Research Programme

FIC is currently working on a number of major projects with partners. Following an extensive prioritisation process, we have developed a work programme for the next two years.

Our projects cover a range of issues – including specific events such as the impact of the credit crunch on vulnerable consumers; research and development on specific product areas such as affordable insurance and equity release; big picture issues such as how to fund long term and social care in light of demographic trends; changing consumer behaviour; and new ideas such as social investment bonds.

We are seeking funding for some of these projects. Any organisations or funders interested in becoming a sponsor for one of these projects, please contact Mick McAteer, Director, The Financial Inclusion Centre, mick.mcateer@inclusioncentre.org.uk.

Recent projects

The Perfect Storm

We have recently completed a major project with the National Consumer Council (NCC) looking at the impact of the credit crunch and other market developments such as the ending of millions of fixed rate deals, and substantial increases in household bills such as gas and electricity on vulnerable, overindebted consumers.

The report highlights which groups of consumers are most vulnerable to the ‘perfect storm’ and sets out a range of measures to protect them including new guidance for lenders on treating borrowers in arrears fairly.

The Consumer Crunch

We have recently completed a project for the Consumer Council of Northern Ireland looking at the impact of economic conditions on vulnerable consumers in the region – in particular, the project looks at the implications for financial inclusion and financial capability. The report highlights groups of consumers who are most vulnerable to changing economic conditions and proposes a financial inclusion and financial capability action plan to protect consumers.

Insurance in Northern Ireland

We are currently working on a major project with the Consumer Council of Northern Ireland investigating whether insurance markets may be operating to the detriment of consumers in Northern Ireland. Concerns have been raised that, compared to the rest of the UK, consumers in Northern Ireland may: be paying more for insurance; have less choice of products and providers; face restricted access to insurance; and be underinsured and therefore less protected against risks. We are investigating whether these concerns are borne out by the evidence. Where consumer detriment is evident (in the form of price differentials and/ or restricted access), we are examining the reasons underlying the current position and developing solutions for tackling the detriment.  

New projects

We are currently in the process of planning two new projects – one sets out to identify financial capability interventions that are actually effective at changing consumer behaviour, the second will undertake R&D into the innovative concept of social investment bonds designed to increase the level of sustainable funding for third-sector organisations involved in combating financial exclusion. We have some limited funding for these projects but we would very much welcome additional funding from interested stakeholders.

Identifying effective financial capability interventions

The overarching purpose of the Government’s/ FSA’s financial capability strategy is to change consumer behaviour so they make better informed and more effective financial decisions.

FIC is developing a work-stream looking at the demand side behavioural and psychological barriers that can cause consumers to self-exclude from financial services, and undermine financial capability. Policymakers and other stakeholders have a number of interventions at their disposal to influence or change consumer behaviour including: ‘self-help’ tools such as printed and web-based information; interactive web-based tools; personal guidance/ advice delivered via telephone helplines; face-to-face advice; and more direct engagement programmes using trusted intermediaries or ‘change agents’ (such as the TUC’s workplace based Pensions Champions).

However, little systematic, comparative analysis has been done in the UK into the effectiveness of financial capability initiatives in changing consumer behaviour and improving consumer outcomes. Therefore, this project will:

• identify which interventions have been the most effective at changing behaviour;
• develop best practice models and disseminate results; and
• develop evaluation tools for high level policymakers and delivery organisations.

Social purpose financial instruments/ social investment bonds

Innovative business models are needed to overcome distribution economics that prevent retail financial services providers reaching large groups of excluded lower income or higher ‘risk’ consumers. One possible model is to develop partnerships between the institutional financial services industry and the third sector. However, additional, sustainable funding is needed if the third sector is to expand its role in meeting the financial needs of excluded consumers.

Therefore, this project would explore the potential for ‘social purpose financial instruments’ as a mechanism for providing social investment capital for the third sector.

One model is ‘social investment bonds (SIBs)’. These SIBs would consist of an investment portfolio consisting of, say, 60% conventional bonds with 40% reserved for social investment purposes. Trustees of SIBs would invest social investment capital in suitable third sector organisations – for example, credit unions looking for additional loan capital. The construction of the bond portfolio is intended to provide investors with a reasonable rate of return and allow them to invest for a social purpose[1]. The potential market for these bonds consists of philanthropists, private client investors, and ethical investment institutions/ pension schemes.

The project will:

• undertake detailed research and  development into the design of these bonds including the legal, regulatory and governance structure;
• explore the market for such bonds; and
• critically, develop methodologies for screening and evaluating potential investments, and measuring ‘performance’ of investee organisations.

Forthcoming projects

Following a prioritisation process, we have identified a number of priority areas to work on over the next three years. We are seeking new sponsors for these projects.

Impact of regulation and public policy on exclusion

This project will evaluate the impact of the regulation and public policy on financial exclusion and underprovision. Many commentators hold that the current approach to regulation presents a major supply-side barrier to inclusion by pushing up distribution costs.

