes across different consumer groups, looking at how consumers use products, the benefits they receive, and common customer segmentation characteristics. This analysis will support a thorough fair value assessment by evaluating a target market and relevant consumer groups. This is crucial when firms identify poor value for groups of customers, especially vulnerable customers (which are also a particular focus of the FCA’s Cash Savings Market Review update – see our separate Engage article). Firms should be familiar with the FCA’s vulnerable customers guidance. Smaller firms may, for example, be able to use management information to identify behaviours of customers who are at risk of not benefitting from the value a product has to offer. For example, customers that show no evidence of active engagement with their products for a significant period (logins, calls) may be at greater risk of not receiving fair value.
  • Considering costs to the firm: While there is no requirement that firms must include costs in assessments of value, if a firm seeks to justify higher prices principally based on the costs it incurs to provide a product the FCA expects to see a clear rationale within the fair value assessment. Detailed cost allocation and analysis can be complex, and it may be less suitable for smaller firms with more simple product offerings.
• • Mitigating actions: Firms should act promptly when their analysis shows that consumers are not receiving fair value. Fair value assessments need to include analysis of the root causes of consumers not getting fair value so that firms can identify appropriate mitigating actions to take. These actions should be specific and should be monitored for impact and success.
  • Effective governance: Firms should take advantage of their governance arrangements to ensure ‘rich discussion and consideration of how they are abiding by the Consumer Duty’. Firms need to review their fair value assessments on a regular basis appropriate to the nature and duration of the product (PRIN 2A.4.2R(2)), including conducting a new initial assessment when there is a significant adaptation of a product or service (PRIN 2A.4.3R(2)). Firms should conduct their regular reviews of fair value assessments in a reasonable and proportionate manner. When deciding how regularly to review a product or service, firms should taking into account factors such as the nature and complexity of the product or service, the nature of the customer base, including whether there are significant numbers of vulnerable customers, and any indicators of customer harm (FG22/5 6.67). As with all requirements under the Duty, for smaller firms this obligation should be interpreted reasonably in light of the relevant circumstances. In particular, the FCA would not necessarily expect the same level of formality in smaller firms with much simpler governance structures.
• We have significant experience in supporting firms on projects relating to Consumer Duty requirements - from undertaking initial gap analysis work, project managing and supporting the implementation of a rolling program of enhancements and operational changes.
• The combination of our legal and consulting teams provides you with a full range of services, and clear guidance on how the solutions can be applied within the business. If you would like to discuss how we can help you, please reach out to any of the people listed in this article or your usual Hogan Lovells contact.

What’s next?

• The FCA will continue to work with firms to ensure they are taking an appropriate and proportionate approach to the price and value outcome.
• The FCA has warned that it will take action where firms do not make improvements in response to feedback, or if firms’ products and services are clear poor value outliers when compared to the price and value of similar products and services.

Read on for a more detailed look at the FCA’s update on the price and value outcome.

Background

The Consumer Duty sets a high standard of protection for retail customers across financial services and firms have made significant compliance efforts prior to the implementation period. Firms are required to ensure that their products and services offer fair value to retail customers.

There are requirements to provide assessment of price and value across several parts of the FCA Handbook. The specific focus of the price and value outcome is to ensure that the price a customer pays for a product or service is reasonable compared to the overall benefits they receive.

In May 2023, the FCA published findings from its review of 14 firms’ fair value assessment frameworks. The aim of the review was to understand how firms in different sectors are implementing the price and fair value requirements, and to ensure that the FCA’s internal supervisory and regulatory approaches to fair value reflect industry thinking (see our Engage article on this review here).

In its review, the FCA identified the following key areas for further consideration by firms:

• Collecting and monitoring evidence that demonstrates that products and services represent fair value;
• Clear oversight and accountability of the necessary remedial actions if they do not provide fair value;
• Where relevant, ensuring sufficient analysis of the distribution of outcomes across groups of consumers in the target market, beyond broad averages, to demonstrate how each group receives fair value; and
• Summarising and presenting fair value assessments in a way that enables decision-makers to robustly discuss whether the product or service represents fair value, such as by being clear on any limitations in the analysis or evidence.

The September 2024 update builds on the FCA’s findings from May 2023 and collates insights from the first year of the implementation of the price and value outcome.

FCA’s priority industries

The FCA’s publication considers:

• How firms are assessing fair value for consumers;
• How firms are using fair value assessments to deliver good outcomes; and
• Examples of good and poor practice, particularly for producing fair value assessments.

The update provides insights from the FCA’s supervisory activity on price and value in the three areas that it has prioritised since the Consumer Duty came into force and where it has concerns about the interests of consumers.

Cash savings

Following its July 2023 report, the FCA has reviewed the fair value assessments of easy access savings accounts with the lowest interest rates across the 9 largest banks and building societies (see our Engage article on this update here).

