Financial Regulation

Supplementary written evidence submitted by the Financial Ombudsman Service

1. Natalie Ceeney, Chief Executive and Chief Ombudsman at the Financial Ombudsman Service, and Tony Boorman, Principal Ombudsman and Decisions Director at the service, appeared before the Committee on Thursday 14 October 2010. At that session, the Committee asked for supplementary information in four areas:

a) the compliance costs for industry of handling complaints;

b) the relationship between the number of consumer enquiries received and the number of full-blown cases investigated, and our views on whether consumers should be charged a fee for using the service;

c) a breakdown of where in the United Kingdom cases come from, with data on the service’s accessibility for different groups, and

d) a view from the ombudsman service on the regulatory landscape and, in particular, the regulatory powers that the CPMA should have.

2. This supplementary memorandum provides further information on those four areas.

Complaint handling compliance costs

3. The direct costs of the Financial Ombudsman Service are forecast to be £110m in the current year.  These costs are paid entirely by the financial services industry in the form of a levy and a case fee.  In 2010/11 the levy paid by firms amounts to £18m (which is equivalent to less than 3% of the total levy raised by the FSA to cover their costs and those of the FSCS, CFEB as well as our own).  The case fee in the current year is £500 per case, and the first three cases a year for each financial business are free.  In the previous financial year more than 95 per cent of FSA regulated firms paid no case fees at all.

4. But, of course, these figures give a misleading impression of the total cost to the industry of handling complaints:

· Only a small proportion of complaints made to firms ever come to the ombudsman service.  FSA figures show that firms received 4,344,109 complaints in the year to 30 June 2010. The number of cases received by the ombudsman service was under 4% of this number – 163,012 in the last financial year.

· In around half the cases we investigate we award redress to the consumer which may range from a modest amount up to (in a few cases) the maximum of £100,000 that we have power to award – although the majority of awards are at the lower end of that spectrum.

· If they are doing their job properly, firms should take account of ombudsman decisions in previous cases when dealing with other complaints they receive, so ombudsman decisions may have an impact on many other cases which never get us far as the ombudsman service.

5. However, it would be wrong to regard the cost to the industry of handling complaints, whether they come to us or not, as "compliance" costs - as if they were something imposed on them from outside.  A proportion of complaints are, of course, vexatious.  But many complaints refer to things the firm should never have been doing in the first place, either because it was in conflict with the financial business’s legal or regulatory responsibilities or because it was against any basic principle of customer service. The redress we award is usually intended simply to put the customer back in the position they should have been in the first place.

6. The rules about how firms handle complaints from consumers, and the wider handbook of rules and regulatory requirements, are determined by the FSA. Those rules are set by the FSA following consultation and cost benefit analysis. Our own responsibilities under the Financial Services and Markets Act are focused on resolving promptly and with a minimum of formality those individual complaints that are referred to us by consumers. In this evidence, however, we have looked across the whole system, working from the basis of our own experience in resolving individual complaints.

7. A critical part of our work is feeding back to regulators, firms and customer groups the experience we have gathered from complaints about how problems can occur in financial services and how complaints can be handled fairly. We work closely with firms and customer representatives to ensure that our decisions have the intended impact and that there is an opportunity for similar problems to be avoided in future. This does give us some influence over the total costs of complaint handling, and an opportunity to help firms to reduce overall costs, and the industry improve overall customer satisfaction.

8. The following paragraphs look at the six main drivers of the cost of complaint handling for firms in more detail, together with the steps we are taking to help eradicate unnecessary costs.

Cost driver 1: How well is the underlying business managed?

9. As noted above, complaints are an indication that something has gone wrong in the firm. Data recently published by the FSA has shown that the volume of complaints varies significantly from firm to firm in a way that is not readily explained simply by the relative scale of the businesses concerned. In our experience, well managed firms that focus on responding to the needs of their customers experience few complaints. In contrast, where a firm generates large volumes of complaints, there are normally underlying problems with the way in which its customer functions and/or products have been managed.