The interaction between benefits (eg. pensions credit) and savings makes providers apprehensive about providing services to consumers on the margins. More generally, the current regulatory regime makes it comparatively difficult for consumers to save and invest, while credit is more accessible.

Conversely, consumer groups take the view that robust regulation is a prerequisite for promoting consumer confidence - a necessary condition for encouraging consumers to use financial services.

Furthermore, the reaction to the sub-prime crisis and other financial market turmoil may result in tightening of prudential regulation standards which could push up the cost of capital for banking and insurance firms – this is in turn could lead to more consumers being priced out of the market.

This project will evaluate these competing hypotheses by:

• quantifying the impact of conduct of business and prudential regulation on distribution costs; and
• evaluating the impact of regulation on adviser and producer behaviour in the market.

 The final report will also include recommendations for a regulatory approach that strikes the balance between allowing the industry to operate and providing an appropriate degree of consumer protection.

This is very topical given the FSA’s Retail Distribution Review (RDR), recent Insurance Conduct of Business (ICOB) and Mortgage Conduct of Business (MCOB) reviews, and review of prudential regulation in the aftermath of the credit crunch.

Paying for long term and social care

Major demographic and socio-economic trends are radically reshaping the financial services landscape and mean that consumers face more uncertain and unpredictable futures. Rising living standards and vastly improved health care means that UK citizens are on average living longer – which is good news but comes at an obvious cost in the form of a rising bill for decent pensions, health and social care.

The UK needs a new, radical vision of how to fund a dignified and secure old age for all its citizens. The ageing population will put increasing pressure on the public purse. The Wanless review estimated that the number of people 65 and over will increase by 47% over the period 2002 to 2026, with the number of persons aged 85 or over increasing by 86% over the same period. The fall in the birth rate undermines support ratios so that comparatively fewer people are economically active and paying taxes to support citizens who are not economically active.

It’s not just the ageing population we have to consider. The extended family and carers have traditionally been an invaluable source of support for vulnerable consumers. But the fall in the birth rate, and the rise in single person households means that the support mechanism provided by the family will disappear for many in society.  For example, the number of one person household aged 55-64 will rise from 980,000 to 1,768,000 by 2026 (increasing by 36,000 per annum), the 65-74 old group will rise to 1,544, 000, up 22,000 per annum and the 75 and over group to 2,372,000, up 32,000 per annum (DCLG, 2007). The Pensions Commission suggests the number of childless pensioners will double from 10% to 20% in the next 20 years.

Overall, the gap between the funding needed to meet consumers’ long term healthcare needs and the actual level of funding the state can realistically provide is growing. It may seem like stating the obvious but pensions and health and social care are not a ‘free good’ - they have to be paid for. The UK is partly funding costly retirement by raising the state pension age. But even these reforms leave a significant shortfall to be funded. The new Personal Accounts coming on stream in 2012 will complement employers’ pensions and retail personal pension products and make a significant contribution to building up pre-retirement funds. But much more needs to be done to fund decent health care for longer periods.

There are really only two ways of funding health and long term care costs i) by the state on a pay as you go basis – from the current prevailing tax base  or ii) ‘pre-funding’ through the accumulation of assets or by insuring those needs. Costs can be pre-funded through individual private insurance, employer provision or alternative quasi-market mechanisms[2].  

It seems sensible to assume that there is a natural limit on the proportion of future welfare costs that can be met through taxation given political constraints. We think the state will focus its role on meeting the needs of the most vulnerable consumers and providing a foundation level of long term care for other consumers. Any additional needs over and above this core level of provision must be pre-funded through asset accumulation and insurance.

Therefore, this project will investigate a number of mechanisms for funding long term care including:

• a working age, personal lifecare fund designed to meet the social insurance needs of consumers such as income, health insurance, and to fund costs of long-term care; and
• a post retirement fund, to combine annuities and other assets (such as housing assets) to maximise income in retirement or to pay the costs of long-term care.

The project will investigate the economics of funding, regulatory issues and interaction with state benefits, plus consumer attitudes towards paying for social and long term care.

Affordable and sustainable housing finance

The fact that the UK already has a serious financial exclusion problem in a hitherto benign economic climate should be a grave cause for concern amongst policymakers, consumer advocates and industry. However, following the sub-prime crisis in the USA and the Northern Rock crisis in the UK, mainstream lenders in the UK are set to tighten lending criteria. The so-called credit crunch could have a chilling effect on retail financial services.

More vulnerable consumers could be priced out of the market or denied access completely to mainstream housing finance or affordable credit. The credit crunch could have a particular impact on the estimated 3 million consumers who have fixed rate and discount rate mortgage deals due to unwind over the next 2 years; younger/ first time buyers; consumers with interest-only mortgages; and consumers in the sub-prime mortgage market. Moreover, as the risk appetite of mainstream retail lenders in the UK changes, this will have longer term impacts on affordability in the housing market.

