Written evidence submitted by the Green Deal Finance Company (HEE0093)

Introduction

1. The Green Deal Finance Company (‘GDFC’) is a not-for-profit company.  It was established to set-up, finance and administer Green Deal Plans (‘Plans’) on behalf of Green Deal Providers (‘Providers’) within the Green Deal framework set up by the previous Coalition Government.  As a debt administration vehicle, the GDFC does not deal directly with consumers or market or sell Plans to them.  Under the framework, these activities are conducted by Providers.

2. The GDFC was staffed at peak activity with some 16 FTEs.  It is currently staffed with 11 FTE reducing to 4 by the end of November 2015.

Executive summary

3. Over the past three years, the GDFC has established a nationwide Pay-As-You-Save (PAYS) infrastructure.  In 2¼ years of operating this infrastructure it set up 13,800 Green Deal finance plans worth nearly £50m for households across the U.K. (excluding Northern Ireland).

4. As a not-for-profit, the GDFC made use of the low default rate of payment of electricity bills to offer Green Deal finance for home energy efficiency measures with a high level of financial inclusivity.  Over 80% of the adult population satisfied the GDFC’s credit threshold and all successful applicants for its finance were offered the same interest rate and terms.

5. As a result of its policies, the GDFC offered the great majority of consumers who had less than prime credit scores more competitive borrowing rates than conventional consumer finance.  Its loans were available to 30% of the U.K. adult population that otherwise could not have accessed credit on reasonable terms, if at all.  The GDFC therefore created a new and competitive form of lending for home energy efficiency which achieved a high level of financial inclusion.

6. There is emerging evidence that the level of arrears in Plan repayments is as good as or better than the original assumptions based on the low default rates of electricity billings.  This could validate PAYS as a prudent form of lending with a high level of financial inclusion to householders to enable them to finance energy efficiency measures in their homes.
7. The GDFC was achieving record levels of growth of some £2.5m of applications a week when the Government decided not to provide further funding to the GDFC.  In response, the GDFC is completing the process of putting its loan book into run-off:  some £93m of Plan repayments will be collected over the term of the Plans and applied to repaying the GDFC’s borrowings used to fund the Plans including £25m of senior debt provided by the Department of Energy and Climate Change (DECC).

8. As a consequence, the GDFC’s infrastructure will remain fully funded for many years.  It will be capable of reactivation to offer Pay-As-You-Save finance for home energy efficiency with new funding that would not need to be provided by Government if the following conditions could be met:-

        default experience over the next 2 to 3 years meets or outperforms original assumptions (as the emerging experience is indicating)

        the performance of the energy suppliers, who collect and pass Green Deal Plan repayments to the GDFC, reaches a uniform standard at the best levels currently being achieved

        the consumer protection regime for the Green Deal is maintained and enforced, particularly in view of the low income and older households taking out Plans

        some outstanding but secondary issues with the Green Deal legal framework are resolved

9. The principal challenge to any policy to reduce U.K. carbon emissions through home energy efficiency is that the cost of efficiency measures is often more than householders are prepared to pay in return for the energy savings and other benefits which the measures generate.  This difference therefore has to be tackled with incentives or regulation.  By maximising the availability to consumers of competitive finance for energy efficiency measures, the GDFC remains capable of reducing the subsidy that would otherwise be required to persuade consumers to implement the measures, or the cost to consumers of complying with regulations.  The GDFC’s infrastructure therefore has the potential to offer significant value to the tax-payer as an instrument of future energy efficiency policy.

