Why the FCA has got it wrong on “value”

As you will well imagine I have been the recipient of a good number of views and a lot of feedback on how firms in the GI market are reacting to the FCA’s expectations arising from its Thematic Review of Value in GI Distribution Chains. I have never known so much concern (and indeed anger).

I think there are three main themes which have come to my notice.

1. Which objective?

 The FCA has three statutory objectives. These are:-

• to protect consumers,
• deliver lawful competition; and
• to deliver integrity within financial services markets.

The FCA has a habit of muddling these, so that an intervention designed to meet one objective ends up screwing up another.

The classic example is portraying the problems with PPI as a consumer (product) issue when actually the issue (and the intervention by the Competition Commission) was directed at value shifting – a competition issue. The result of the FCA interventions has been to portray the PPI product as a “problem” – not the true problem which was the manipulation of pricing in the marketplace between two regulated products when sold together.

So, we have to ask in relation to the concerns with “value” in GI distribution chains – what is the core source of the problem which the FCA is seeking to address?  Whilst the FCA hang everything on “value” it is pretty clear to me, and most of my clients, that what the FCA actually don’t like is high commissions and/or high mark ups on net premiums.

The FCA is not (should not be) talking at all about whether the consumer “values” a warranty or some mobile phone insurance other than in the context of the requirements of the Product Intervention and Product Governance Sourcebook (PROD) – that a target market, with a demand or identified need exists?

In many markets, for many products, you cannot test, nor deliver, on this unless or until you find an outlet via which the public can “discover” a product.

If the FCA do not recognise, and support this, then it will be inhibiting competition – whilst what it is actually seeking (in truth) is “value” (in monetary terms) for customers.

This leads me to the second theme.

2. Does a high retail margin deliver poor value?

The FCA seem very certain that this is, universally, the case. It approaches the issue down so many different avenues that it is difficult to assess the fundamentals – but, whether it is:-

• the hint of a 50% commission cap in the Thematic Review, or
• the casting of the net premium as the base indicator of “value”

the FCA is clear that:-

“the number (or nature) of parties in some distribution chains increases the price of GI products and adversely affects the value of the products”.

It is a universal law of the supply side of economics that parties in a distribution chain will increase the price of products, so I jolly well hope that the FCA is not using its competition objective as a basis for such sweeping propositions.

The FCA will know as well as you or I that, in the retail sector, mark ups of 100% (and far more and far less) are the order of the day. Just have a look at the CDs or DVDs on your shelf (if you are of a certain age) – these were sold to you with mega percentage mark up – and you valued them hugely.

So, when the FCA say that “the number and the nature” of distributors in a chain is the lever for a price which it does not think delivers value – it better do some pretty careful thinking about what it is really saying?

If it is talking about the number of distributors, it can only reasonably object if one or more of that number are wholly unnecessary to the process of bringing the product to market. If that is the case then there may be some competition issue within a market which tolerates wastefulness. But is that really the FCA’s “problem”?

I think the problem lies with the second of FCA’s concerns – the “nature” of some parties in the distribution chain.

In the Thematic Review Report the FCA is very clear where it thinks the problems in that regard come from:-

• the involvement of parties who are retailers or brands and whose business is predominantly non-regulated. The FCA says that “This appears to give a significant degree of influence over the regulated product and its sale (including its price) to these non-regulated parties”; and/or
• the point of sale advantage enjoyed by such distributors – because these are secondary sales accompanying the sale of another (non-insurance) product. The FCA says that “this gives the distributors ownership of the customer relationship”.

So, the FCA is really saying that the problems of value come from the nature of firms which arrange insurance which are:-

• non-regulated “brand” retailers; and/or
• those which have a point of sale advantage in the add-on sales (secondary) environment.

Hang on a moment. I hope the FCA is not saying that the second of these is a causal issue, because the FCA itself has undertaken and remedied the point of sale advantage via its, competition objective based, Add-on Market Review.

We are therefore left with a really interesting revelation.

What the FCA actually fundamentally objects to is insurance finding its market via strong brands with activity often, but not always, outside its regulatory perimeter – where the power over the marketplace lies with distributor firms and not with regulated “manufacturers”.

The FCA may not like that, but you try telling a small dairy producer that they should not accept the mark-up which a supermarket demands in order to find a market for their milk?

An economist will counter, correctly, that the consumer wins because of the power of the brand to keep end user (milk) pricing low, but my point is that the power of a brand can be an (almost) priceless gateway to a market.

What value, FCA, do you put on that?

The problem which many of my clients have identified is that the FCA has entirely overlooked, or ignored, the “key money” which many manufacturers, in many markets, have to pay in order to access a market which will allow their products to find customers, which they can identify but could not, themselves, ever access.

The core point is then (as with the PPI saga) if that “key money” is actually funded by value shifting between primary and secondary retail offerings, then there may be a competition issue to be remedied – but it has absolutely nothing to do with the “value” of the product related to the distribution chain within which it is offered.

Far superior economic talents than mine need to be hitting the FCA hard on this issue.

I will conclude my overview of this theme with this requirement from the FCA:-

“A difference between risk premium and the final selling price, that bears no reasonable relationship to the benefits or services provided by firms in the distribution chain, can indicate that the level of value that product is offering is causing harm to customers”.

One of my clients has observed that a 100% margin on the sale of insurance via a retail (brand) is entirely consistent with the margin which the retail brand takes on the wholesale price of the primary products to be insured. He takes the view that this consistent margin across all products underlines the reasonableness of the insurance relationship.

He concludes (and I would agree) that the FCA’s “beef” is about regulated financial products being sold in markets where supply and (access to) demand regulates the market – rather than the FCA!

3. The logical outcome

If theme 2 above appeals to the aggressive capitalist within you and your firm – let’s finally look at how some other firms are reacting. There is a strong view around that says that manufacturers should urgently be doing two things:-

• renegotiating commission/premium deals to eliminate any in excess of 50%; and
• either as a lever for the foregoing, or out of genuine concern where distributors are also regulated, recommending that distributors consider redress to all customers who have paid a premium in excess of 50% above net premium.

If I were a compliance advisor, and had any risk adverse vein in my body, having read what the FCA have to say, I could hardly argue against such courses of action. However I will leave you with another thought . . . .

If theme 3 is to emerge as the outcome from the FCA’s input, you may as well give up now – and FCA’s apparent desire to gain total regulatory control over the pricing for general insurance will be achieved.

Alternatively, your firm, can/should, in close conjunction with all others (via trade associations or any other medium you can achieve) get into the FCA’s face now to underline the problems which an imperfect and illogical focus on “value” will cause for the market, and ultimately for consumers – and to do something about it.