Therefore, this project will investigate alternative quasi-market debt funding models and mortgage/ debt products to create affordable housing finance. In particular, the project will learn lessons from the US sub-prime crisis to see if securitisation and similar concepts can be applied safely.

The role of alternative institutions and the third sector in tackling financial exclusion

Due to diseconomies of scale, prohibitive distribution costs, risk-based pricing, and reputational and regulatory risk, mainstream financial providers are finding it increasingly hard to meet the needs of excluded consumers. Expanding the role of third sector organisations could provide a solution. The third sector is trusted by, and understands the needs, of vulnerable consumers and has the existing infrastructure in place to reach excluded groups. This project would therefore evaluate the potential for third sector organisations such as Community Development Finance Institutions (CDFIs), Community Interest Companies (CICs), established charities, credit unions, housing associations, local authorities, and ‘new mutual organisations’ to provide access to excluded groups. The project would evaluate: the greatest areas of need; funding mechanisms for the third sector; the capacity and willingness of the third sector to expand its role; and legal and regulatory issues. This project would stand alone but would particularly complement the project on social investment bonds outlined above.

Access to affordable home equity schemes

Around 60% of the total £6.5 trillion wealth in the UK is in property - the over 65s have £1.1 trillion of unmortgaged equity. For many consumers, property is the single biggest asset they have and they are relying on home equity to boost income or provide dignity and security in old age. Yet the home equity market has so far fallen well short of its potential. A range of contributory factors mean that significant numbers of consumers do not have access to viable home equity products. Preliminary analysis has identified two main groups of consumers who are excluded from the market.

The first group refers to those consumers who commercially viable for the market but are denied access to products because existing market conditions restrict the ability of providers to meet their needs. The second group refers to consumers who excluded in the conventional sense because they do not have sufficient home equity to be commercially viable for the retail market – alternative business models and products are needed for this group.

This project will investigate the viability of using home equity to meet core financial needs. It will focus on vulnerable consumers with comparatively small amounts of equity in their homes. It will investigate the barriers that inhibit mainstream providers offering home equity solutions; and undertake research and development into innovative, affordable home equity plans for consumers with low amounts of home equity based on partnerships between third sector organisations and the financial services industry – for example, housing associations, local authorities, and other quasi-market solutions.

Funding income in retirement and asset decumulation products

The introduction of personal accounts in 2012 should improve the position for ordinary consumers trying to build up retirement funds. However, little attention has been paid so far to the other main part of the pensions equation – converting those funds built up over time into an income in retirement.

The conventional mechanism for creating an income in retirement has been to purchase an annuity. Annuities have many significant advantages for consumers. They can provide a ‘guaranteed’ and predictable income in retirement and the income is paid for the rest of the consumer’s life. This means that consumers do not have to take the risk of trying to guess how long s/ he is going to live for and spread available assets over that time – which if current demographic trends continue could be a significant length of time.

Conversely, the very features that are considered attractive in annuities have attracted criticism. For example, apart from the money taken as a tax-free lump sum, insurers keep the funds they use to generate the income on the death of the consumer. This can make annuities seem unfair.

Moreover, 80% of pension pots are worth less than £30,000 which generate low incomes. The fragmented nature of the annuities market means there is a real problem with the lack of economies of scale. Therefore, this report will investigate:

·         consumer behaviour with respect to annuities and post retirement planning;

·         innovative mechanisms for enhancing income from annuities such as collective schemes to generate economies of scale.

The project will also investigate the regulatory issues and interaction with state benefits, and make recommendations for a new regulatory framework that allows post-retirement incomes to be maximised.

Affordable insurance and protection products

A number of major socio-economic and demographic trends mean that consumers – particularly those on lower and medium incomes - face more unpredictable and uncertain futures. Yet the total ‘protection gap’ is estimated to be in the region of £2.3 trillion (or £130billion per annum). Only 1 in 3 households with incomes <£20k have life insurance, while only 12% have income protection insurance. Close to half the households in some of the most deprived areas do not have home contents insurance. The level of underprovision in the UK means that substantial numbers of consumers are left exposed and vulnerable in the event of a major life risk or shock. The protection gap amongst vulnerable consumers is likely to grow as the use of risk based pricing by mainstream insurance companies becomes even more prevalent. It could be argued that the protection gap represents a major public policy challenge on the same scale as the higher profile ‘pensions crisis’.

The project will investigate: the barriers that prevent greater take up of insurance and protection products; and undertake research and development into innovative, affordable insurance for vulnerable consumers. This will include: the feasibility of distribution partnerships between the industry and the third sector (the industry would ‘manufacture’ products with distribution via third sector partners); and the potential for new social-capital funding mechanisms for the third sector to develop affordable protection products (in this case the financial services industry would act as a wholesale or institutional provider of risk capital).