ASIC's report on financial services disclosure1, prepared in conjunction with the Dutch Authority for Financial Markets (AFM), concludes that disclosure is not enough. The real value of the report, though, lies in the insights it gives into what else should be done.
In their report, ASIC and AFM provide a detailed and well-researched assessment of disclosure's effectiveness in informing consumers about financial products, enabling them to make good purchasing decisions and for driving competition. Their overall finding, that disclosure is necessary and contributes to better financial markets but that it has distinct limitations, is consistent with previous reviews2.
The Report is particularly interesting, though, due to its depth of analysis and the insights that may be drawn from them; insights which will be relevant to:
- meeting the fairness obligation in section 912A(1)(a) of the Corporations Act;
- avoiding "significant consumer detriment" which could lead to use of the Product Intervention Power; and
- perhaps most importantly, implementation of the Design and Distribution Obligations (DDOs).
ASIC's commentary on the Report included an express reference to that last point. Commissioner Danielle Press noted:
Tweaking disclosure is not the answer… The upcoming design and distribution obligations (DDOs) provide an opportunity to prioritise consumer needs – to design and offer products and services that deliver value (not surprises) and are sold fairly. I encourage you all to read this report and look at what you need to do in your own organisations to monitor consumer outcomes and prepare for DDOs3.
The Report sets out five bases for its conclusion that disclosure alone is not sufficient. Let's look at what they say and what we can draw out of each.
1. Disclosure does not solve the complexity in financial services markets
Financial products are complex and that is no less the case for insurance. Even those products which are relatively standard and well understood, such as comprehensive motor and home insurance, will normally contain several dozen pages which set out the scope of cover, its exclusions, the conditions that apply and the rules for making a claim. The Report notes the difficulties that this creates for consumers in determining whether any particular product is right for them and in comparing it to competing products.
With the best will in the world, this cannot be resolved through simpler disclosure while the product itself remains complex. The home insurance Key Facts Sheet is a good example of that. The compromises that had to be made in order to summarise the home product into two standard-form pages meant that the resultant document had very limited value.
More critically, the Report observes that some firms unnecessarily add to product complexity. Examples given include:
- the bundling of products together, such as credit cards and travel insurance; and
- the use of complex pricing arrangements for products with, for instance, discounts and loyalty points.
There may be good intent in some of these situations. Many consumers would value the addition of reward points and complimentary insurance to credit cards. However, they also pose a challenge, in that the complexity they add can make understanding the product and comparison with other products difficult.
The Report also refers to examples of what it considers bad intent. This it refers to as "sludge". That's a relatively new term which grew out of the work led by Richard Thaler on "nudge theory". Whereas a "nudge" should be used for good, "sludge" involves use of the same behavioural science tools against the interests of those being nudged.
The Report cites a number of examples of this – describing "strategically complex" products, unfair sales tactics and high friction claims handling processes as examples of "sludge".
The Report provides further support for the need to simplify insurance products where at all possible. That will not only allow for simplified disclosure and improve the prospects of customer understanding; but will likely also simplify the terms of the Target Market Determination and the Distribution Obligations needed to support it, for implementation of the DDOs.
Product issuers should also consider whether there are any aspects of the product, having regard to the context in which it is sold, that have the potential to be identified as "sludge". Conversely, it should consider whether aspects of the product or its distribution could be re-cast to nudge customers towards more positive decisions, consistent with the intended target market.
2. Disclosure must compete for consumer attention
The second point made by the Report is that disclosure cannot overcome advertising and sales practices made to attract, distract and influence consumers. It refers to an increasing use of "sophisticated marketing and sales techniques", in some cases using valuable data analytics, to influence purchasing decisions.
Disclosure documents, on the other hand, are often long and complex, so not easily digested. As has been found by the Insurance Council in its reviews on this subject4, many customers do not access the Product Disclosure Statement (PDS) at all or, at least, skip large parts. Without something more, the disclosure documents cannot compete.
Technology is also playing an increasingly important part in all of this. The delivery of products and services online, and through mobile phones, is bringing valuable convenience to consumers, but it can also enable poor decisions to be made more easily.
