FCA Consumer Duty: The top biases you need to know about

14 December 2022

This year the application of behavioural science in the UK received a boost from the Financial Conduct Authority (FCA). The regulatory body has been experimenting with behavioural science for a decade to improve outcomes for consumers.

7 min read
7 min read

This year the application of behavioural science in the UK received a boost from the Financial Conduct Authority (FCA). The regulatory body has been experimenting with behavioural science for a decade to improve outcomes for consumers. Now it has been judged it’s time to broaden behavioural science’s use across the finance sector through the new Consumer Duty regulations.

For the first time, the new regulations require all financial organisations that sell to consumers or SMEs to use a behavioural science approach to test their products and communications. This will ensure that all customers fully understand what they’re buying or agreeing to, prices are clear and reasonable, offer fair value, and all products meet a genuine consumer need.

For many financial firms, the regulatory timeline may look challenging. While some larger retail financial brands may have behavioural science teams in-house, many don’t. And all the planning, testing, and reviewing needs to be completed by the end of April 2023.  What’s more, it represents a rare time that compliance and research teams will work together, with compliance driving the process with the consumer insights team’s support.

One thing reviewers will have to look out for is biases and heuristics. Some, like ‘anchoring’ where a higher comparison price is used to make the medium ground appear good value, we see on a daily basis. Some are intentional, while others, such as ‘status quo’ and the tendency to stick with an existing selection even when a better one might be available, are unintentional.

While you’ll need to look out for all potential biases, there are common ones we often see in financial services that it’ll be important for you to consider when you embark on your testing.

Hyperbolic Discounting
Applying fees later in the lifecycle of a product, which consumers are likely to put significantly less weight on than a fee charged at an earlier date.

Survivorship/hindsight bias
Customers’ tendency to ignore products, providers or assets which have exited the market and pay attention only to those that remain (which includes only those which were more successful). This can lead people to overestimate investment assets’ average returns.

IKEA effect
Customers place a higher value on products they have “constructed” themselves. Outside of the world of bookshelves, this could apply to portfolios or products that the customer has put effort into configuring.

Confirmation bias
Customers seek evidence to confirm their existing beliefs and ignore other information (such as warnings about risk).

Base rate neglect
People’s tendency to ignore the underlying probability of events and focus only on changes or relative probabilities. For example, customers might be influenced by a 20% increase in the failure rate of European banks and be tempted to move their money into unconventional assets, which have a much higher failure rate. 

Sunk cost fallacy/escalation of commitment
Once a consumer has invested money in an asset, even if it loses value, they overvalue the asset compared to its market price and may end up buying more of it.

Halo effect
Companies or assets that have performed well in one dimension are assumed to perform well across others, even without evidence.

Procrastination / cognitive load and friction avoidance
Customers prefer to do nothing or put off a decision or action if it saves them the effort of thinking about it. This could lead them to keep paying for a more expensive product or service even when a better option is available.

Customers feel more compelled into buying when they are made to feel like they have to buy immediately. This can be elicited by words indicating urgency, such as 'buy now' or claiming that a product is very scarce and they have to obtain the product before it runs out.

Emotional framing
The tendency of consumers to answer questions on insurance products based on how it makes them feel rather than rationally assessing the information and facts. This can be triggered by communicating the product details in a more emotive manner.

Social proofing
To help make decisions, consumers may rely on appealing to what decisions others are making. If there are signs of what products are most popular, they can be biased towards these products purely because of their popularity without assessing the products at all.

Mental accounting
Customers often put money into different mental accounts. This means spending on insurance products is constrained by the budget allocated to it. Meaning decisions over how much to pay are taken in the context of the budget within that category rather than the amount of money they have as a whole. 

Of course, within behavioural science, there’s lots of debate about whether biases are “errors”, or whether they are a natural, positive consequence of how the brain works. This is an interesting debate. But from the FCA’s point of view, biases prevent consumers from getting the best financial outcomes, and they are to be avoided. Each bias can show up in a different way and may need its own form of test to cover you for the Consumer Duty regulations. An expert review is vital, many of these biases can be difficult to identify, and an expert will be more likely to spot high-risk areas where consumers might be influenced towards undesired outcomes.

The first step is a behavioural audit and customer journey review. Desk research looks systematically through all your product design and communications, always with a critical eye on potential biases and other cognitive ‘traps’.

Next, a set of customer interviews are recommended: we find that interviews work better than focus groups when discussing financial decision-making, as it’s easier for people to open up about these topics without their peers looking on. This should explore customer needs (since the FCA requires firms to show that products meet a genuine customer need), decision-making and the customer’s degree of understanding of the type of product they are buying. You can also look for potential biases in this process by presenting decision-making scenarios and listening to the customer’s language and reasoning when they respond.

Finally, a quantitative testing phase can include comprehension tests, where you present documents to a representative sample and then ask questions to test how well they understand. You can also use narrative research, attitudinal surveys or choice-based testing (we use approaches called System 3 and Behavioural Conjoint) to test in more detail how consumers perceive your category and how they respond to product offerings and prices. This can help uncover any consistent ways in which your customers might be making suboptimal decisions and tell you how to help them do better. 

If the research uncovers any risks or biases that you can help customers to avoid, you should now have data to help improve your products and communications. If you make significant changes, you may want to retest some of them with a second round of research. 

This research program will not only help you to be compliant with the new rules but can uncover a deep pool of new insights about your customers and their needs. This can be an opportunity for an insights team to work in partnership with compliance, potentially unlocking new budgets but, more importantly, giving the company a new perspective on how to provide the best possible service to customers. In the past, marketing initiatives have often been in tension with compliance – with the regulatory team telling you not to say what you want to! But in meeting these regulations, we have often found that good marketing instincts can help customers understand products better and to make the decisions that are best for them.

Leigh Caldwell
Partner & Founder at Irrational Agency