Business, Innovation & SkillsWritten evidence submitted by Payplan

Executive Summary

1. The current debt management environment results in serious consumer detriment and provides sub-optimal returns to creditors

(a)Consumers are paying fees well in excess of the reasonable costs of providing debt management services.

(b)The quality of advice actually provided to consumers is often poor.

(c)Creditors are mistrustful of the debt management sector as a whole, feel unable to distinguish between good and bad providers and as a consequence are increasingly charging interest to consumers in genuine financial difficulty to mitigate the costs of inappropriate arrangements.

2. There is an opportunity to use the Tribunals, Courts and Enforcement Act 2007 (the TCE Act), with only very limited changes, to bring about an environment in which consumers can be confident they are getting good quality advice whichever provider they use and creditors can trust the repayment proposals made to them and offer appropriate support and interest-charging concessions to consumers in genuine financial difficulty.

3. Each year consumers pay in the order of £250 million in fees to debt management companies which reduces the repayments they are able to make towards their debts. Allowing all providers access to the “fair share” model of funding debt management (and preventing them from making any additional charges to consumers) would make this a free service for consumers and increase returns to creditors by approximately £150 million per year.

Background

The extent of consumer debt problems

4. At any time up to 5 million individuals report: arrears on consumer credit; failure to keep up with their mortgage payment obligations; or that meeting their credit commitments is a “heavy burden”. Of these, only one in six seeks advice from any other source.1

5. People in debt often believe that their situation is commonplace, a normal part of life. They probably know people in similar situations.

6. Although debt is unpleasant, consumers are likely to have lived with it for years. They are reticent about moving into a new way of managing money (status quo bias) especially as they perceive that getting help may involve significant loss (house, car or even relationships).

7. They are unrealistically optimistic about their future prospects. This is probably what got them into difficulty in the first place. Even when they seek help they do not generally look for long term solutions, they are more interested in short term fixes.

About Payplan

8. Payplan is a major provider of telephone based debt advice and solutions—including “free to consumer” debt management plans funded by voluntary “fair share” contributions from the credit industry. This year we will advise over 100,000 overindebted consumers. We are a Money Advice Trust partner agency and work closely with other providers within the free sector such as Citizens Advice Bureaux and National Debtline.

Context

Why engaging with the debt management sector can currently present a high risk for consumers

9. Whilst consumers get used to living with debt many are moving quickly to a situation where intervention is inevitable. Our average client has a net household income of £2,100 per month at the point they contact us and commitments (including minimum contractual debt repayments) of £2,900 per month. They are either doing without basic essentials (food, fuel etc) or their debts are increasing by £800 per month. Put another way, each month they delay seeking advice extends their debt repayment term by three months. In hindsight most of our clients dearly wish they had called us much sooner than they actually did.

10. Because people in debt delay getting advice until they feel in crisis they look for “first aid” rather than a long term solution. They want payments reduced to affordable levels and someone to deal with their creditors. They do not generally focus on the longer term, and probably do not want to think about the many years of debt repayment that may lie ahead. For providers, addressing these immediate fears can be much more profitable than actually helping to get them out of debt.

11. A provider who gives consumers unrealistically high expectations about the speed of setting up a debt management plan (DMP), the degree of creditor co-operation and sets repayments at a level that is very comfortably affordable (because they are stretched over a long period of time) will convert a high proportion of leads to business.

12. A provider with a low conversion rate will not be able to pay as much for a lead (either to a “lead generator” or through direct marketing costs) and so will lose market share.

13. A provider with a high conversion rate is likely to be profitable even if many of their plans fail at an early stage, as they all too often do.2

14. Because of these commercial drivers there is an increasing focus amongst providers on “first aid” rather than debt resolution. In many instances, the marketing material issued by providers is targeted towards vulnerable debtors, offering instant but often unsustainable solutions. For example, phrases such as those listed below are used with little or any qualification on the websites of providers.

(a)“Debt problems? Our debt management plan helps 1000s of people get out of debt.”

(b)“We’ll talk to your lenders on your behalf, asking them to accept lower payments.”

(c)“We’ll handle all letters and phone calls from your lenders. All you do is make one monthly payment, and leave the rest to us.”

