How Many Debt Arrangement Schemes Will Be Completed?
17th December 2012
Changes To The Law To Encourage Use Of DAS
The Scottish Government is considering implementing formal debt solution reforms. Concerned to ensure that creditors receive a fair return on what is owed to them, many of the proposed reforms appear to be intended to encourage or force people to use Debt Arrangement Schemes (as opposed to the personal insolvency alternatives).
It would seem to be logical that directing people towards DAS (rather than protected trust deeds or bankruptcy) would improve creditor returns.
Debt Arrangement Scheme Attrition Rates
In many respects, informal debt management plans operate in a similar way to the Debt Arrangement Scheme. While DAS provides a vastly superior level of protection and certainty to a debtor, both types of repayment scheme involve the debtor repaying (in total) the amount that they owe in full.
Debt management plans are frequently criticised for high failure rates. Indeed, it’s well-known that many people who start a DMP fail to complete it.
When purchasing “books” of DMPs from each other, debt management companies take a keen interest in the attrition rate historically associated with the book. This attrition rate determines the likelihood that clients will carry on with their debt management plan and eventually complete it. A “rule of thumb” often mentioned in the debt management market is that the attrition rate might be up to 2% of clients leaving their plan each month (there are DMP providers that believe their attrition rate is significantly lower than this).
Given the similarities between DAS and debt management plan repayment schemes, we were curious to understand the attrition rates that the Debt Arrangement Scheme is experiencing.
Collating Data About DAS
To be able to work out the failure rate of DPPs you need to understand how many are currently active and how many are being revoked.
The Accountant in Bankruptcy does not provide this data in a single format as far as we are aware. They do however provide most of the data required to work this out in their Annual Report and Accounts. We thank the AIB for promptly and courteously providing us directly with completion and revocation statistics (that are yet to be published) for the first quarter of this current financial year.
We do however point out that there appear to be several issues with the AIB’s published DAS data that have made our task a little tricky (and potentially therefore subject to revision). See the Statistical Footnotes at the end of this article. We used the published data (as best as we could where it appears to be contradictory) to try to calculate how many active DAS DPPs currently exist:
* The AIB are re-checking this number. We will amend it if required.
We can see that the number of DPPs being approved has rocketed in recent times. The message about the very significant benefits of DAS (especially in comparison to a DMP) appears to be reaching a much wider audience.
Given the growth in the number of DPPs that are being approved it is natural that there will also be an increase in the number of DPPs that will be revoked. It cannot be expected that any type of debt solution will reach a successful conclusion on every occasion. However, it did seem to us when reviewing the data that the rate of revocations appears to be climbing sharply.
Calculating Debt Arrangement Scheme Failure Rates
From the data table above we can see that at the end of the 2011/12 financial year there may have been 7582 active DPPs.
197 DPPs were revoked during the first quarter of 2012/13. We are assuming that none of these revocations relate to the 1478 DPPs approved during the same quarter. For example, it seems unlikely that a DPP which was approved on May 15th 2012 would have been revoked by June 30th 2012.
Annualising the 197 revocations for the quarter (4 x 197) we might therefore assume that 788 DPPs out of the 7582 that existed on March 31st 2012 could be revoked during the course of the 2012/13 financial year.
This equates to an annual failure rate of 10.39%.
The Cumulative Effect Of A 10.39% Failure Rate
It’s possible to extrapolate a 10.39% failure rate to find out how many Debt Arrangement Schemes are likely to be completed.
For example, of the 8830 active DPPs that existed at the end of the 1st quarter of 2012/13 how many are likely to reach completion?
The answer of course depends upon how long they are expected to run for. The longer the anticipated term of a DAS the fewer that are likely to be completed:
Using the 10.39% attrition rate previously mentioned we can see that:
- Around 72% of three year DPPs will likely be completed.
- The current average term of 6 years and 8 months for a new DPP is likely to be completed by less than half of those that started them.
- Two thirds of 10 year debt arrangements schemes are likely to fail prior to completion.
Low Completion Rates & Diminished Creditor Returns
A 10.39% annual attrition rate is certainly not especially high. For example, it compares very favourably with the figures generally taken as fact in the informal debt management industry. The DAS process generally delivers quality advice, a sound financial structure and incentives (legal protection and cessation of interest). In combination these factors appear to secure a relatively low attrition rate.