10. Any reactivation of the GDFC’s PAYS infrastructure to offer finance for home energy efficiency measures would benefit from the following particular lessons learned:

        lower interest rate:  the interest rate which the GDFC offered was determined by the cost of its finance, which in turn reflected its risks as a start-up venture and the absence of default experience in Plan repayments.  The GDFC’s interest rate was competitive for many but demand would be much more easily established if it could offer a materially lower rate than conventional consumer finance.  This should be possible if the default rate is confirmed as very low while the GDFC completes several years of sustainable operation

        marketing and incentives:  demand for the GDFC’s finance can only develop in proportion to underlying demand for home energy efficiency measures.  This in turn depends on promoting the benefits of home energy efficiency to consumers, generating awareness of the options available, and driving take-up with sufficient incentives.  Any relaunch of PAYS lending, indeed any home energy efficiency programme, will need to be supported by widespread and effective marketing campaigns and an incentive regime that addresses the difference between the cost of measures necessary to achieve carbon reduction and the benefits consumers are prepared to pay for

        an alternative incentive mechanism:  where financial incentives are needed to reduce carbon emissions through home energy efficiency, PAYS lending can be used to apply the incentives by reducing repayments for targeted measures.  This has significant advantages because it reduces the upfront cash incentive required and enables the cost of incentives to be profiled for the long term over the life of the measures, broadly matching the profile of carbon reduction

        increase in selling channels:  the current legal framework permits only one distribution channel for the sale of Green Deal finance:  Green Deal Providers selling in the home.  Demand would benefit by liberalising the way in which consumers can access finance

        reduction in complexity:  the GDFC streamlined the selling process for Green Deal Plans but more could be invested in simplifying the proposition to consumers, making it easier to understand

11. The GDFC is aware that other options for PAYS may be considered alongside the option of reactivating its infrastructure.  The options should be assessed against whether they retain or improve upon the level of financial inclusion and borrowing terms achieved by the GDFC.  Otherwise, such proposals could merely duplicate existing forms of consumer credit.

Background

12. Over the past three years, the GDFC has established a nationwide Pay-As-You-Save (PAYS) infrastructure which it has used to set up nearly 14,000 Green Deal finance plans worth nearly £50m for households across the U.K. (excluding Northern Ireland).  The geographic distribution of Plans, which broadly follows population density, is shown in Figure 1:-

Figure 1:  Geographic distribution of Green Deal Plans

13. In successfully setting up and operating this infrastructure, the GDFC completed the mandate for the company as set out in the Information Memorandum that accompanied its capital-raising in 2013.

14. Further background on Green Deal finance is contained in Appendix 1.

Green Deal finance and financial inclusion

15. The default rate on payment of electricity bills is substantially lower than the default rate for conventional consumer credit because of the need to avoid interruption to electricity supplies.  By making loan repayments part of the electricity bill, the GDFC could make use of the low default rate in two ways.  It could provide finance for energy efficiency measures to a much wider proportion of the population than served by conventional consumer credit providers, and it could offer all applicants for its finance a relatively low interest rate to reflect the low default risk.
16. The GDFC therefore decided to set its credit threshold at as low a level as possible to reflect its not-for-profit status while ensuring that the threshold remained consistent with responsible lending practice.  As a result, based on data provided by the credit reference agency used by the GDFC to assess whether applicants passed its credit threshold, over 80% of the adult U.K. population satisfied the threshold for Green Deal finance.  This compares with conventional unsecured consumer credit, which the GDFC understands is only available on reasonable terms to about half the adult population.  This meant that Green Deal finance was available in principle to about 30% of the population who otherwise could not raise the money to finance the up-front cost of making energy efficiency improvements to their homes.

17. In addition, the GDFC decided to offer the same interest rate and terms to all eligible applicants, consistent with its not-for-profit status and reflecting the anticipated low default risk.  Taking the GDFC’s cost of borrowing and Plan set-up and annual maintenance charges into account, the all-in borrowing cost expressed as an Annualised Percentage Rate (APR) of Plans from 10 to 25 years at loan sizes of £2,500, £3,500 (close to the average Plan size) and £5,000 were as follows:-

Figure 2:  Table of APRs of Green Deal Plans (term in years)

18. The average APR in the GDFC’s book was 8.3% for an average Plan size of £3,600.  Only a 9% of Plans had APRs in excess of 9.0%.  This compares with an average interest rate on 5 year unsecured bank loans to consumers in the U.K. in the year to 30th June 2015 of 9.0%[1] and an average cost of credit card debt of 17.7%[2].  The range in interest rates paid on various types of unsecured consumer finance compared with the average APR on Green Deal finance can be seen in Figure 3 taken from evidence which Frontier Economics provided to the Committee on Climate Change in 2014:-