10. While it might seem obvious to most that poor management of a firm costs that firm money, it is disappointing that some firms see complaints as an unwelcome business cost rather than an indicator of where business improvement is needed. It would be wrong, therefore, to see the costs of complaint handling within firms as a ‘compliance burden’ – it has to be seen as part of the customer service cost of running an effective organisation, and a potential differentiator of good service.

Cost driver 2: How do firms treat complaints?

11. The Financial Ombudsman Service sees a wide variation in the way financial services firms treat complaints. Some see complaints as an ‘insight’ that indicates areas for business improvement and provides an opportunity to engage positively with their customers. Others see complaints as a regulatory compliance cost. However, the evidence shows that good complaint-handling pays dividends for businesses. The TARP (Technical Assistance Research Project), for example, found that customers who complain and who are subsequently satisfied are 8% more loyal than if they had no problem at all. So the costs of effective complaint handling may actually produce a positive return for firms.

12. We work with firms of all sizes across the financial services sector to help get this message across, and we also publish data to show firms the differences between good and poor levels of complaints referred to us. Positively, we are already seeing firms changing their practice to deal with complaints more swiftly, which not only lowers their costs, but is far more likely to retain the loyalty of that customer.

Cost driver 3: Customer reactions and claims management companies

13. Of course, complaining is about the reaction of a customer to the actions of the firm. In our experience, most customers try to avoid complaining. Indeed raising a "formal complaint" against a large financial institution can be a daunting experience even for the most capable of customers. One of our key objectives is to ensure that our service is accessible to all customers that need it. But, of course, there are a small minority of customers who raise vexatious disputes. The ombudsman service dismisses these promptly. Similarly, we have a front-line contact centre which is expected to deal with around one million customer contacts this year, which allows us to give many consumers the information that they need on the phone, without needing to take their issue further into a formal complaint. Our goal is to only take on cases where there is a genuine dispute to be resolved.

14. The past decade has seen the growth of claims management companies (CMCs) – businesses who take on complaints for customers in exchange for a fee paid by the customer. The service we provide is informal and accessible, designed to ensure that consumers do not actually need assistance from third parties, such as CMCs. CMCs can drive perceptions of a "compensation culture", encourage vexatious or unnecessary complaints, and add unnecessarily to the costs of both customers and firms by the antagonistic way in which some pursue complaints. But CMCs can also provide a helpful service for some customers who feel unable (perhaps because of time constraints, or lack of confidence) to raise a complaint against a financial firm. And CMCs, through their marketing, can help draw customers’ attention to cases of widespread detriment and customer concern.

15. There is clear concern within the financial services industry that CMCs are adding to the total cost of complaint handling across the sector. Our view, from seeing the CMCs at close hand, is that, like any industry, there are good companies and poor companies in the sector. Poor CMCs are bringing the good ones into disrepute. Regulation of the CMCs is the responsibility of the Ministry of Justice, not of the Financial Ombudsman Service or the FSA. We believe that stronger and more effective regulation of the CMC sector would both reduce the total compliance costs and improve the experience for firms and consumers alike.

Cost Driver 4: the rules and requirements surrounding complaint handing

16. While complaints are an inevitability in any industry, every industry structures the rules for handling complaints differently. In the financial services sector, there is a formal approach, codified in the dispute resolution (DISP) section of the FSA Handbook, for the way in which firms need to handle complaints. The responsibility for making the complaint-handling rules and overseeing how firms operate them is that of the FSA.

17. Our view is that the financial services sector does appear to have become overly ‘rule bound’. This is not just a regulatory issue though – we see cases where the firm will argue to us that ‘the rules didn’t say that I couldn’t do X’. But sometimes X is clearly against the general law which applies alike to regulated firms and unregulated businesses, and often X is clearly against any basic principle of customer service. In the supermarket sector, for example, it would be considered ludicrous if Sir Terry Leahy considered it a regulatory burden that his staff had to deal with complaints that say his company’s meat products kept going off, or if he were to question ‘where in the rules does it say meat needs to stay fresh?’. He would of course do the reverse – fix the products, and do so without the need for regulatory intervention.