15. Providers taking this approach increase their market share at the expense of those who do not. Consumers who have a bad experience with one provider are less likely to engage with another. The result of this is that many more consumers than necessary are ending up in the Collections & Recoveries Departments, of creditors feeling that debt management is not the answer. This seriously limits opportunities and economic activity for the individuals concerned and, given the extent of consumer over-indebtedness, has a wider impact on society in general.

Free debt management and solution providers

16. The free-to-consumer advice sector has an alternative offering—a creditor-funded DMP whereby the consumer pays no fee, yet receives the same (or most likely far better) help and on-going support than that offered by fee-chargers. These arrangements tend to be much more sustainable and, because they are fee free, offer a quicker route out of debt for consumers. Fee-chargers are currently unable to access this alternative model since it requires creditor support on a provider-by-provider and creditor-by-creditor basis.

Debt management fees

17. Fees charged to consumers vary but typically a provider will charge an initial set-up fee equivalent to the first two repayments and the application of an ongoing management fee of 17.5% on further repayments. Increasingly additional charges are made for things like annual reviews and the variation of payment levels.

18. With an average DMP repayment level of £300 per month, set-up fees are likely to be in the region of £600 and year one management fees £525. By way of contrast Payplan and the Consumer Credit Counselling Service (CCCS) operate the “fair share” model under which 100% of repayments go towards debt reduction and those creditors who support us pay a percentage of funds distributed to them. Because not all creditors support Payplan and the CCCS (even though both manage debts for non-supporting creditors) fees under the fair share model in this example are likely to be as low as £288 in year one with no front-loading. Furthermore, fee-chargers have de minimis fee levels which allow them profitably to sell their services to people with low repayment levels—Payplan does not. Despite this Payplan is able to cover the costs of setting up and running DMPs on this substantially lower fee structure.

Why is the current regulatory provision insufficient?

19. Providers of DMPs must hold a consumer credit licence. They are also meant to comply with the Debt Management Guidance issued by the Office of Fair Trading (OFT), although the organisation lacks the resources proactively to monitor compliance. The OFT did, however, undertake a review of the sector in 20103 which identified widespread problems.

20. Despite this guidance being in place for over a decade and most providers belonging to a trade body established to uphold standards (the two main trade bodies are the Debt Management Standards Association—DEMSA - and the Debt Resolution Forum—DRF), the OFT issued formal warnings to 129 of the 172 firms it surveyed—informing them that they faced losing their consumer credit licences unless immediate action was taken to comply with its Debt Management Guidance. The OFT found widespread evidence that “frontline advisers working for debt management companies are lacking in competence and are providing poor advice based on inadequate information.” Since then a number of firms have surrendered their licences.

21. Restricting/controlling the marketing and operations of providers via the OFT’s Debt Management Guidance, particularly following publication of the compliance review, has helped improve transparency about fees somewhat and made advertising more balanced, although there is still little evidence that this has improved the quality of advice provided. Without adjusting the commercial drivers—particularly the front-loading of fees—Payplan does not believe that OFT intervention can have a significant effect on the path chosen by consumers and the poor outcomes that result from those choices.

22. Given the lack of resource to police adherence to its own Debt Management Guidance the OFT has encouraged self-regulation amongst companies within DEMSA and DRF membership, but it would be easy to comply fully with all existing codes of practice and still operate a model which focuses on high conversion rates at the acquisition stage and invests little in long term client support.

23. Increasing awareness of free and ethical advice has been of some help, but making the messages sufficiently compelling to overcome those put out by those providers with more questionable business models is a challenge. There is also a fear that, if that awareness-raising exercise were too successful, free-to-consumer providers would be swamped by the demand for advice and support.

Payplan’s Recommended Solution

Introduce an independent audit that everyone (consumers, creditors and Government) can trust

24. To improve initial advice—which is key to ensuring successful outcomes—Payplan considers that providers should be required to undergo a regular audit by an “approved” auditor to standards set by an independent body or committee.

25. The audit would focus particularly on whether advice was given in a balanced way (because it is very easy to steer consumers down a particular path) and whether the assessment of consumer circumstances (in particular income and outgoings) was thorough, accurate and consistent across providers. The audit would be substantially “tougher” than any of the current codes of practice which, in our view, give providers too much latitude to set up inappropriate arrangements.

