A simply appalling scheme

Lloyds Banking Group has been fined £28m by the Financial Conduct Authority for simply awful management of staff. From the FCA's press release:
"The Financial Conduct Authority (FCA) has fined Lloyds TSB Bank plc and Bank of Scotland plc, both part of Lloyds Banking Group (LBG), £28,038,800 for serious failings in their controls over sales incentive schemes. The failings affected branches of Lloyds TSB, Bank of Scotland and Halifax (which is part of Bank of Scotland). 
This is the largest ever fine imposed by the FCA, or its predecessor the Financial Services Authority (FSA), for retail conduct failings.
The incentive schemes led to a serious risk that sales staff were put under pressure to hit targets to get a bonus or avoid being demoted, rather than focus on what consumers may need or want".
And according to the FCA's Tracy McDermott, the FCA's findings "make unpleasant reading". Indeed they do. I've read them, and I have to say that they describe one of the worst employee compensation schemes I have ever seen.

The people affected were retail branch sales staff. So we are not talking about traders or top managers with telephone-digit salaries and bonuses resembling the GDP of a small country. We are talking about ordinary people with ordinary salaries. At Lloyds TSB, base salaries ranged from £18,200 to £72,600, with most people in the range £33,706 - £46,621, while at HBOS, base salaries ranged from £22,000 to £73,000. So the base salary in most cases was sufficient to ensure a reasonably comfortable lifestyle.

Except that it wasn't. Usually, in sales teams, the base is fixed and performance-related pay takes the form of bonuses which are additional to the base pay. And indeed, LBG sales staff did have bonuses - sometimes very large ones (more on that shortly). But their BASE salaries also depended on performance. A poorly-performing branch sales adviser could lose up to 35% of their base pay. At those salary levels, these were extremely severe penalties. When your base pay is £40,000, a cut of 35% probably means losing your house. It is hardly surprising therefore that sales advisers would sell customers products that they didn't need or were unsuitable for them. If the choice is between mistreating customers and losing your house, what would you choose?

The bonus schemes also created considerable incentive for mis-selling. There were both individual and team bonus schemes, and additional one-off incentive payments. This graphic from the FCA Final Notice report shows how the addition of individual and other bonuses inflated pay:

And there is a similar inflation in pay for HBOS, too:

Note that these are MONTHLY figures. For a mid-tier sales advisor, this would be a very substantial addition to his salary.

There was collusion between managers and staff over mis-selling. The FCA notes that managers' bonus schemes depended on the performance of their staff, so they had an incentive to encourage mis-selling that inflated the bonuses of their staff or prevented their demotion. But there is a human angle to this, too. The severe financial penalties for under-performance would have presented a considerable management challenge. It is difficult enough to give someone a bad performance rating when you know this will cost them a pay rise and possibly blight their future career with the company: performance management schemes are often skewed to the upside  for exactly this reason. But when you know that giving someone a bad rating will result in a pay cut that could mean they lose their home, you might be understandably reluctant to do this. Any half decent manager would massage the figures to prevent the penalty being applied, in the interests of team morale if nothing else. Financial penalties of such severity are no way to manage people.

The sales incentives and penalties structure in effect set up a competition between employees and customers. Good customer service may include not selling products, if they are unsuitable or not needed. But at LBG, this would have resulted in financial penalties. So meeting customers' needs could come at a considerable cost for staff. This created perverse incentives: employees were rewarded for bad service and penalised for good. That is bad design in any performance management scheme and appalling in one where there were severe financial penalties for bad performance.

In short, this was a simply terrible scheme for staff, managers and customers alike.

The FCA says that LBG should have had procedures in place to monitor the sales of sales advisers at risk of financial penalty or close to financial reward (promotion or extra bonuses), because those people were most likely to mis-sell. And it criticises LBG management for their blindness to the risks of such a scheme:

"The root cause of these deficiencies was the collective failure of the Firms’ senior management to identify remuneration and incentives for advisers as a key area of risk requiring specific and robust oversight..."

But there is a wider issue, too. The abuses described in the FCA's report happened after LBG was bailed out in the financial crisis.  Massively expanding insurance product sales was a deliberate strategy on the part of LBG's Board because of poor returns on investment products. From the FCA's report:
From 2010, the Group had a target for its combined retail bancassurance
business to approximately double its customer base by 2015. In seeking to meet
this growth target the Group’s strategy was to focus on sales of protection
products over investment products. There were a number of reasons for this
strategic focus on protection: 
(1) the Group wanted to increase the profitability of its bancassurance
business, and protection products were more profitable; 
(2) the Group’s analysis showed that there was a ‘protection gap’ in the UK
market and wanted to meet the protection needs of customers;
(3) the financial crisis had resulted in a fall in customer demand for
investment products; and 
(4) the Group had reduced its appetite for sale of investment products, which
it saw as higher risk from a regulatory perspective, including anticipated
regulatory developments. 
4.7. During the Relevant Period, as a result of the various factors described in
paragraph 4.6 above, LTSB’s sales of protection products increased by 65% while
its sales of investment products decreased by 54%. During the same period
Halifax’s sales of protection products increased by 94% while its sales of
investment products decreased by 68% and BOS’s sales of protection products
increased by 67% while its sales of investment products decreased by 67%. 
The FCA report shows that sales advisers were incentivised to sell insurance products in preference to investment products, even when this did not match with customer needs. The extent to which the over-selling of insurance products (especially life insurance) and under-selling of investment products will adversely affect customers in the future remains to be seen. It's worth remembering at this point that LBG has been forced to make greater compensation payments for PPI and other mis-selling than any other bank, and the full extent of its exposure is not yet known, although it has substantial provisions. 
Regulatory fines and compensation for customers are inadequate. LBG has bought its return to profitability at the cost of ripping off its customers and abusing its staff.  The Board should resign.


  1. Standing in a long LloydsTSB queue during a valuable lunch hour, a member of staff tried to sell insurance products to this captive audience. My suggestion that the indiviudal might be better employed reducing the queue met with a round of applause. I now bank elsewhere.

  2. Another scandal. I think that you must be right, Frances, to say that fines and compensation are inadequate, because these do not penalise those personally responsible for the scheme. But then neither does the resignation of the Board, since it appears that the person principally to blame left the Board some time ago. There needs to be some way of holding people to account effectively even though they've already left the scene, probably with a handsome financial reward

  3. High pressure selling of investment products has been going on at Lloyds for a very long time. I was hauled into a Lloyds back office about 25 years ago and subjected to some very heavy handed and obnoxious sales techniques.

  4. £28 million? Sounds like a lot of money, but presumably for an organisation the size of Lloyds, that's barely more than a rounding error in the accounts.

    I think you're spot on about regulatory fines being inadequate. On the other hand, if the directors were had been personally fined £28 million, then I guess that might focus a few minds. I would love to see directors being held personally liable a lot more often when this sort of thing happens

  5. I think we know, after five years of this financial crisis unwinding, that perverse incentives have been behind a lot of bad institutional behaviour.

    I don't think it should take a specific investigation to bring pay practices like this to light. It ought to be part of normal disclosure for financial and other institutions to disclose their pay and incentive practices. You could write a computer program that could score pay and incentives for propensity to abuse.

    And lets include Charities and NGOs with high paid executives in that, as well.

  6. I notice that Iceland has jailed some of its bankers. Just saying...

  7. It feels like we come full circle back to your suggestion, Frances, that vanilla retail banking simply isn't profitable enough to make commercial sense.

    I'm not sure where we go from there though...

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