18. Inevitably, the rules-based culture endemic in the sector does create costs for all concerned. It allows poor customer service to be tolerated, where ‘compliance’ and ‘rules’ overtake common sense. Moving away from this culture requires a different mindset across the whole sector. If this shift could be made, it would both reduce costs and improve customer service.

Cost Driver 5: Costs of dealing with the Financial Ombudsman Service

19. Under the rules set by the FSA, financial firms have up to eight weeks to resolve their customer’s complaint. Only if a firm has issued its final decision on a complaint (or has failed to do so within eight weeks) and the customer refers the matter to us, can the ombudsman service consider a complaint. So firms have an adequate opportunity to resolve matters without the need for the ombudsman to be involved.

20. There are two ways in which firms could reduce the number of complaints that come onto the ombudsman service. First, some firms – including some large groups (as our published data shows) – could change their practice whereby they reject significant numbers of cases that they know or should know the ombudsman service will uphold, presumably hoping that some consumers will just give up. Second, many firms are poor at explaining things – so that, in many of the cases where we do not uphold the complaint, it is only when the consumers get to the ombudsman service that they receive a clear explanation of why their complaint is misconceived.

21. If a complaint is referred to the ombudsman service the firm will, of course, incur some additional administrative costs. First, it will normally incur a case fee of £500 if it has already had three cases with the ombudsman service that year (the first three cases being free). In our last financial year, more than 95% of FSA-regulated firms paid no case fees to the ombudsman service at all. More than half of all the case fees were paid by just four of the UK’s largest financial groups.

22. Second, the firm may incur some additional administrative costs of its own as a result of the need to respond to our investigations. But generally those costs should not be significant for a firm that has already complied with the FSA’s requirement for it to carry out an adequate investigation of a complaint when it is first referred to the firm. Where the firm has done what FSA requires, it should usually have the information we need on hand in its complaint file.

23. Our costs are significantly lower than the costs of using the civil courts – as we explained in our evidence before the Committee. Importantly, we don’t require lawyers to represent either consumers or firms, which reduces the total cost to firms compared to working with the courts. We do, particularly with smaller firms who are unused to using the ombudsman service, sometimes see firms expecting to engage with us in a very legalistic way, which incurs costs for the firm concerned. We are working across industry, and particularly with trade associations, to stress that firms do not need to do this, so that we can reduce their costs of engaging with us.

24. Sometimes, however, the firm’s perception of the costs it needs to incur in handling complaints fairly is based on misapprehensions about the actual approach that the ombudsman service takes. Certain myths seem to persist and can shape perceptions of "compliance costs". For example, whilst it is not helpful if firms no longer have records of transactions, this is far from necessarily fatal to their ability to defend complaints about those sales.

25. We recognise that false perceptions of requirements can be a significant issue in shaping business costs. We therefore take considerable care to explain our decisions and "bust myths". We do this, for example, through our on-line technical resource which clarifies and illustrates our approach to the various types of complaint that we see most frequently (see: http://www.financial-ombudsman.org.uk/publications/technical.htm ).

26. We acknowledge that the control of our direct costs is important for both firms and consumers. That is why we are mid way through an internal cost reduction programme and, among other things, why we have commissioned a value-for-money review by the National Audit Office.

Cost driver 6: Cost of redress

27. In around half of the cases we investigate, we award redress to the consumer, which may range from a modest amount up to (in a few cases) the maximum of £100,000 that we have power to award. The majority of awards are at the lower end of that spectrum – in PPI cases, for example, the average award is around £2,500. It is important to note that our awards are invariably intended simply to put the customer back into the position they would have been in but for the error by the financial firm. We do not "fine" or penalise financial firms, rather our awards are restorative.