26. The cost of this audit (which would be proportionate to the size and general level of compliance of the operator) should be borne by the provider. Audit findings would be sent to the OFT (or its successor) and used in determining the continuing fitness of an operator to hold a consumer credit licence.

27. An audit should have two key components:

(a)an “objective audit” linked to the OFT’s Debt Management Guidance

   This would be an audit similar to the mystery shopping template used as part of the OFT compliance review, whereby a sample of cases are closely checked against a set of debt advice process steps/criteria/indicators set out in the Debt Management Guidance. An example of such an audit in current practice is the Independent Quality Assessment of Legal Services.4

(b)a “subjective audit” linked to a new Code of Debt Management Ethics

   This would involve an auditor assessing whether a consumer has been unduly influenced through a contrived manner, tone or behaviour or as a result of the provision of inaccurate/partial information to choose or dismiss a particular solution during the advice process. The benchmarking for this type of “subjective” audit opinion will be contained in a Code of Debt Management Ethics.

28. The auditor would determine whether providers were compliant in both of these areas. If not, and the breach was capable of straightforward remedy, then a short period would be allowed for remedial action to be taken, but then the report would be sent to the OFT with providers that continue to flout the rules being individually identified on the OFT website. It would then be for the OFT to use existing enforcement powers to deal with non-compliant providers.

Appoint an independent auditor

29. The Audit Commission practice is to prescribe and publish transparent auditor policies5 that ensure effective external auditing functions for public services are available and can be procured for outsourcing purposes. Payplan considers that the OFT could adopt the same practice to facilitate the appointment of a skilled and experienced organisation to conduct the objective and subjective audits outlined above at a competitive price, eg

(a)An OFT-approved Statement of Debt Management Auditors’ Responsibilities.

(b)An OFT-approved Code of Debt Management Auditors’ Ethics.

30. These two documents would outline the essential skills requirements expected of a provider if it is to undertake an effective and independent audit. They would also define the audit and reporting scope. Audit fees would be paid for by individual providers, would be proportionate to the size of the organisation and general level of compliance and set out in a transparent fee policy.6

Control of fees charged by DMP providers

31. Consumers seeking advice are usually operating in a stressful environment and are unlikely to shop around on price,7 consequently fee levels have significantly outstripped inflation in recent years. High set-up fees make it commercially viable to establish arrangements that are almost certain to fail. Competition for leads pushes up advertising costs and allows providers who charge higher fees to grow at the expense of providers charging lower fees. A cap on fees or, ideally, a requirement to fund DMPs solely using the “fair share” model (which would be made available to all providers) would align the interests of providers, creditors and consumers as well as—ultimately - Government.

Alternative suggested by some fee-chargers - Introduce an audit process, but do not limit fees

32. Instead require better price transparency and encourage consumers to shop around on price.

33. Payplan does not believe that increased price transparency would make a significant difference. Providers already publish their fees in fairly accessible areas of their websites yet those charging them at the higher end of the range continue to expand their market share. Although some consumers shop on price, most do not—and so advertising expenditure would need to remain high in order to retain market share.

34. There would still be a commercial incentive to charge set-up fees to as many people as possible rather than invest in high levels of support for existing clients. By contrast, an environment where it was profitable only to set up arrangements which worked over the longer term would align provider interests much more closely with those of consumers and their creditors.

35. Almost the worst case scenario would be to require providers to undergo an independent audit against one of the current self-regulatory industry codes of practice. This would simply give greater legitimacy to providers, whilst doing little to address concerns around the conflict between commercial incentive and best advice, and very probably result in increased fees as audit costs were simply passed on to consumers.

Introduce certainty of repayment term

36. Although creditors do not generally have confidence in the repayment proposals made by many providers it is not commercially feasible to challenge individual plans that are being proposed as they lack evidence to counter the information presented to them. Consequently creditors feel compelled to accept proposals but increasingly charge consumers interest on their debts.