Guaranteed Asset Protection (GAP) insurance

The FCA’s general insurance value measures data in 2022 and 2023 indicated that GAP insurance may not be providing fair value to customers. After writing to firms, the FCA intervened through a number of measures, including imposing requirements on firms to temporarily suspend the sale of GAP insurance. The FCA has since lifted a number of the requirements and is assessing a number of fair value assessments produced by firms in this space.

Platform cash

The FCA is concerned by a number of investment platforms and self-invested personal pension operators who retain a large portion of the interest earned on customers’ cash balances. The FCA conducted multi-firm work and sent letters to firms. The FCA is reviewing fair value assessments from 10 firms.

The FCA has used this work to gather examples of good and poor practices, as outlined below.

FCA findings

Before setting out its findings, the FCA noted that price should not be the sole consideration when firms are assessing fair value. The FCA’s rules do not set prices, require prices to be low, or require firms to charge the same as competitors.

Holistic considerations across the Consumer Duty outcomes

Firms should take a holistic approach, both to the price and value outcomes specifically and to the Consumer Duty generally. This means that a product or service which does not meet customers’ needs, causes foreseeable harm or frustrates customers’ objectives is unlikely to offer fair value regardless of its price. Conversely, a product which meets all of the other elements of the Duty is likely to offer fair value.

Poor practice: For cash savings work, use of a regressive interest rate tiering, where lower interest rates are paid as balances grow, disadvantages customers with high cash balances. The FCA found that the majority of funds received the lower rates, which indicates that customers were not initially offered appropriate products which suited their needs or they were not sufficiently monitored and prompted to move to more appropriate accounts. If this practice had been inspected holistically while considering non-pricing characteristics, the analysis would have suggested that customers did not sufficiently understand the implications of the tiered rate.

A further concern of poor consumer understanding arises where firms’ pricing structures are complex and opaque. Some firms deliberately complicate their pricing structures in order to obfuscate information for consumers.

Some investment platforms and self-invested personal pension (SIPP) operators charged both a platform fee on cash holdings and retained some of the interest earned on customers’ cash balances, effectively ‘double dipping’.

The FCA stated that these examples showing that some products and services are poorly designed and do not meet the needs of their target market are less likely to provide fair value to customers. Where firms identify a significant risk of consumers not receiving fair value, firms should consider appropriate mitigating actions. This could include adjusting the core features of a product, ensuring there are alternatives available, effectively communicating with and supporting consumers so they are in the right products, and monitoring the effectiveness of such measures.

Assessing fair value

A fair value assessment should critically assess the proposition from the point of view of the retail customer. The FCA has seen examples of good and poor practice regarding:

• Grouping products or services

The FCA’s guidance provides that firms may group similar products or services together where the customer base, complexity, and risk of customer harm are sufficiently similar. However, firms should be aware that oversimplifying the analysis risks hampering an adequate assessment of each product or service.

Good practice: A combined analysis of the portfolio of savings products which analyses each individual savings product’s fair value can be effective if it maps out how each of these products have a different target market and the characteristics of these markets.

Poor practice: An assessment which groups products together despite material difference in interest rate structures and terms and conditions (e.g. instant access, restricted access, and fixed term accounts).

• The identification of the target market for a product or service

The Consumer Duty requires that a manufacturer’s products provide fair value to retail customers in the target markets for the product.

Good practice: The FCA observed a firm using a tool to segment its target market for cash savings accounts into groups based on the customers’ needs and objectives (e.g. children and parents, those new to saving, more regular maintenance savers, and those wanting to maximise returns). The firm also set out expected and unexpected behaviours for each segment. The assessment mapped unexpected behaviours to potential risks of poor value and identified actions to mitigate these risks.

Firms could incorporate the fact that target markets may develop over time. A change in the target market is likely to amount to a significant adaptation requiring a reassessment of the product.

Poor practice: Use of very broad target market definitions was poor practice. For example, some GAP insurance providers defined their target market generically as anyone who buys a car.

• Consideration of the cost, benefits, and limitations of the product or service

A manufacturer’s fair value assessment must include the expected total price to be paid, benefits and limitations of the product to the customer. If products have different overall fees and charges depending on their use, firms should consider how best to assess the overall price.

Good practice: One assessment by an investment platform analysed their pricing models, detailed third-party fees and charges, and explained how a governance committee oversees third-party services.

Poor practice: One investment platform referred to the proportion of the overall charge made up by their product charges as fair value without any supporting analysis or evidence. Another firm stated that customers received fair value on the basis that all charges are disclosed and agreed between the adviser and the customer.

Some GAP insurance providers stated that the benefit of their product is ‘peace of mind’ to customers. The FCA was critical of these statements due to the very low proportion of premiums paid out in claims which suggested that this was not the case.

• Evidence of appropriate benchmarking

Firms can consider benchmarking and outlier analysis to compare the price and value of their products and services. For example, a manufacturer may find it helpful to consider the market rate and charges for a comparable product to ensure a thorough fair value assessment.