28. A common concern we encounter from industry is that of ‘back book liability’ from a single ombudsman service decision. In short, firms can become concerned that a single ombudsman service decision will require them to review all of their sales practice or product in an area, with potentially significant costs. It is certainly true that, on occasion, we encounter cases which all stem from a single underlying issue – and where it would be sensible practice for the firm to learn from it, and apply the lessons from our decisions more widely. Typically this occurs in cases of systemic failure – as with mortgage endowments and PPI – where the regulator is normally heavily involved. So costs here might more accurately be seen as responding to such systemic failures and not around the cost of ombudsman decisions. But whilst they receive a great deal of attention, such circumstances are relatively rare. In the majority of cases, we are simply looking at the individual circumstances of the case, and our findings will have no bearing on the next case. We are working with trade associations and firms to explain this clearly as we believe it will help firms to reduce their concerns over the costs of redress.

What we are doing to help reduce the total cost burden

29. Since the ombudsman service was established, we have actively shared our knowledge and experience with the outside world - to help consumers and firms settle disputes without the need for our involvement, and to try to help prevent the need for complaints in the first place. Enhancing the transparency of our work can only assist firms and customers better understand the reality of what we do – and hence reduce the need for cases to be referred to us. As we said at the committee hearing, we believe that more transparency will help firms and consumers alike do even more to reduce complaint volumes, and to learn from the underlying issues – all of which will reduce costs.

30. We publish data about the volume and outcome of cases both by product type and by major firm. In addition to the on-line technical resource mentioned above our technical helpdesk handled over 16,000 queries last year in an effort to assist firms and customer advisors resolve cases without our formal involvement. We describe our general approach to topical and emerging issues through our ombudsman news publication, and by talking to individual firms and trade associations at meetings and seminars on a range of complaint related topics.

31. In respect of our own costs and plans we consult each year with key stakeholders about our plan and budget – describing our plans for the year and the costs that this will impose on firms. As mentioned above, we are actively looking at ways to reduce our costs and to improve our efficiency, and we have commissioned an external value-for-money study by the National Audit Office in order to provide assurance that our service is delivered efficiently and effectively.

Consumer fees and access

32. The Committee asked about the relationship between the number of consumer enquiries we receive and the number of full-blown cases we investigate, in the context of whether consumers should be charged a fee for using the service, together with a breakdown of where in the United Kingdom cases come from, with data on the service’s accessibility for different groups. The Annex to this memorandum gives the statistical evidence requested, using data that is found in our Annual Review for 2009/10.

Accessibility

33. The data in the Annex shows that the consumers who used the ombudsman service in 2009/10 broadly reflected the distribution of the population across the UK, the proportion from minority ethnic backgrounds and the proportion with some form of disability. It also showed a steady socio-economic shift in consumers using the service, with a higher proportion now coming from semi-skilled or skilled (rather than professional or managerial) backgrounds. The data also showed that the age profile of users broadly reflected the ownership of financial products across the population. The Annex also explains how the number of complaints received by firms translates into the number of enquiries, investigations and ombudsman decisions that we handle – showing that the complaints we handle is a very small proportion of those that firms handle.

Free access for consumers

34. We believe that there is a strong case for continuing to provide free access to the ombudsman service for consumers. Accessibility to the service is fundamental to the objective of building confidence in the financial services sector. Requiring consumers to pay an up-front fee for using the service would be unlikely to deter the small number of vexatious consumers that approach the service (whose complaints we summarily dismiss in any case), but would instead be likely to deter consumers with financial hardship with more meritorious complaints.

35. In our experience, the charging structure that the ombudsman service has for many years adopted (primarily a case fee payable for the fourth and each subsequent case referred in relation to the financial firm and a levy payable by all firms by reference to size), has been generally supported by financial firms as a practical and fair means of recovering the service’s costs. It is worth noting that the voluntary ombudsman schemes established by the banking and insurance industries before the Financial Ombudsman Service was set up adopted very similar fee structures and did not make any charge to consumers.

