A fresh start? Responding to the Insolvency Service review of the personal insolvency framework

By Ed McDonagh, Senior Public Policy Advocate

The Insolvency Service’s recent call for evidence on the personal insolvency framework provides an opportunity to assess how well the framework is working from first principles. It will be no surprise to anyone that we see significant problems in the insolvency sector.

It’s illuminating to consider a critical view of the framework’s stated objectives: giving people experiencing debt problems a ‘fresh start’ and ‘can pay, will pay’: maximising returns for creditors. Getting the objectives of the framework right is key to delivering an effective system of debt relief.

‘Fresh start’ and ‘can pay, will pay’

While ‘fresh start’ and ‘can pay, will pay’ appear sensible objectives for the insolvency framework, they have limitations.

The former loosely alludes to being debt free, but for consumers this does not necessarily amount to a meaningful fresh start.

The latter doesn’t necessarily account for increasing levels of consumer financial vulnerability and the evidence that the design of consumer credit products and conduct of firms often contributes to problem debt.

So both the underlying objectives need, to some extent, defining and qualifying.

We think that the concept of a ‘fresh start’ should be broadened from a narrow focus on debt relief to a wider set of consumer outcomes including, for example, improved health and wellbeing and financial resilience.

The Insolvency Service could use these outcomes to establish a regulatory framework akin to the FCA’s Consumer Duty, which gives an example of an alternative approach that balances creditor returns against a broader frame of good consumer outcomes.

Strengths and weaknesses of insolvency solutions

StepChange outcomes research evidence suggests clients who are able to access insolvency solutions generally experience good outcomes: a majority feel that their debt situation is ‘sorted out’ and they are making progress with their debts. On average, wellbeing scores improve considerably.

However, some clients also report difficulty meeting repayments, suggesting that budgeting guidelines can be overly restrictive. Solutions can also be difficult to set up or fail when clients’ circumstances change. Although improved, wellbeing scores tend to remain below national averages.

Elements of the insolvency framework make long-term recovery more challenging

Credit reporting means people are affected by insolvency for six years after accessing a procedure no matter their financial behaviours or how their circumstances change.

And crucially, access to insolvency is restricted, so many of those who most need a fresh start are excluded.

Barriers to insolvency include stigma, unaffordable fees and requirements to give up assets that put off people worried about consequences like housing insecurity or disruption for children.

In a recent survey of clients, 24% cited the stigma associated with insolvency as a main negative, while 21% cited the restrictions (such as budgeting constraints and limits on access to credit) placed on them.

Those accessing insolvency procedures are also at risk of being offered an inappropriate solution because of well-documented instances of IVA mis-selling, which sees nearly a third of IVAs fail early. When this happens, consumers can face backdated interest and charges added to their debts, leaving them worse off than before they were sold an IVA.

Reforming insolvency to support good outcomes

There are evidently issues in the current insolvency landscape that should be addressed. In the short- to medium-term, the Insolvency Service should focus on reducing access barriers, ensuring solutions function well and addressing problems in the IVA market.

Some steps to achieve this include:

· Scrapping DRO fees and reducing bankruptcy fees, at a minimum for those receiving means-tested social security payments, and examining the potential for others to pay the fee in instalments alongside repayments (rather than up front).

· Reviewing and increasing flexibilities within DROs and bankruptcy, such as the treatment of assets, missed debts and changes in income to make procedures more sustainable.

· Addressing high failure rates and poor client journeys in the IVA market by (among other measures) reforming fees to incentivise sustainable solutions and requiring everyone to access FCA-regulated debt advice before entering a personal insolvency solution.

A broader aim of the review should be putting outcomes at the centre of the purpose and design of insolvency to reflect a world with highly developed consumer credit markets and significant consumer financial vulnerability.

This should see the Insolvency Service adopt a stronger consumer protection stance, addressing distortions in the insolvency market while acting as a cross-government advocate for those who are not currently well-served by the insolvency framework. This would mean particularly speaking up for those struggling with debt who have deficit budgets who are often left with limited options to address debts and can be left in limbo.

A longer term vision could simplify access, costs and flexibility

In the long-term, a sharper focus on outcomes demands a simpler and better joined-up personal insolvency framework. This would mean simplifying the solution mix, rethinking discrepancies in treatment of income, assets and changing circumstances, and a more coherent approach to application fees and funding (including funding of scheme providers).

We hope the Insolvency Service listens to the feedback of the advice sector and debt advice clients when considering options for reform. Consulting on a clearer definition of ‘fresh start’ would be an excellent starting point towards a system of insolvency that delivers for consumers and wider society.

StepChange’s full response to the call for evidence can be found online here.