37. Payplan is of the view that if creditors had confidence that providers were giving suitable advice, only allowing consumers who were in genuine financial difficulty access to DMPs, and setting repayment rates at an appropriate level, they would be far more willing to suspend interest charges and any enforcement action being considered. This would give consumers some certainty about their repayment term and incentivise them to maintain payments into their DMPs over the whole of the repayment term. Creditors would then have reduced collection costs and faster debt repayment. Creditor support for this policy could be voluntary (for example by incorporating it within The Lending Code) or mandatory (perhaps by making this a condition of their consumer credit licence).

Stakeholder benefits

38. Were these three interlinked strands adopted, consumers could approach any provider and have confidence that they were receiving balanced advice and good quality solutions, confident that they were not risking being ripped off through the charging of excessive fees.

39. Competition would stop being about advertising expenditure and the inevitable link to set-up fee levels (often precisely to fund such marketing) and start being about quality of service. The companies that thrived under this regime would be those able to offer good service levels throughout the life of the arrangement rather than those whose objective was simply to entice consumers into DMPs that had no realistic prospect of long term success.

40. DMPs would be much more likely to lead to debt repayment than at present, genuinely resolving debt problems for the majority of consumers who entered them. This would be achieved at far lower cost than under the present regime and significantly increase the speed at which creditors were repaid.

41. It might be worth noting that this scheme only works if it is commercially viable for those fee-chargers who want to provide a good service at a reasonable cost without set-up fees to make the transition from the current free-for-all high fee environment to a more socially responsible one. It would be important therefore to have a managed transition, perhaps by phasing in new fee structures over a period of time.

Mechanism for Bringing About Change

Analysis of deficiencies

42. From the above discussion, it will be apparent that the principal weaknesses in the present arrangements are as follows:

(a)The targeting of vulnerable consumers who may often be unaware of the alternative forms of free to debtor advice which may be available.

(b)The levels of fees charged and the manner of charging them.

(c)Ensuring compliance by providers with the OFT’s Debt Management Guidance.

Regulatory Structure

43. In addition to the Regulation of DMP providers under the Consumer Credit Licensing Regime, there exists also Part 5 (“Debt management and relief”) of the TCE Act. Part 5 provides for the setting up of a regulatory regime in respect of DMPs. Certain broad principles are set forth in the Act itself, but the detail is to be filled in by way of Regulations. In particular, section 113(1) of the Act provides for a debt management scheme to have effect subject to “relevant terms” which are defined in section 113(2) as including (a) terms (if any) specified in Regulations that relate to the approval. Such terms may be imposed upon the scheme operator (section 113(4)). The Minister responsible for the making of Regulations is the Lord Chancellor (Section 130 (1) of TCE Act).

44. In terms of section 129, the Supervising Authority is the Lord Chancellor or any person authorised by him to approve debt management schemes under section 111. As Part 5 is not yet in force, no such appointment has yet been made. However, under the Consumer Credit Act 1974, debt management companies are currently licensed (and thus supervised, albeit fairly loosely) by the OFT, and since the Office has developed expertise in this area, it may well be that it would be appropriate to appoint the body to continue acting as the supervising authority under Part 5 of the TCE Act.

45. This opens up the possibility of regulations being made under section 130 having the purpose of imposing mandatory requirements upon operators that would need to be met to the satisfaction of the OFT before a scheme could be approved.

46. Although the Bill that became the TCE Act received Royal Assent on 9 July 2007, no Commencement Order has yet been made in respect of Part 5, and, consequently, no Regulations have been promulgated under it to date.

47. Were a commencement order now to be made, that would permit the making of appropriate regulations. How such a mandatory regulatory scheme might work can be seen in the analogous provisions of Part 1 (“The debt arrangement scheme”) of the Debt Arrangement and Attachment (Scotland) Act 2002, and the current Regulations made thereunder, namely, the Debt Arrangement Scheme (Scotland) Regulations 2011 [Scottish Statutory Instrument 2011 No. 141].

