In the late 80s and early 90s, hundreds of thousands of people were sold pension plans which were unsuited to their needs.
Last November, a survey by the PIA found that as many as one in three long-term pensions contracts are being surrendered within three years of their purchase, suggesting that a large proportion of recent sales of pension plans are also unsuitable to their buyers' needs.
In addition, the performance tables published in the trade press show clearly that there are still many companies selling products which, although they may not be unsuitable, offer very poor value to their customers.
Thus, nearly 10 years after the Financial Services Act 1986 came into effect, it seems clear that the regulatory system set up under it has not succeeded in improving the lot of consumers of retail financial products or in helping the good providers to drive out the bad providers.
What were the reasons for this and is the newly established Financial Services Authority, which is expected to replace the present regulators in 1999, likely to be more successful?
The lack of success of the present regulatory system was not due to deficiencies either of regulatory organisations or of personnel. The senior staff of most of the regulatory bodies and the conflicts within and between then have not helped – but they have not been an overwhelming handicap.
The real weakness was rather the fundamental principle of the system. This system was based on the belief that consumers could be protected by prescriptive regulation. Rulebooks were drafted by lawyers with little understanding of how markets work.
Companies and selling agents were obliged to offer best advice – it was assumed that best advice could be defined. In pursuit of this mirage, more and more detailed information was required to be collected from consumers and ever more complicated rules were devised for salesmen to follow.
The possibility that rogues would cheerfully tick boxes while honest men could get confused was overlooked.
The new FSA may recognise that experience over the last 10 years suggests very strongly that consumer protection by means of prescriptive regulation is unlikely to be successful.
Its prospectus, published at the end of October 1997, is not, however, entirely encouraging,. It states that the FSA's three "high-level aims" are to protect consumers of financial services, promote clean and orderly markets and maintain confidence in the financial system. The promotion of competition is not specifically included in its list of objectives.
The absence of such an objective is in stark contrast to the legislation for privatising utilities which placed a statutory duty to promote compe tition on the regulators of telecoms, gas and electricity.
The thinking behind this legislation was presumably that competition is the best way of ensuring that the consumers' interests are protected and that regulation should be limited to correcting market imperfections and failures but that, in the short to medium term, the dominant positions of the incumbents in the utilities markets require statutory regulation to curb their market power.
The hope, which shows some encouraging signs of being realised in big parts of the telecoms, gas and electricity markets, was that, in the long run, the need for statu-tory regulation would disappear and that consumers' interests would be adequately pro tected by competition between suppliers and general fair trading and competition law.
It is unlikely that current financial services regulators have a fundamentally different view about the power of market forces to keep suppliers honest. A more likely explanation of their apparently different approach is that they believe that the retail financial services market is already competitive but that, because of the specifics of its products, for example, the difficulty of judging quality and the infrequency of repeat purchases, competition has not in practice produced the normally expected results.
In fact, competition has not produced these results because it has been ineffective. The ineffective competition, which characterised the industry certainly until the early 90s and is still present, is reflected in weak price competition and unnecessary complication of contract terms, competition on peripheral issues such as selling methods and orientation to selling agents rather than customers.
This culture of obfuscation rather than transparency reinforces the already high barriers to exit in the industry and helps suppliers to survive rather than, in better functioning markets, being forced out. In the last five years, the entry of new competitors, for example,direct sellers and retailers, and more concentration on price and quality by a few incumbents, has strengthened effective competition. There is, however, still a long way to go.
Effective competition occurs when suppliers compete with each other on price and product quality – underperforming companies are driven out of the market.
Effective competition is likely to be a much better way of promoting integrity in the industry than any number of rules about how the sales process should be conducted or about training and competence.
Effective competition should lead most financial services businesses to recognise that integrity is important to their success.
A reputation for trustworthiness is a competitive asset in the personal investment market. A trustworthy company has its own internal discipline and standards. The danger of regulation by procedural rules is that it can generate the opposite kind of culture. "If we can get away with it" replaces "Our reputation is at stake". It externalises the discipline, laying off the task of being honest to an outside inspector.
In retail financial services in the UK at the present time, the best way to promote effective competition is by improving the quality of information available to consumers by helping them to understand it
The regulatory changes introduced in 1995, mainly as a result of pressure from the Office of Fair Trading, which brought the compulsory disclosure of information about charges, lapse rates and commission, were a belated step in the right direction.
The disclosure of independently measured investment returns for individual companies and the profitability of new business would be more useful additions.
However, information which is more understandable is needed even more than additional information. The amount and the complexity of the information which a consumer needs to make an informed choice in the pension market is now so great that the ordinary person cannot expect to be competent to understand it.
Perhaps the simplest way of improving the quality of information available to consumers is the establishment of a ratings' agency – a cross between Standard and Poor's and Which? – that will perform for the individual the fun ction of interpretation which is performed for investors in the bond market by ratings' agencies.
This agency should be capable of giving consumers an objective assessment of the overall performance of companies and the quality of their contracts. It should indicate best buys as well as companies whose products should be avoided.
The need to improve the quality of information is made more compelling by the Government's plans for stakeholder pensions, contracts which will be delivered without advice but which are directed to a segment of the population which is urgently in need of advice.
If the Government proceeds with the proposals outlined in its consultation docu ment of November 19, those on low incomes will face a daunting patchwork of collective membership and partnership schemes from which to choose.
In these circumstances, the interpretative function of a ratings' agency will be even more necessary.
Although any ratings' agency should, ideally, be independent of the Government, the regulators and the industry, the new FSA could play an important role in encouraging its formation. By bringing about the disclosure of more information by suppliers, notably about investment performance and profitability of new business, they would enable ratings' agencies' judge-ments to be better informed.
Consumers are likely to benefit greatly if, in the coming months before it takes up its regulatory responsibilities, the FSA decides to give much higher priority to the promotion of effective com petition and if the OFT helps it in this task.