Warning call for complex products

THE risks and costs of financial products are too complicated for many consumers to understand and may need to be spelt out by governments.

Warning call for complex products

THE risks and costs of financial products may need to be spelt out in future, perhaps by governments, because products that have become too complicated for many to understand, a leading financial academic has suggested.

Professor Kevin Davis, director of the Melbourne Centre for Financial Studies, says financial deregulation has brought substantial and widespread economic benefits but has led to greater financial risk being borne by households.

"Many do not properly understand or appreciate the risks, costs, or rewards associated with the range of financial products available and marketed to them,'' he writes in Dialogue, a journal of the Australian Academy of Social Sciences.

"Persistently high profit rates of financial institutions and incomes of financial advisers raise the question of whether, despite competition in financial markets, many consumers pay too much for the financial products they need (or feel they need) to purchase.''

Citing American studies, Professor Davis suggests that confusion over financial products means the financially naive are subsidising sophisticated households.

"No market player has an incentive to eliminate this cross-subsidy,'' he says.

Professor Davis argues that government policies are causing or providing incentives for individuals to take on more financial risk.

"In particular, concessional tax treatment of capital gains income, accompanied by the allowance of negative gearing, gives incentives for socially unproductive financial risk-taking by individuals.''

Superannuation policy is also increasing risk-taking, he says.

"Recent legislation that endorses indirect leverage and increased risk taking by self-managed super funds in instalment warrants has opened the door for an explosion in similar financially engineered products targeted at these funds.''

Professor Davis says the gap between the financial knowledge required and that possessed by many households for effective involvement in the modern financial system has created substantial unresolved problems for policy makers. So far, the answer has been a menu of improving disclosure, education and advice.

However, "financial literacy campaigns, a policy priority (also taken up by financial institutions under their social responsibility charters), while laudable, seem unlikely to make substantial inroads in resolving identified problems''.

In addition to housing affordability for Generations X and Y, Professor Davis identifies three potential future problems for baby boomers: longevity risk, where savings run out before death; high administration costs as self-managed superannuation funds in the pension phase decline in size; and risks from the complexity and irreversibility of contracts used to finance retirement accommodation.