The ongoing Northern Rock saga has left consumer trust in the financial services industry in tatters. But, as Peter Carvill finds out, those with high personal debt cannot have it both ways.
When the long-expected credit crunch seemingly began to bite in September, and a subsequent series of events led to customers queuing outside branches of Northern Rock to withdraw their savings, financial analysts were able to trace both events back to the collapse of the US sub-prime lending market earlier in the year.
Sub-prime lending seemed like a good concept as the US experienced a housing bubble between 2001 and 2005. As the value of homes increased steadily and interest rates remained low, lenders gave loans to borrowers who would normally be deemed too much of a risk to provide credit for.
Since 2005, however, interest rates in the US have risen causing many borrowers to default and lose their homes. At the same time, the housing market devalued, meaning lenders repossessed properties that are now worth less than the original amount lent to purchase. With lenders having raised their funding through debt-based bonds, investors and banks have become nervous about absorbing any more debt and stopped buying the bonds, which has caused shudders across the financial markets.
This all led to the Northern Rock crisis because rumour and fear have a way of driving markets. The core of Northern Rock's business has been its lending and the capital for these mortgages and loans has come from the sale of bonds based on this debt to investors. As the US sub-prime market seemed to falter at the beginning of September, investors became more nervous about buying any more bonds based on mortgage debt and Northern Rock's cash flow slowed to a trickle, with its shares plunging in value by more than 30% over a handful of days.
Reality check
The effects were dramatic and dominated the UK news for over a week as Northern Rock customers withdrew more than £2bn of savings from the troubled bank. Having granted an emergency loan to Northern Rock and informing customers that the majority of their savings were guaranteed under law, the Bank of England and the UK Government took the unprecedented step of declaring that they would guarantee all savings with Northern Rock.
This ongoing saga has left the protection industry with an opportunity that few could have foreseen: the chance to educate the public about the benefits of income protection (IP). "The main issue," according to Roger Edwards, product director at Bright Grey, "is that the crisis demonstrates that people do not want to risk losing their savings."
Yet, according to the most recent industry reports, there is a £2.3bn protection gap and Roy McLoughlin, an IFA at Master Adviser, estimates that "nine in 10 people don't have adequate protection through the workplace or the home".
Now, it seems, is the perfect time to promote protection, yet the market instability that has brought about these favourable conditions may also work against IFAs trying to protect their clients' interests. Peter Le Beau, managing director of Le Beau Visage, sees the knock-on negative effect that could occur: "People may be happy to have debt, but they are not happy to insure it, and a crisis like this knocks the little confidence people have in the financial services environment."
But there may be a way forward through this for IFAs. Le Beau proffers the opinion that, "the people withdrawing money will be risk-aversive, and these are the people who are likely to buy protection".
IFAs need then to emphasise the benefits of IP, and allay customers' fears and doubts. Some of what may be put across could be perceived as little more than 'scare tactics' but, as McLoughlin says, "if people realised their exposure to serious illness, would they also queue around the block for IFAs?"
The Northern Rock and sub-prime crises are a good focal point for any discussion about a client's financial planning due to the recent blanket media coverage. A good IFA would point out that if a customer is so concerned about their money that they would close bank accounts at the first hint of a coming storm, then they should also begin to seriously look at their protection needs and the products to support them. n