Attrition cannot be eliminated. Individuals will inevitably experience changes in circumstances that render DAS either unsuitable or unattractive. The longer their DPP is due to run for the more likely such an event becomes. Motivation will be another key factor. An extremely long DAS is unlikely to encourage high levels of motivation. The longer a DPP is scheduled to last the more likely demotivation will lead to failure prior to completion.
The cumulative effect of attrition becomes increasingly pronounced over time. Nearly three quarters of those starting a 3 year DPP are likely to finish it. Two thirds of those starting a 10 year DPP are likely to see their DAS fail prior to completion. For the current average term (6 years and 8 months) only around 50% of DPPs are likely to be completed. DAS therefore appears best suited to manage relatively modest sums of debt that can be fully repaid in a short period of years.
Encouraging a shift from personal insolvency to DAS might initially appear to be in the best interests of creditors. However, the cumulative effect of revocations over time means that this will not be the case. Creditors clearly cannot have any expectation that anywhere approaching 90% plus of what is owed to them can be delivered (on average) by the Debt Arrangement Scheme.
Persons currently entering protected trust deeds typically have higher levels of debt than those who embark upon DAS. Therefore, should they be encouraged or forced to enter DAS in the future, most are likely to be entering into DPPs with expected terms much longer than the current 6 years and 8 months average. This will lead to extremely high rates of failure in the long-run and therefore significantly diminished creditor returns compared to expectations.
The same principles of attrition can also be applied to protected trust deeds. The current proposal to extend the minimum term of a trust deed to 4 years will also result in higher failure rates. The longer the term of any debt solution, the more pronounced the impact of changed circumstances and reduced motivation will become.
Long DPPs may also come with an extended economic cost. Most disposable income that a family possesses will be paid towards debts in DAS for an extended period of years. A lack of disposable income will leave a family contributing relatively little money into their local, regional and national economies for many years.
The Scottish Government may well be well-intentioned in trying to find ways to ensure that creditors are treated fairly. However, their proposals in respect of directing people away from trust deeds and into Debt Arrangement Schemes are highly unlikely to achieve this goal.
We pointed out last week that the proposed protected trust deed minimum dividend is a disaster waiting to happen. The data on anticipated Debt Arrangement Scheme failure rates in this article further underlines the point. When you dig into the data, forcing people to enter long DPPs will not help most of them out of debt and it will not generally result in their creditors being (almost) fully repaid.
DAS is a terrific scheme that is deservedly now enjoying greater success. For a motivated debtor the opportunity to clear a modest amount of debt, at an affordable rate, while protected from creditors and interest, is a superb prospect that most will value and complete.
Forcing people with much larger debts to enter very long DPPs will crush motivation. Failure rates will soar and creditor returns will crumble. It’s to be hoped that Scottish Government will take notice of this evidence and reconsider their intentions. It would be a shame if an excellent scheme such as DAS were to become tarnished by much higher failure rates and poor creditor returns in the future.
Statistical Footnote – AIB Data Issues
- The 2012 Debt Arrangement Scheme Review states that there were 149 approved DPPs in 2005/6 and 134 in 2006/7. In fact by checking the AIB Annual Report and Accounts for the same years we can see that they have used the number of applications rather than the number of approvals in the data used in the 2012 DAS Review. It appears that the Review should have stated 128 for 2005/06 and 99 for 2006/07. We have used the figures from the Annual Reports.
- The 2012 Debt Arrangement Scheme Review also states that there were 386 approved DPPs in 2008/09. The Annual Report and Accounts for that year states that the figure is 908. The figure of 386 appears to have been taken from the 2008 Debt Arrangement Scheme Review where it is clearly indicated that the figure of 386 relates only to the period April 1st to September 30th 2008. We used the figure of 908.
- The data for approved revocations in the past 5 quarters appears to be contradictory. The AIB Annual Report for 2011/12 states there were 297 approved revocations in the period. The DAS Review covers the period from the 2nd quarter of 2011/12 to the 1st quarter of 2012/13. They report that there were 524 accepted revocations during this period. The AIB informed us that the revocations for 1st quarter 2012/13 were 197. That therefore leaves 327 revocations that must have occurred during Q2/Q3/Q4 of 2011/12. However the 2011/12 financial year in total only had 297 approved revocations (including those from Q1 as well) according to AIB Annual Report and Accounts. It appears to be impossible to reconcile these figures with each other. We used the figures as presented to us but note than some error (which may have led us to understate current Debt Arrangement Scheme attrition rates) may be present.
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