48. Alternatively, were Part 5 of the TCE Act not to be brought into force, then it might be possible to go some way towards addressing the issues by way of the introduction of updated Debt Management Guidance, published by the Office of Fair Trading pursuant to its powers under section 25A of the Consumer Credit Act 1974 (“the CCA”). In the event that the DMP provider proposed to operate its business in a manner inconsistent with that guidance, it would be a basis for the OFT determining under section 25 of the CCA that it was not a fit and proper person to hold a licence. In the event that the operator failed to follow the Guidance that would justify the OFT being minded to withdraw their consumer credit licence.

49. Indeed, even in the case of implementation of Part 5 of the TCE Act, there may be scope to consider whether it would be more appropriate to make certain requirements mandatory as part of the regulatory regime under that statute, whilst others were made the subject of amended Debt Management Guidance issued under the CCA.

50. Whichever regulatory route were taken, it would, however, be necessary to make one minor amendment to the primary legislation, (Part 5 of the TCE Act) to enable the proposals contained in this submission to be implemented, as explained below. Subject to this one minor amendment, Part 5 the TCE Act (if implemented) would enable the creation of a framework by means of the projected Regulations and amended Debt Management Guidance, under which the three deficiencies outlined at the head of this section could be addressed.

Fee-Charging Models

51. As currently drafted, section 124(1) of the TCE Act provides

(a)“The operator of an approved scheme may recover its costs by charging debtors or affected creditors (or both).”

52. and Section 124(2) provides:

(a)“costs means the costs which the operator incurs, taking one year with another, in connection with the approved scheme, so far as those costs are reasonable”

53. It will be seen that this would permit charging models in which costs are recovered from either the debtor or the creditor, but it is understood that there is some ambiguity over the use of the word “costs”, in particular whether that permits the making of charges which include a reasonable level of profit or whether it is limited to recovery of actual costs excluding any element of profit. Although there is a charitable sector, it is very small and unlikely to be able to cope as the sole providers of DMPs and there is clearly a market need for the fairshare model.

54. In these circumstances, the sole amendment which Payplan would suggest to the primary (though as yet unimplemented) legislation would be to clarify the provisions relating to costs in the following manner:

(a)Section 124(1) should be amended to provide:

(b)“The operator of an approved scheme may recover its charges by charging debtors or affected creditors (or both).”

(c)and section 124(2) should be amended to provide:

(d)“charges means the costs which the operator incurs, taking one year with another, in connection with the approved scheme, along with any charges made by the operator, so far as those costs and charges are reasonable.”

55. The Financial Services Bill or perhaps some other draft primary legislation emanating from the Department for Business, Innovation & Skills might conveniently provide the legislative vehicle through which the minor changes to section 124 of the TCE Act proposed above could be effected.

56. If the route of amending the TCE Act were taken, the Regulations made under it so far as they related to charges and costs could simply provide:-

(a)“Charges by approved operators

(a)An approved operator shall not impose charges by way of costs to the debtor and/or affected creditor under section 124(1) of the Act which are greater than either:

(1)[]% of the relevant debt; or

(2)£[], whichever is the smaller.”

57. Alternatively, the Regulations could make provision for specific fees and charges according to a table of fees set out in a Schedule to the Regulations. This would allow them to be varied periodically to account for changes in the cost of providing debt management services.

Audit Requirements

58. The ultimate guarantee of effectiveness of these proposed reforms is the introduction of an audit regime as discussed earlier in this submission/ It may be possible for such auditing requirements to be mandated by regulations made under the TCE Act via section 113 (5) and Schedule 21 paragraph (1) (b) thereto, which permits second legislation to be made concerning the governance of the scheme operator. It may, however, be that this aspect of regulation would fit more comfortably within revised Debt Management Guidance issued under the CCA.

Conclusion

59. There is presented at this time a real opportunity to improve the activities undertaken by debt management companies and to ensure a consistent standard of service for consumers is achieved. In particular, there also exists scope to address the abuses which have been identified, including by taking steps to ensure that only reasonable fees are charged by debt management companies.

60. If it is intended to bring Part 5 of the TCE Act into force, then (subject to the minor amendments to section 124 outlined previously), these significant improvements could be achieved for consumers within the minimum regulatory regime that would be necessitated as a result of bringing Part 5 into force. Alternatively, similar results could also be achieved without any significant undue regulatory burden by means of revising the Debt Management Guidance issued under the CCA.

14 November 2011