Good practice: A GAP insurance provider benchmarked its products against other similar products, using FCA established insurance value measures such as average claim payout. This allowed for a more objective analysis.

Some firms compared their non-price benefits to reach informed conclusions. For example, impressions data helped one firm assess how regularly customers used insights, tools, and guidance provided to assist investors.

Poor practice: Firms who only examined their products against a favourable subset of the market were less effective in their assessments.

Differential outcomes

The FCA Handbook requires firms to identify whether any group of customers experience different outcomes compared to other customers of the same product. Firms should particularly consider whether any retail customers who have characteristics of vulnerability may be less likely to receive fair value, and whether the product provides fair value to each different group of customers in the target market.

• Assessing customer groups

Good practice: One cash savings fair value assessment broke down a target market into segments. It looked at whether the costs that customers are likely to incur may increase the risk of harm and considered mitigation strategies.

Poor practice: Some firms struggled to provide data and concrete evidence in relation to different customer outcomes. One firm did not sufficiently consider the impact of introductory rates and bonuses. It did not provide evidence to support its claim that fair value was still being given to customers who did not opt in for bonuses or who received lower bonuses.

• Assessing vulnerable customer groups

Firms’ fair value assessments must include characteristics of vulnerability that could be in the target market and the impact that these characteristics would have on the delivery of fair value.

Good practice: One firm used ‘care flags’ for relevant customers’ accounts which are visible to customer support staff. The firm then makes additional provisions to support such customers, such as helping to fill out forms.

Poor practice: Many firms did not have adequate processes to proactively identify vulnerable customers, thereby relying on less effective self-reporting processes. Firms should consider their processes from the potentially vulnerable customer’s perspective.

• Cross-subsidisation

Cross-subsidisation occurs when higher margins on some products that a firm sells compensates for lower margins or negative margins on other products. A firm’s fair value assessment should consider any such practices.

Good practice: A firm included additional analysis to show the average contribution that each savings product makes to overall profits. It mapped out how each product has a different target market and its characteristics. The firm demonstrated that its product offerings and pricing strategies were aligned with the needs and characteristics of different customer groups.

Poor practice: Some firms suggested that higher savings rates could be subsidised by higher mortgage rates. These firms’ fair value assessments did not analyse how the relationship between savings and other products affects savings customers and mortgage customers.

Considering costs to the firm

Firms can consider the costs to manufacture and distribute a product in fair value assessments. This can provide context to pricing decisions.

Good practice: Fund managers made use of activity-based methods to allocate their fixed costs between funds, which enabled a more informed assessment of how profitability varies between such funds. An investment platform further linked the amount of interest retained to the costs to the firm of managing customers’ cash.

Poor practice: Some firms cite costs as important but do not provide sufficient explanation of their relationship to fair value.

Mitigating actions

Firms should take prompt action in response to identification of fair value concerns.

Good practice: A firm used transactional data to identify customers who were not using a product in line with its intended use. The firm proactively targeted communications to these customers, some of whom transferred to more suitable accounts. The firm is continuing to monitor these customers.

Poor practice: A firm acknowledged potential risks of poor value but proposed communications did not set out the actions that customers could take to receive better value. (for example, considering alternative products in the firm’s portfolio).

Effective governance

Firms should prepare reports for their governing bodies which set out the results of monitoring customer outcomes. The FCA expects firms to have Board (or other equivalent body) champions who advocate for the price and value outcome. Governance arrangements should ensure a rich discussion and consideration of how the firm is abiding by the Consumer Duty.

Good practice: Some firms have mature governance and committee structures to oversee and challenge the fair value assessments. Firms use robust product approval processes to provide senior level challenges to product design.

Poor practice: Some firms who identified material issues could not evidence how they escalated this to their governing bodies.

The application of the FCA’s findings to small firms

The FCA acknowledges that small firms may not have the resources or infrastructure to implement certain recommendations. For example, small firms may lack the ability to commission supplementary customer analysis. In this case, small firms could gauge consumer understanding through the nature and volume of customer complaints. Through such information flows, small firms can investigate whether consumers are engaging with products in unexpected ways.

Trade associations can also support small firms by helping them understand consumers in their sectors and their sources of frustration in general.

It may not be possible for small firms to complete cross-market benchmarking exercises due to the small size of their market, and the pricing of alternative products may not be available. In such cases, small firms can instead benchmark against a relevant sample of products including a range of different value propositions.

The FCA would not expect a high level of formality of governance arrangements in smaller firms who may not be able to establish such structures.

Next steps

The FCA will continue to work with firms to ensure they are taking an appropriate and proportionate approach to the price and value outcome. It makes it clear that it will act where firms are not making improvements in response to feedback, or if firms’ products and services are clear poor value outliers when compared to similar products and services.

In-scope firms have plenty of food for thought from this and the FCA’s Cash Savings Market Review update which was published at the same time (see our separate Engage article). All affected firms should take the opportunity to assess and make any required enhancements to their approach to documenting and demonstrating fair value.