36. The suggestion of a fee or deposit payable by customers is made from time to time by some commentators – who suggest that it would deter vexatious or unnecessary complaints. We doubt that in practice this would be the impact. In our experience the determined complainant is unlikely to be deterred by a fee (after all far larger fees do not avoid vexatious litigants appearing in the courts). And the administration of small fees or deposits could add significantly to ombudsman service overheads. But, more significantly, a fee would detract from the assurance that the ombudsman service provides that if things go wrong there is an independent, accessible, impartial service that is free to customers and available to resolve complaints. It is a significant part of the recognition criteria adopted by the British and Irish Ombudsman Association that "those complaining to the Ombudsman should be entitled to do so free of charge".

37. In the particular circumstances of the financial services sector, consumer fees are likely to be a significant barrier for many consumers with meritorious cases, particularly those who are in financial hardship. Equally, just because some consumers pursue their complaint in an unfocused way that may seem unreasonable to a firm does not mean that the case has no merit - or that the complaint should be categorised as "vexatious". In fact, in 2009/10 we concluded that only 0.4% of our total caseload could be categorised in that way.

Mass Failings and regulatory powers

38. Inevitably many of the perceptions of the impact of the work of the ombudsman service have been set against the background of mass failings – complaint issues like mortgage endowments, splits and PPI. In these cases large volumes of complaints were made but regulatory solutions were, for whatever reason, slow to emerge. In such circumstances the ombudsman service has needed to continue to make decisions on complaints – decisions that some have seen as filling a regulatory vacuum. The absence of clear and effective mechanisms for regulators to handle these mass failings has led to particular pressures on the ombudsman service over the past decade.

39. So, in our view, a critical component of the regulatory structure going forward is that there are clear mechanisms for dealing with such cases in future. That would mean not only ensuring that the new regulator has an effective power to address ‘back book’ issues (similar to the new-style s404 enacted in the Financial Services Act 2010), but also a wider armoury that delivers effective deterrence and credible redress promptly.

40. There is, of course, a wider public policy debate about the appropriate weight of the various checks and balances FSMA puts in place over regulatory decision making. But, from our perspective, the present system has been too slow to respond to developing pressures and has in consequence too often left the ombudsman service as the sole means of safeguarding customers when more concerted action on redress would have been appropriate. If those powers are not in place within the reformed system then the ombudsman service will need to continue to fill a policy and regulatory vacuum by resolving thousands of individual complaints on the basis of what is fair and reasonable in all the circumstances of the case.

41. The ombudsman service will continue to play an important role in this new architecture. Our ability to respond rapidly and fairly on individual complaints is a critical safeguard for customers – regardless of any wider background to their case. However, we recognise the wider benefits that can be achieved for all parties from broadly based regulatory settlements in areas of mass claims. The ombudsman service has been supportive of the new powers that the regulator has been given (Section 404) to enable the ombudsman service to be positioned clearly in line with a regulatory decision on general redress. And we continue to work with the regulator and others to find solutions to systemic issues. But we would urge the Committee to resist any approaches that suggest that the ombudsman service automatically ‘put on hold’ cases when there are in the view of some parties wider issues that should be explored. If the ombudsman service were required to put case handling ‘on hold’ whilst systemic issues were investigated by regulators, the service would be paralysed across significant parts of its workload. The result would be significant consumer detriment. The answer to the issue of how we deal with systemic issues is for us to improve the regulatory architecture to enable swifter action, not to paralyse the body which is dealing with the consumer detriment in the meantime.

42. As we contended earlier, this set of regulatory powers should not be a regulatory armoury built around the need for an extensive rule-book. That simply encourages a "tick-box" compliance approach by many firms, and leads some firms to see treating customers fairly as a compliance issue rather than simple good business sense as in many other sectors of the economy. In our view, the regulator’s armoury would be more effective if it were instead one which recognised that transparency can be a more powerful tool than traditional rules-based regulation – where both the successes and failings of firms are "out there" for all to see, and where both the regulator and ombudsman service can support good business behaviour by being given, and using, powers to be more open about things that they see.

