KY(V)C: Know your (vulnerable) customers
The treatment of vulnerable customers has long been high on the Financial Conduct Authority’s (FCA’s) agenda, but the issue will come even more sharply under the spotlight in the months ahead. The regulator has announced a review of how firms are handling customers at risk of financial harm.[1]
Vulnerability may sound like a simple concept, but it covers a wide range of characteristics. In its guidance on vulnerable customers the FCA states: “A vulnerable customer is someone who, due to their personal circumstances, is especially susceptible to harm – particularly when a firm is not acting with appropriate levels of care”.
This wide-ranging definition includes consumers with health issues from mobility to impaired vision or hearing, as well as countless other physical challenges. Vulnerability may also arise through mental health issues or social factors, for example low financial literacy or lack of access to or familiarity with the internet.
Crucially, vulnerability is not a fixed state. People may become temporarily vulnerable due to a change in circumstances, such as job loss, bereavement, an unexpected medical diagnosis or divorce. Again, we can imagine almost countless life events that might quite suddenly make an individual vulnerable.
Vulnerable consumers are clearly not a small minority and the FCA’s latest Financial Lives survey estimated that almost half of all consumers (47%) show one or more characteristics of vulnerability.[2]
The principal challenge firms face is identifying when a customer is vulnerable. The cause of vulnerability may not be obvious, perhaps because it is a matter that the customer is reluctant to talk about. Sometimes the customer may not even be aware that their current situation and the pressures they are facing make them vulnerable.
There is no easy fix for firms. Identifying a vulnerable customer often depends on picking up signals in conversation and spotting significant comments, such as a customer referring to a deceased partner, regular medical appointments or unexpected expenses.
Identifying vulnerable customers and ensuring they receive the appropriate service must be central to a firm’s activities and much of the process comes down to having skilled and sympathetic employees who are attuned to the issues.
Vulnerability and capacity for loss
One area that is critical when advising vulnerable customers is assessing their capacity for loss (CFL)[3]. Not all vulnerable customers have a low CFL, but some will. And of course, if a customer becomes vulnerable because of a change in circumstances (such as job loss or divorce) then their CFL may well be significantly affected.
The FCA expects all firms to assess their customers for CFL, but there is a wide variation in how firms go about this vital task. Too many make no clear distinction between attitude to risk and capacity for loss. A recent review of retirement income advice by the FCA found that just 30% of firms carried out an assessment for capacity for loss separately from attitude to risk.[4]
There are three possible approaches to measure CFL. The first is to carry out financial modelling, taking a customer’s current finances and standard of living and playing out a range of potential outcomes relating to expenditure, income and investment returns to assess their impact.
Another is to ask some simple questions to get the customer’s view on what they can afford to lose in terms of, say, investment losses.
The third is a more systematic questionnaire, such as that offered by A2Risk, which poses a range of questions designed to capture in more detail the relationship between the sums invested, outgoings, expectations of earning capacity and other factors.
It is worth noting that as well as being vitally important that vulnerable customers are assessed for their CFL, the process of assessment itself may help identify those who are vulnerable.
Having established the customer’s CFL and having checked for new information relating to vulnerability, the adviser can now turn to the key objectives:
- Ensuring their finances allow them to meet their essential needs
- Creating a ‘rainy day’ fund for unexpected contingencies
- Medium-term financial goals
- Long-term financial goals
A2Risk has a range of tools to help the adviser do this. We know the outputs need to be clear and simple. We also know from speaking to our clients that vulnerability and CFL are an increasingly pressing issues and we are keen to hear insights and experiences of these challenges
Addressing attitude to risk, capacity for loss and vulnerability must be both a rigorous exercise using carefully calibrated tools and human endeavour based on personal skills and customer service.
The firms that combine these elements will be the ones that stand out in an increasingly competitive landscape.
[1] Review of firms’ treatment of customers in vulnerable circumstances | FCA
[2] Financial Lives 2022 survey: insights on vulnerability and financial resilience relevant to the rising cost of living | FCA
[3] The FCA’s Finalised Guidance on Assessing Suitability (March 2021) defined capacity for loss as: ‘The customer’s ability to absorb falls in the value of their investment. If any loss of capital would have a materially detrimental effect on their standard of living, this should be taken into account in assessing the risk that they are able to take’.