TMDs done, now what?

As you are probably already aware, the new Product Design & Distribution Obligations (DDO) are due to come into effect in October this year. My conversations with super funds, wealth managers, investment managers and banks suggest that the larger players have been on the DDO-journey for some time. Smaller players less so.

The current focus for many has been on answering these important questions:

1. What is a ‘product’?

Does adding a feature to one of our products make it a new product and therefore require a separate target market determination (TMD)? Do each of the options within our products constitute separate products that require separate TMDs? And if we bundle products, should we then need to create a TMD for each bundle?

ASIC provides some guidance on these questions in its regulatory guide. The short answer seems to be that there is no single best approach, so long as you consider everything that is relevant to consumer outcomes.

2. How will we report?

How should we manage information flows, particularly where our products are distributed by third parties (including by advisers, mortgage brokers and platforms)? This has been a key topic discussed across various industry forums.

Still lying ahead of many organisations are other big questions, many of which require an understanding of consumer decision-making and behaviour. They relate to the fact that product issuers are required to take ‘reasonable steps that are reasonably likely to result in financial products reaching consumers in the target market’.

Unless those consumers are optimising econo-bots, behavioural considerations will be relevant. So, what are those questions?

1. What can we ask consumers?

If product distributors ask consumers about their needs, their preferences and their circumstances, will the responses to these questions be sufficient to determine who they can distribute a product to and who to exclude?

Based on the psychological evidence, my response is ‘in some circumstances, but certainly not in others’. Consumers’ responses are notoriously unreliable for some types of questions. Questions that ask consumers to predict their future behaviour, future needs or future preferences can each be dangerous. Their responses are likely to be subject to a number of well-documented and predictable biases, such as prioritising the present over the future, or failing to anticipate and account for the impact of changes in their life circumstances.

Even some questions about aspects of consumers' current circumstance and behaviour are likely to be systematically biased. An example of this is when a doctor asks a patient how much alcohol they consume each week; their actual consumption is likely to be higher than what they claim. In contrast, when asking whether they will pay off their credit card balance every month, for many consumers their repayments are likely to be lower.

Similarly, consumers are likely to have difficulty identifying what they do or do not understand. This can then cause a ripple effect, making it increasingly difficult for them to reliably answer questions about, say, their preferences and tolerance for risk.

It can be hard for consumers to answer questions about risk at the best of times, particularly if they don’t really understand the risks involved or the potential impact of those risks on their financial futures. This is relevant for investment products that are designed for consumers with different risk profiles, or for products that are designed for consumers with different levels of portfolio diversification. It's also relevant for various types of insurance products.

It’s not that product distributors should avoid asking these types of questions necessarily. Rather, it’s that a behavioural lens is required when framing the questions, in interpreting and relying on the responses, in asking clarifying questions, and in considering whether more reliable sources of information are available.

2. What do we need to do to our web site and disclosure documents?

It is not sufficient for product issuers to just disclose product-related information and expect consumers to make appropriate choices – this often doesn’t work and is largely the reason we now have DDO. In contrast to this traditional approach, to comply with the DDO requirements ASIC expects product distributors to consider how else they can assist consumers to make appropriate decisions.

What does this involve? It could require changing how information is framed and presented to consumers on web sites, in disclosure documents and in related materials. This information should be presented as part of a ‘choice architecture’ that nudges consumers towards appropriate choices and away from inappropriate ones.

This could include changing the categories and sub-categories that are used to display investment information in pie charts and in tables, as each can demonstrably influence consumers’ preferred investment option.

It could include changing the number of insurance options that are displayed, or the order in which they are displayed, or how they are labelled, or how they are compared. In the absence of these measures consumers are likely to make no choice, or choose the cheapest option. If what is in their best interest is different from this, changes are likely to be needed.

It could include providing rules-of-thumb or ‘heuristics’ to simplify complex and difficult decisions. The result is that, rather than becoming overwhelmed, the consumer is guided through the complexity.

It could include removing ‘frictions’ from some parts of product distribution process (to smooth the path to consumers making appropriate choices), and adding frictions to others (to create a barrier to inappropriate choices). Those frictions could include suggesting consumers speak to a customer service office or an adviser when a particular consumer appears to be at risk of making a rash decision, or one that is at odds with their apparent needs.

The list of possibilities is long. It’s about choosing the right nudge for the right consumer and the right context.

Having appropriate choice architectures is about more than just removing jargon and replacing it with simple terms, or removing clutter and replacing it with white space. Both of these might help, but in terms of positively influencing consumers' choices, they are just the tip of the iceberg. A good consumer experience is necessary but not sufficient.

The challenge here is that choice architectures are likely to influence consumers’ choices beyond their conscious awareness. This means that while choice architectures can have an important impact on consumers' decisions and outcomes, consumers won't tell you that they're important. And for the same reason, unless they are versed in behavioural finance, choice architectures can also be overlooked by product issuers and distributors too.

3. What do we need to do to our products?

As part of DDO, product issuers are required to consider how the product performs ‘in the hand of consumers in the target market’.

Hopefully product issuers won’t need to modify their products much, but behavioural research suggests that some changes might be required to better align products with good consumer outcomes. For example, given that consumers often lack vigilance and will-power, the default arrangements that are baked into products can powerfully impact consumer outcomes, for better or worse.

Those default arrangements could include what happens when a consumer fails to make a payment on a loan, or when their term deposit reaches maturity without them providing reinvestment instructions, or when they fail to specify to their insurer whether they smoke, or when they fail to identify from which investments they would like their pension payments drawn.

In these circumstances are consumers charged a dishonour fee, rolled into a lower-interest deposit product, assumed to smoke, or left exposed to high risk investments in their old age?

Or are they provided timely reminders to remedy missed payments or missing information? Do automated fund transfers from their savings account cover their missed loan repayments? Do they get automatically rolled over into an equivalent term deposit? And do they benefit from automatic portfolio rebalancing?

While these might not be the best options for all products, for all consumers or in all contexts, the psychological research suggests that these types of default arrangements are likely to benefit more consumers more of the time.

In formulating their response to DDO, the psychological research doesn't provide a panacea. Rather, it can be used to ask the type of pertinent questions raised in this article, and it can provide frameworks, tools and strategies for formulating appropriate responses.