To the extent they have not already done so, product issuers should consider the marketing and sales techniques they use in connection with retail products with a view to identifying aspects that may not align with positive customer outcomes. In the immediate term, those might need to be varied or removed if they carry a risk of breaching the fairness obligation or causing "significant customer detriment". In the (slightly) longer term, they may also need adjustment or augmentation to meet the requirements of the DDOs. Technology should be harnessed in a way which leads customers towards good decisions, in support of these obligations.
3. One size does not fit all – the effects of disclosure are different from person to person and situation to situation
The Report notes that "one-size-fits-all" disclosure rules are not easily adapted to consumers' different decision-making processes and styles. Some consumers, for instance, prefer to rely on documented information; others prefer advice. Some are cautious; others will trade that off for convenience. Some like words; others relate better to pictures and diagrams.
Similarly, some situations allow for better consideration of disclosure materials. Reading them online in the peace and quiet of an office, for instance, will likely be more effective than reviewing a hard-copy document during a face-to-face meeting.
As the Report says:
While some forms of disclosure are undoubtedly useful for some consumers in some contexts, no one disclosure will suit the needs of all consumers.
The effectiveness of disclosure can be improved by:
- tailoring it to the likely preferences of customers in the target market; and
- delivering it in a manner which maximises the potential for them to consider it prior to purchase.
As to the first of these points, there may be improvements that can be made to the PDS, though there are limitations in that area. It is not possible to have more than one PDS for a single product, for instance to cater for different preferences, and the document needs to comply with the prescriptive requirements of the Corporations Act. What can be done, though, is to augment the PDS with additional disclosure in various forms, such as diagrammatic representations, video explanations and the like. While care needs to be taken to make sure that this additional disclosure accurately describes the cover in the PDS, they could prove a potentially valuable aid for some consumers.
As to the delivery of disclosure material, it may be that improvements could be made to existing processes to improve the way it is presented to consumers prior to purchase. That will vary by product and distribution channel and may require some lateral thinking. That thinking should be done within the context of setting the Distribution Obligations needed to meet the incoming DDO requirements and having regard, if applicable, to the potential application of a deferred sales model.
In both regards, consumer testing may help with clarifying what will be of assistance in practice. That testing will also be useful in assisting product issuers to establish that "reasonable steps" have been taken in the implementation of the DDOs5.
4. In the real world, disclosure can backfire in unexpected ways
The Report observes that disclosure can, in some cases, actually produce negative outcomes for customers. By way of example, the Report states that:
- research suggests that the disclosure by salespeople of a conflict of interest can actually increase the propensity for the salesperson to recommend biased choices and for the consumer to accept that advice; and
- the requirement that credit card statements include a "minimum repayment" amount to avoid penalties has been found to increase the proportion of consumers who only make that payment, thereby resulting in them paying a higher level of interest.
In reviewing the PDS and, possibly more importantly, collateral documentation and explanatory material, it will be important to consider whether any of the various elements of disclosure might have the potential to be interpreted negatively and, if so, whether other steps should be taken to minimise the risk of that happening. Using an insurance example, ASIC noted in its recent report on consumer credit insurance6 that sales staff were highlighting the cooling-off period to consumers during the sales process. The cooling off period is an important consumer right which should be clearly explained and yet, in that situation, ASIC found that the disclosure was being used to encourage consumers to purchase a product they were unsure about. It was leading to poor purchasing decisions and consumer outcomes.
5. A warning about warnings
The Report's last point is a relatively simple one; that the use of warnings in disclosure material relating to the risks and features of financial products will not always be effective. Studies carried out on warnings used in the Netherlands and the United Kingdom show that those have rarely resulted in changed behaviours. In Australia, the Report refers to the General Advice Warning as an example of one that is not well understood by consumers and to a warning relating to the costs of short-term loans as one that proved ineffective in changing behaviours.
Consumer risks associated with financial products are unlikely to be materially reduced through the inclusion of warnings in disclosure material. More substantive steps will need to be taken if those risks are to be mitigated in practice.
The central message of the Report is neatly summarised in its conclusion.
Firms that are proactive in aligning their product design, distribution and communications with consumer needs, capabilities and expectations will build customer trust and minimise regulatory costs.
The joint Report provides further useful guidance on the substantive change that is required in order to meet that expectation.