Figure 3:  Relative consumer credit borrowing costs

19. It was sometimes commented that there are a number of advertised consumer credit and mortgage finance offers with headline APRs which were significantly below the Plan APRs in shown in the table in Figure 2.  However, the Select Committee is asked to note that:

        under the Consumer Credit (Advertisements) Regulations 2010, these offers need only be available to 51% of successful applicants without restriction on what the rest are charged.  In practice, the low APRs advertised are only available to consumers with prime credit scores

        in relation to the mortgage offers, only about one third of households in the U.K. have mortgages.  As a result of facility fees and ancillary costs, it would usually be relatively expensive to finance a borrowing of small amounts by increasing a mortgage facility or re-mortgaging

20. As a result of its policies, the GDFC offered the great majority of borrowers who had less than prime credit scores a more competitive APR than conventional unsecured consumer finance.  This proportion includes 30% of the adult population that otherwise could not access credit on reasonable terms, if at all.  In so doing, the GDFC created a new and competitive form of lending for energy efficiency with a high level of financial inclusion.

Maximising the amount borrowed and repaid out of expected savings

21. By lending against the expectation that whoever is the bill-payer in a property will have a strong propensity to pay for electricity supply, the GDFC could extend the term of Plans towards the expected lifetime of the energy efficiency measures.  This allowed it to offer Plans for up to 25 years, thus maximising the amount of finance which it could offer against a given level of savings under the Golden Rule.  For example, the average Plan in the GDFC’s book was £3,600 over a term of 19 years based on annual savings of £383.  The same savings could only repay a loan of £1,500 over 5 years.  By extending the borrowing term of Plans, the GDFC more than doubled the amount that could be lent against energy savings, so providing a material amount of finance for the measures.

22. Recognising the long term nature of the loans the GDFC made no charges for early repayment.

The GDFC’s loan book

23. On 23rd July, the Government announced its decision not to provide further funding for the GDFC to enable it to continue building demand.  The GDFC ceased quoting for new Plans with immediate effect and implemented preparations to fund all Plans for which it had quoted and to put the loan book of Plans into run-off.  Plan repayments will be collected over the term of the Plans and applied to repaying the GDFC’s borrowings raised to fund the Plans.

24. As at 23rd July 2015, the GDFC had 16,952 Green Deal Plans and applications for Plans on its loan administration system worth £60.75m.  It was receiving record levels of applications for its finance, averaging 667 applications a week worth £2.5m.  In the preceding week the GDFC achieved its highest ever level of 712 applications worth £2.7m.  In the preceding year, weekly application levels had increased threefold and the amount of Plans and applications in process had increased fivefold.  Charts of the growth achieved by the GDFC are shown in Figures 4a and 4b.

Figure 4a:  Green Deal finance growth from inception in May 2013 to July 2015

Figure 4b:  Green Deal finance growth in the year to July 2015

25. Almost all the Plans financed by the GDFC contained at least one of three principal measures:  condensing boilers, solar PV panels, or solid or cavity wall insulation.  A table of the principal measures financed by the GDFC is shown in Figure 5.

Figure 5:  Principal energy efficiency measures financed by the GDFC

26. All the Providers actively selling Green Deal finance and responsible for the growth in demand for Green Deal finance were Small to Medium-sized Enterprises (SMEs).  As at 23rd July, the GDFC was supporting 70 Providers across the country with total allocations of £78m of finance which they could offer their customers to purchase energy efficiency products.  Since the beginning of 2015, 12 Providers had completed induction in the use of the GDFC’s finance and systems, offering the prospect of further growth in Plans demand as they entered the market.

27. To support demand, the GDFC significantly reduced the complexity of the Green Deal Plan process (which it had not designed) and simplified the documentation used by Providers.  It also ran an Assistance Programme helping Providers, almost all being SMEs, overcome commercial and technical matters.