43. Consistent with this, we continue to believe that the existence of an independent ombudsman service at arm’s length from the regulator is an important way of ensuring proportionate and risk-based regulation. The regulator will be better able to focus on the key risks to consumers as long as there is an ombudsman service in the background that is capable of resolving the day-to-day disputes between firms and consumers that arise. To that extent the ombudsman service can, without itself being a regulator, provide an effective "nudge" towards fair and reasonable behaviour by firms without the attendant compliance costs

ANNEX

The following tables give a breakdown of where the consumers who use the Financial Ombudsman Service come from and what groups they belong to, and give a breakdown of the outcomes of the inquiries that the service receives.

Overview of cases received and resolved by the Financial Ombudsman Service

Data published by the FSA show that financial firms received 4,344,109 complaints in the year to 30 June 2010 – and these numbers do not include complaints which the firm is able to resolve by close of business on the next business day. The ombudsman service’s processes are designed around the principle of "subsidiarity", whereby a complaint should best be resolved at the most local possible level – preferably by the firm itself direct with the consumer. For the small minority of complaints that ultimately reach the ombudsman service, we first "triage" them to see if they can be resolved quickly and without our formal involvement – or if they can be dismissed straight away as vexatious. This means that only around one is six of these enquiries need to be dealt with formally by the ombudsman service – using mediation, recommended settlements and adjudications as appropriate. And of those, only 6.5% in 2009/10 were "appealed" by either party to the final stage of our dispute-resolution process – a decision by an ombudsman.

Where do consumers live who complain to us?

The location of people using the ombudsman service continues to broadly reflect the spread of the population across the UK as a whole – although a proportionately higher number of people from Wales and London used the service and fewer complaints came from Scotland and Yorkshire. There was generally a similar pattern of complaints across all areas of the UK, although a higher proportion of complaints from the North related to PPI than in the South.

What was the socio-economic background of consumers who complained to the ombudsman service in 2009/10?

There has been a steady socio-economic shift in the consumers using the ombudsman service. Over the last three years, the proportion of complaints from skilled and semi-skilled workers has risen by 21%, while those from professional and managerial backgrounds have decreased by 23%. We have seen a significant increase in complaints involving current accounts, overdrafts, credit and PPI – products which are held by a wide socio-economic range of consumers. Almost two thirds of complaints to the ombudsman service about PPI were from consumers in socio-economic groups C1 and C2.

Breakdown of the 14% of consumers whose disputes we settled in 2009/10 that have told us they have some form of disability

Being accessible is something the ombudsman service takes very seriously. A person’s background or ability should not act as a barrier to having their complaint considered fairly and impartially. The 14% of consumers that told us that they have some form of disability is in line with estimated number of disabled people in the UK. Many of our disabled users do not ask for – or require – any adjustment in the way we deal with their case. But we ask all users when they first contact us whether they would like us to adapt the way we communicate with them, to meet any particular needs they may have. This might include providing information in, for example, Braille, large print, sign language recorded on DVD, or using Text Relay.

Ethnicity of our website users in 2009/10

The proportion of people who brought complaints to the service and who defined themselves as belonging to a non-white ethnic group broadly reflected the figure for the population as a whole. However, our research shows that consumers from minority ethnic backgrounds are generally less likely to know about the ombudsman service, although this varies significantly between different communities. We have therefore focussed our outreach activity to reflect this, for example through our long-term relationships with ZEE magazine and Black History Month. We have also worked with the traveller and gypsy community, following complaints about the way in which firms require proof of address and identity. We have also seen similar issues in our work with the migrant worker community.

What age were consumers who complained to the ombudsman in 2009/10?

Two thirds of consumers who use the service are between the age of 35 and 65. Around half the UK population is between these ages. This "over-representation" of people in the middle age brackets reflects the fact that they are more likely to own a wider range of financial products – and are also more likely to know about their consumer rights, including their right to complain to the ombudsman service. However, almost a quarter of complaints during the year about investments were brought by consumers over 65. And consumers under 25 were proportionately up to three times more likely to complain to us about car or motorbike insurance compared with all other age groups.