What does it mean to be vulnerable?

An elderly person grappling with online banking. A cancer patient unable to get insurance. A person with low literacy and numeracy. All these people are vulnerable in financial terms. They are, according to FCA Occasional Paper No.8, “especially susceptible to detriment” and “may be significantly less able to represent their own interests”.

But what about a Masters student in their early 20s? Could they, a tech savvy, healthy and highly educated young person, also be vulnerable?

The answer, as we’re increasingly seeing, is unfortunately yes.

In fact, many more people fall under the bracket of “vulnerable” than you might expect. For the Masters student, credit card and overdraft debts accrued while at university, along with student loan repayments, make their financial position precarious. And they are not alone. The picture of vulnerability in the UK is fiendishly complex, with people of all different backgrounds and circumstances held back and weighed down due to their financial situation.

This complexity creates something of a challenge for regulators.

In order to establish whether to intervene in financial markets and how, regulators assess the likely impact of their actions, by considering the expected costs and benefits. Is it possible to factor vulnerability into these assessments? And if so, how?

The case for vulnerability as a regulatory consideration

We know that regulatory interventions that aim to prevent harm and/or ensure proper redress can be of particular benefit to vulnerable consumers. This is because they are at a heightened risk of:

• Frequency of harmful episodes: vulnerable consumers may be easier targets for mis-selling and scams, as well as being more likely to suffer from barriers to access to financial services and difficulty in finding the most suitable products in the market.
• Intensity of harm: monetary losses and psychological detriment may be more damaging to those who are already in difficult situations.
• Duration of harm: vulnerable consumers may be less likely to be aware of detriment (e.g. excessive charges), learn from past mistakes and adapt their behaviour to advance their interests.
• Failure to secure redress: they may find it difficult to exert their right to compensation when things go wrong.

Interventions geared to protecting the vulnerable also have the value of sustaining overall trust in financial markets. After all, we are all prone to go through difficult circumstances in life and the knowledge that institutions with the power to do so are looking out for our wellbeing is comforting.

Making it work in practice

So we can conclude that there is a strong case for factoring in vulnerability when assessing the merits of intervention.

But the next question is more difficult. How can policymakers actually incorporate vulnerability into their assessments, given the wide list of factors that can make a consumer vulnerable?

The first thing to do is to consider what aspects of vulnerability are most relevant in a particular policy intervention. In most situations a qualitative judgement can be made about how much vulnerable consumers are likely to be affected by a particular intervention. Given the higher frequency and intensity of detriment they suffer, vulnerable people are likely to benefit more from interventions than other, more resilient consumers.

So, for example, while a policy protecting consumers with learning difficulties when buying financial products may create net costs for the whole of society, it could still be considered sensible when weighing up the need for the intervention.

But is there anything we can do beyond weighing up these factors qualitatively?  Can and should we bring in any quantitative assessment to assist policymaking? In short, are we ready to say that the loss of X pounds (e.g. from a scam or unduly high charges) entails greater harm to the vulnerable? If we are, how can we quantify this difference?

An approach applied elsewhere by policy makers has been to group together citizens in similar circumstances and assign different welfare weights.

In their 1999 study for the OFT, Cowell and Gardiner describe the theoretical underpinning of this approach and review evidence that people are more sensitive to losses when they face difficulties in meeting basic needs.

The use of differential welfare weights can be found in some of the key structures that guide public life. For example, assuming they reflect voters’ preferences, progressive tax systems like the UK’s imply a collective belief that £1 matters more to those with low incomes.

We can also observe the weighting of impacts in the Treasury’s “Green Book – Appraisal and Evaluation in Central Government”. The Green Book recommends the assignment of weights in relation to “equivalised income”, i.e. income adjusted by family type. Impacts on the 20% with lowest income are weighted approximately twice as much as those to middle income citizens, and four times as much as impacts to the “richest” 20%.

Meanwhile, in the Department for Communities and Local Government Appraisal Guidance we see the use of income weighting in relation to interventions that benefit residents in social housing tenure. The DCLG assigns a 1.72 weight to low income social housing tenants, implying that an extra pound given to a social tenant generates the same benefit as £1.72 given to an average-income citizen.

Income-based weights: a silver bullet?

So there’s some precedent when it comes to incorporating explicit income-based weights into policymakers’ cost benefit analysis, or CBA.

Indeed, applying this approach, which enables regulators to consider the broader impact of their interventions on a more systematic basis, could enhance regulatory decision-making in financial services. Furthermore, assigning quantitative welfare weights to vulnerable groups may result in a clear and transparent rationale for a regulatory intervention that otherwise wouldn’t have survived an assessment of net public value.

And yet, income-based weighting does have its downsides.

Even when regulators are able to measure incomes accurately, or at least estimate them well, the way weights are determined can be controversial. The study by Cowell and Gardiner, for example, shows that the weights assigned to different income groups are highly sensitive to the specific assumptions and methodological approaches utilised.

And of course, if we apply weights based purely on income, we do not take direct account of other forms of vulnerability. While income can determine health status and is correlated to some adverse life events that may cause vulnerability (e.g. job loss), focusing on this measure solely may decrease the focus on difficult circumstances not reflected in income levels.

After all, detriment to the vulnerable often occurs in ways that cannot be easily expressed in monetary terms at all. Think, for instance, about difficulties in accessing essential banking services, or the stress and anxiety when a consumer is subject to undue pressure from lenders who fail to comply with forbearance requirements and engage in threatening behaviour. These stress factors can’t be expressed in pounds and pence, but that doesn’t make them any less potent.

Conclusions

Vulnerable people are often unable to protect themselves and tend to suffer more from poor outcomes in financial markets. As a consequence, it is clear that vulnerability should enter the qualitative assessment of costs and benefits of alternative interventions.

The question of whether this could and should also be done quantitatively is difficult.

Personally, I’d argue that income-based weights can provide a useful guide in the case of some interventions. When policies specific to protecting the poor are assessed the relative weights recommended in the Green Book could be kept in mind, for instance.

A much wider lens will be required in general, though, stretching beyond income to consider age, illness, mental health and financial literacy, to name a few. Only by considering vulnerability in its many potential dimensions can we ensure that financial markets provide real opportunities, and not threats, to those in severe difficulty.