28. Following the Government’s decision, many Providers wound up their Green Deal activities and laid off employees.  A large number of Plans were cancelled prior to installation.  Currently, the GDFC has 13,805 Plans on its loan administration system worth £49.7m, of which it has funded £47.5m and has agreed to fund a further £2.2m on completion of installation.

Make-up of the GDFC’s Plan-holders

29. In analysis undertaken with the credit-reference agency used by the GDFC, the GDFC estimates that about 27% of Plans (c.3,700 Plans) were taken out by householders who otherwise could not raise the money to finance the up-front cost of making energy efficiency improvements to their homes.  In the private rented sector, which accounts for about 1,000 of the Plans funded by the GDFC, the proportion increased to 55%.

30. In addition, the GDFC also analysed the demographics of all Plan applications it received, classifying them into four categories of households based on 14 demographic segments used by the agency:

        a Prime group able to borrow on the best advertised rates

        a High Street group able to access credit on reasonable terms

        a Core Pay-As-You-Save group with reduced access to credit

        a Borderline group with very limited or no access to credit

31. The chart in Figure 6 below shows the distribution of the U.K. household population and of Plan applications across these groups with estimates of each group’s mid-range household income.  It demonstrates that applications for the GDFC’s finance were weighted significantly towards those with lower household incomes.  These generally consisted of older families and retiring or retired households.

32. The GDFC also established that the demographic segments where Green Deal finance was fully or over-weighted accounted for about 2/3rds of the U.K. household population and a similar proportion of the insulation and condensing boiler opportunities in the U.K.’s housing stock:-

Figure 6:  Distribution of U.K. households and Green Deal finance applications across Prime, High Street, Core PAYS and Borderline credit groups

33. Further analysis by the GDFC demonstrates that over three-quarters (78%) of the applications for its finance were from households with income under £30,000.  Only 6% of applications were from households with income over £50,000.  The median household income amongst Plan applications was about £21,500 and the average was about £26,000.  At these levels of household income, the level of repayment is an important factor for the consumer as well as the cost of borrowing in terms of APR.

Repayment performance

34. Green Deal Plan repayments are collected by the major electricity suppliers with their electricity billings and then remitted to the GDFC.  As a consequence, there will be a level of arrears in Plan repayments attributable to the period of time it takes for suppliers to bill, collect, process and remit repayments to the GDFC.

35. Based on the analysis in appendix 2, the emerging evidence indicates that, allowing for the arrears in Plan repayments attributable to supplier processing, the underlying level of consumer arrears and default is meeting or outperforming expectations.  If this continues to be the case, it will validate PAYS as a prudent form of lending with a high level of financial inclusion to enable householders to finance implementation of energy efficiency measures in their homes.

Lessons learned and observations for the future

1.  Financial inclusion

36. The GDFC demonstrated in just 2¼ years of operation that it is possible to lend to consumers on a pay-as-you-save basis with a very high level of financial inclusion, offering loans for energy efficiency measures to over 80% of the population.  The GDFC offered the great majority of consumers who had less than prime credit scores a more competitive interest rate than available from conventional unsecured consumer finance.  It was able to provide an estimated 30% of the population (55% in the private rented sector) access to finance for home energy efficiency measures which they could not otherwise obtain on reasonable terms, if at all.

37. The emerging evidence indicates that, despite the financial inclusivity of the GDFC’s lending policies, the default rate on the Plans is nevertheless very low as a result of the pay-as-you-save mechanism.  If the default rate is confirmed to be very low over the next two to three years, it will validate PAYS lending as a prudent way for householders to finance the implementation of energy efficiency measures.

2.  Role in reducing carbon emissions

38. The principal challenge to any policy objective to reduce U.K. carbon emissions through household energy efficiency is that the cost of efficiency measures is often more than householders (even affluent householders) are prepared to pay in return for the energy savings and other benefits which the measures generate.  This difference therefore has to be addressed through financial incentives (such as the Feed-in Tariff or the Green Deal Home Improvement Fund) or regulation to achieve the required reduction in carbon emissions.  By maximising the availability to consumers of competitive finance for energy efficiency measures, the GDFC was capable of reducing the incentives that would otherwise be required to persuade consumers to implement the measures, or the cost to consumers of complying with new regulations.

