The poverty premium

It might seem counterintuitive to suggest that it’s expensive to be poor, but many people pay more for the same basic financial services as everyone else just because they have a lower income or lower wealth.

Many financial products and services have what seems to be a deliberately built in “poverty premium” where either the prices are higher, or access to products and services is more difficult, or certain features are restricted. Opportunities for financial mobility are lessened simply because of low income or wealth.

This effect can be seen in several industries including banking and insurance, where the poverty premium can exacerbate the financial challenges faced by those already struggling.

An often overlooked aspect can be financial knowledge and connections, where poorer households can’t afford or can’t access quality financial advice, they might lack the knowledge to interpret financial information, or it can be as simple as not having the same well-informed social circles to support and encourage good financial management that wealthier households take for granted.

The problem is UK-wide, but has a disproportionate effect in some regions. The Fair By Design website has a report that is well worth a read, and an interesting map showing how the poverty premium varies around the country. The areas where the poverty premium is highest are sadly not unsurprising.

Without a poverty premium, much of this money could instead be spent improving living standards and directed to savings and investment, thereby reducing the burden on the state to provide basic and fundamental services that households should be able to afford themselves, and getting more people out of the hard-to-escape poverty trap by building their wealth and making more effective use of limited incomes.

Banking

Low income households are more likely to have cashflow problems, i.e. living pay check to pay check (though this is not restricted to low earners, many high-earning individuals also succumb to lifestyle creep and end up struggling to get by until the next payday).

The banking industry has plenty of methods for extracting money from its customers, mostly in the form of fees that can quickly accumulate. From unarranged overdraft fees, monthly account fees, ATM fees for those that still use cash, fees for sending payments via a branch (though these are disappearing fast), and minimum balance requirements, low-income individuals are disproportionately affected.

The poorest households are also very likely to be the main payers of these fees. This income seems to be subsidising the free banking services that many people take for granted, and banks would argue they’d have to charge fees to all customers to offset a loss of this income.

On the other hand, banks only make some perks available to their wealthier customers. Poorer customers might not get offered premium accounts with higher interest rates, or credit cards with cashback, or lower loan interest rates, or higher unarranged overdraft balances before interest kicks in, or lower foreign exchange rates, or air miles, or whatever it happens to be that the wealthy customers expect and get.

Insurance

My industry doesn’t get off lightly either. The poverty premium can mean insurance is less accessible for lower income customers. There are many factors influencing the price of insurance (I’ll probably explore these factors in future posts), and low-income individuals are often charged higher premiums or may even be denied coverage due to the strong influence of financial rating factors.

For example, low credit scores, living in undesirable areas (undesirable according to the insurer, due to high crime rates or flooding etc.) because that’s where is affordable to live, inability to pay an annual premium up front and having to opt into monthly payments with an interest rate, or just because of their profession (e.g. manual trades could be associated with lower income).

If the customer doesn’t have the funds then insuring a single item rather than buying comprehensive contents cover is often cheaper, but this is actually a false economy. Insurance is a product where it’s difficult to see the value until the unlikely situation where we need to make a claim. This means it’s easy for people to reduce their cover or avoid purchasing optional covers to save money – a potentially very expensive risk that those without wealth in the form of savings could not afford to have happen.

What’s the solution?

The poverty premium goes beyond just inconvenience; it’s a barrier to economic mobility and financial security. It’s also easy to see how a cycle or spiral begins to form where being poor means higher costs which makes it even harder to pay, which might cause more debt, which can affect credit or other measures, which makes it more expensive to get cover, etc. Potentially a difficult spiral to escape from.

Education is needed to improve financial literacy, regulatory reform is required to change unfair practices in the financial services industry and other areas (a step that the new Consumer Duty regulations will hopefully be able to quickly address), and we need to design fairer products and services. That may mean the need to create new companies and organisations that are incentivised to offer them.

There are many other factors affecting wealth inequality, but as a start we need to remove the in-built bias in financial services. Otherwise the upward virtuous spiral of the wealthy who are not burdened with these additional premiums will continue to contrast starkly with the downward vicious spiral of the poor.

References and further reading

1. Fair By Design on Poverty Premium: https://fairbydesign.com/povertypremium/
2. Consumer Duty regulations: https://www.fca.org.uk/publications/policy-statements/ps22-9-new-consumer-duty