Eight ways to measure financial health

• Context
• The study
• Key findings
• Points to consider

Context

Financial inclusion in the United States has evolved significantly in recent years, shifting from its former emphasis on financial literacy and education towards a focus on encouraging behavioural change by improving the financial capability of individual consumers. The Center for Financial Services Innovation (CFSI) introduced a framework for financial health in 2015, taking the discourse beyond knowledge and behaviour towards longer term improved financial outcomes, or financial health. CFSI define financial health as when an individual’s daily routines and behaviours help to build financial resilience to absorb financial shocks, as well as the opportunity to set financial targets and goals.

The study

This 2016 report from CFSI introduced the Financial Health Framework in the United States, showing how eight indicators to measure financial health were developed. Over the course of 2015, the report authors assessed data and insights from the finance sector. The indicators were formed from more than 20 consumer finance studies and from consultations with more than 85 financial service providers and ‘influencers’.

The framework comprised of four components of financial health, each containing two of the indicators to allow an assessment of an individual’s financial health to be made. Benchmarks were used to gauge progress over time, and suggested how the data that was collected could be interpreted.

The aim was for financial companies to collect data on their customers in two forms: financial and survey data. It was assumed that the providers would be able to access administrative or transactional data about their client, while directly asking them the survey questions from the Financial Health Framework.

Key findings

• The research identified four components of financial health - Spend, Save, Borrow and Plan, which was felt mirrored daily financial activities.
• For each component, CFSI identified two indicators of financial health:

Spend

• Spend less than income
• Pay bills on time

Save

• Have sufficient liquid savings
• Have sufficient long-term savings or assets

Borrow

• Have a sustainable debt load
• Have a good credit score

Plan

• Have appropriate insurance
• Plan ahead for financially

For each of these indicators, CFSI identified the data that financial institutions could collect to measure that particular indicator:

Spend

• Difference between income and expenses
• Percentage of bills that are paid on time and in full

Save

• Number of months of living expenses in liquid account balances
• Amount of one’s long-term savings, assets and investments

Borrow

• Debt-to-income ratio
• Credit score or credit quality tier

Plan

• Type and extent of insurance coverage
• Behaviours that demonstrate future financial orientation

The justification for each of the eight indicators was as follows:

1. An individual’s ability to successfully manage cash flow and spend less than their income directly affects their ability to build savings and financial resilience.
2. The extent to which individuals keep up with their bill payments indicates how well they are able to manage their cash flow and day-to-day financial commitments.
3. Having sufficient liquid savings is important for coping with unexpected expenses.
4. Having sufficient long-term savings is necessary to achieve financial security and to be able to make investments in property or education.
5. Having a manageable debt load suggests that people will not be burdened by late payment fees or become overindebted, which could lead to more serious financial difficulties.
6. While not a perfect indicator, credit scores can shed light on an individual’s ability to access low-cost credit and their ability to make the repayments.
7. Appropriate insurance allows people to be more resilient in the face of unexpected expenses, such as a family bereavement or medical fees.
8. Planning ahead indicates that people are mindful of their future and interested in improving their financial situation. CFSI research has shown that planning ahead is highly correlated with financial health.

Points to consider

• Methodological strengths/weaknesses: The methodology appears to be robust and diligent, with systematic research undertaken prior to the conceptualisation of the framework.
• However, the authors acknowledge that many of the aspirational benchmarks given in this report will be beyond the majority of Americans, particularly those that are struggling financially.
• Generalisability/ transferability:This report is of significant interest to policymakers, stakeholders and other parties interested in establishing financial health frameworks.
• The authors stress that while the eight indicators are intended to provide standardisation, they recognise that companies may need to adjust the indicators based on the available data. Likewise, ‘companies can seek innovative ways to aggregate the results, leverage external partnerships, and communicate the results back to customers to help them build financial health’.
• Relevance: While these findings are based on data from a US survey, some of the learning outcomes may be transferrable to a UK context.
• However, this report and the data analysed are now several years old, and there have been numerous changes in both the economy and the regulatory regime since this publication.