39. As a case in point, landlords will be obliged from April 2016 to improve the energy performance of the worst EPC-rated properties in the private rented sector provided there is no upfront cost.  Green Deal finance for energy efficiency measures provided a mechanism for landlords to meet these obligations at no upfront cost by arranging for tenants to repay Plans out of expected savings.
40. Where financial incentives are needed, PAYS lending offers a potentially better way to provide them by reducing repayments for targeted measures e.g. through a subsidised reduction in the interest rate.  This would have important benefits:  it reduces the upfront cash incentive required and enables the cost of incentives to be profiled for the long term over the life of the measures, broadly matching the profile of carbon reduction.  The value of the incentives is also fixed at the outset, so the cost of providing the incentives will gradually decline through inflation.

3.  Consumer protection

41. The Green Deal framework incorporated a significant consumer protection regime in relation to both the assessment and implementation of energy efficiency measures and the sale of Green Deal finance.  This regime included a Code of Practice overseen by the Green Deal Oversight and Registration Body and provided consumers with access to a Green Deal Ombudsman to assess complaints that were not resolved by Providers.

42. The GDFC is strongly supportive of this regime.  The regime is particularly important in view of the demographics of the householders showing a propensity to take out Green Deal finance, which the GDFC’s analysis shows to be people who have low household incomes, and who are principally older families, tenants in privately rented accommodation with low credit scores, and retiring or retired householders, all of whom are more likely to be living in poorly insulated housing.

43. It is essential that the regime is enforced to protect the GDFC’s natural demographic against bad practice and mis-selling.  Ultimately this will ensure the credibility of pay-as-you-save finance and increase its attraction to the people it can naturally assist.

4.  Demand expectations

44. The GDFC implemented a nationwide infrastructure to deliver PAYS and provide the capability to set up, finance and administer Green Deal Plans, as it was mandated to do in its initial capital-raising.  However, demand for Green Deal finance did not build as quickly as had been forecast by founder members of the company together with other stakeholders in the Green Deal.  Low take-up was one of the reasons why Government decided not to continue with the programme.

45. The programme required more time for its development than was originally envisaged in order to overcome very significant challenges that materialised after it was launched.  These included:-

        issues with the Green Deal legal framework which the GDFC worked hard with DECC to resolve

        lack of selling and marketing activity by the major energy suppliers.  As noted in previous evidence to the Committee, the forecast demand build-up relied on significant selling activity by the major energy suppliers using Green Deal finance to mitigate their ‘ECO’ energy efficiency obligations.  However, these obligations were substantially reduced at the end of 2013, effectively eliminating the suppliers’ need to mitigate them

        the constraint on sales channels as a result of the legal framework.  The framework allowed for only one sales channel for the sale of Green Deal finance:  Green Deal Providers selling in the home.  Consumers access finance in a variety of ways and the GDFC made a number of proposals to DECC to liberalise the framework, for example allowing consumers to access finance online

        the complexity of the Green Deal Plan selling process, which made it difficult for consumers to understand.  In response, the GDFC promoted changes to the selling process in 2013 to simplify it significantly.  However, it could be simplified further with changes to liberalise the way in which consumers can access the finance

5.  Future development of PAYS

46. The loan book which the GDFC has created will enable the PAYS infrastructure established by the GDFC to be fully funded for many years from the income stream of £93m of Plan repayments.  It is therefore capable of reactivation to offer PAYS-based lending, building on the lessons learned from the Green Deal programme and using new funding lines which would not need to be provided by Government if the following conditions could be met:-

      default experience over the next 2 to 3 years meets or outperforms original expectations (as the emerging experience may be indicating)

      the performance of all the major energy suppliers in collecting and passing Green Deal Plan repayments to the GDFC reaches a uniform standard at the best levels currently being achieved

      some outstanding albeit secondary issues with the Green Deal legal framework are resolved

47. The GDFC raised its funding on terms agreed at the beginning of 2013 and which reflected benchmarks for borrowing costs at that time and the risks attaching to any start-up venture.  These terms were passed on in the APRs averaging 8.3% which the GDFC offered in financing Plans.  While the rates offered by the GDFC were demonstrably competitive for many, they attracted criticism as being too high and so constraining demand.  Reduction in borrowing costs since 2013, and the GDFC’s improved credit as the sustainable operation which it has now become, mean that the GDFC could raise significantly cheaper finance and offer materially lower rates to consumers to boost demand, if the above conditions were met.

48. Demand for the GDFC’s finance can, however, only develop in proportion to underlying demand for energy efficiency measures.  This in turn depends on promoting the benefits of home energy efficiency to consumers, generating awareness of the options available, and driving take-up with sufficient incentives coupled with readily available finance.  Any relaunch of PAYS lending, indeed any home energy efficiency programme, will need to be supported by a widespread and effective marketing campaigns and an incentive regime that addresses the difference between the cost of measures and the benefits consumers are prepared to pay for.  The finance provided by the GDFC would have the effect of reducing the required scale of such incentives.

49. The GDFC is aware that other options for PAYS may be considered alongside the option of reactivating its infrastructure.  The GDFC recommends that the options are assessed against whether they retain or improve upon the level of financial inclusion and borrowing terms achieved by the GDFC.  Otherwise, such proposals will merely duplicate existing forms of consumer credit and fail to offer additional value.

Green Deal Plan finance

1. Green Deal finance plans are a consumer credit agreement under which householders may borrow money to finance the installation of energy efficiency measures in their homes (such as insulation, condensing boilers and solar panels).

2. The amount householders can borrow is determined by the energy savings expected from the measures they install.  Under the Green Deal framework, Plan repayments in the first year should not exceed typical expected savings (the ‘Golden Rule’) and, on this basis householders can expect to ‘repay as they save’.  In principle, the Golden Rule makes the borrowing under a Green Deal finance plan intrinsically affordable.

3. The calculations of the Golden Rule savings are conducted according to the Government’s Standard Assessment Procedure using assumptions and methodology prepared by an independent body, the Building Research Establishment.

4. A unique feature of Green Deal Plans is that they are attached to a property’s electricity meter and householders repay the borrowings as part of their electricity bills.  Repayments on a Green Deal Plan are treated equally to payments for electricity supply.

5. The Green Deal framework does not apply in Northern Ireland as energy efficiency policy is devolved to the Northern Ireland Assembly.

Repayment performance

1. Green Deal Plan repayments are collected by the electricity suppliers and remitted to the GDFC.

2. The chart in Figure A shows the arrears in Plan repayments as at 30th September 2015.  The arrears experience as a whole would appear to be generally worse than the original assumption which was based on the arrears experience of electricity billings amongst the major suppliers.

Figure A:  Arrears in repayment for Green Deal finance

3. However, there is a wide variation in arrears of Plan repayments across the suppliers as can be seen from Figure B.  This is unlikely to be because particular suppliers are experiencing significantly worse arrears amongst their customers with Green Deal Plans.  Instead the wide disparity is attributable to material delays amongst some suppliers in billing and processing Plan repayments and then remitting them to the GDFC.  The suppliers are generally engaging constructively with the GDFC in addressing and resolving the causes for these delays.

Figure B:  Arrears in repayment for Green Deal finance by energy supplier

4. Figure B also shows that arrears in Plan repayments collected by some suppliers is as good as or better than the original assumption.  This indicates that the underlying level of consumer default is meeting or outperforming expectations.  If this continues to be the case, as this evidence indicates, it will validate PAYS as a prudent form of lending with a high level of financial inclusion to householders to enable them to finance implementation of energy efficiency measures.

5. Analysis by Ofgem of data collected from suppliers indicates that overall arrears levels are at similar levels to the 2012 reference year used in the analysis of anticipated default rates expected for pay-as-you-save finance.  See:  https://www.ofgem.gov.uk/about-us/how-we-work/working-consumers/supplier-performance-social-obligations.

October 2015