should lead to some momentum to overcome inertia as many consumers obtain their most trusted information from others in their circle of friends, family and local community. 15 12. The presence of real, but “hidden” costs, for example the real costs of devoting the time required to assess potential investment options, will also explain some inaction. This is true for households and particularly for organisations, for whom management time and attention is a more closely monitored scare resource. Simplified processes for accessing Green Deal investments (from accredited assessment and installation through to simple and cost-competitive finance packages) should reduce the costs to households and organisations.
Access to Capital and Discount Rates 13. Access to capital: Many households cannot access conventional finance markets to fund energy efficiency improvements, while other households and businesses may face high costs of capital that do not reflect the particular nature of energy efficiency investments i.e. a reliable stream of bill savings. Attaching repayment charges to energy bills should reduce the cost of capital faced by consumers as the cost of default in relation to energy bills is substantially lower than that for consumer credit. This, to a large extent, is the result of consumers‟ unwillingness to risk having their energy supply cut off. The domestic energy bill cost of default runs at circa 1.5% of gross revenue, compared with broader consumer credit costs of default which are significantly higher (see section A below for more details). A key principle of the Green Deal is that only costs which are likely to be offset by savings can be added as a Green Deal charge on energy supply. This principle will be applied to both domestic and non-domestic consumers. This means that Green Deal Finance (GDF) is likely to reduce outgoings, thus improving cash flow and potentially lowering the risk of default on energy bills further (see Section A). Meanwhile, those households currently excluded from capital markets are likely to be able to fund energy efficiency investments at relatively low costs of capital, with interest rates determined, in part, by secondary legislation clarifying the exact terms of where the risk of default on Green Deal payments lies. 14. Credit risks: Adverse selection and moral hazard could undermine confidence in the Green Deal finance arrangements. Finance providers require both an incentive to ensure appropriate risk assessment, and the information to make good risk assessments. The combination of these factors will enable them to offer better financial terms and effectively overcome the barrier outlined above. This suggests that finance providers should be liable for losses associated with their investments. This will incentive them to perform checks on the credentials of customers, installers and assessors and the integrity of the works. However, with energy companies responsible for administering the charge and pursuing missed payments this may result in a moral hazard. Section A.1 discusses these risks and discusses a system to share collected payments in order to ensure that finance providers are liable, but energy companies face an incentive to collect green deal charges that matches their incentive to collect energy bill payments. 15. Private discount rates: High short-run private discount rates16, potentially exacerbated by the information problems highlighted above, mean that consumers are likely to value up-front capital costs substantially more highly than future bill savings. This creates a barrier to the uptake of energy efficiency measures and lead to procrastination over decision making. A potential psychological explanation is that immediate costs and benefits of investments are very real and weighted more heavily in a decision than more distant costs and benefits which are more abstract. The Green Deal finance proposal (see Section A) changes the time profile of the costs and benefits of energy efficiency investments. There would no longer be a large up-front cost, and because of the bill savings principle set out above, the investment would be expected to show a net benefit, or a neutral balance of benefits and costs, in all time periods. By changing the time profile in this way, an investment that had previously been evaluated negatively, would receive a positive evaluation. This exemplifies the broader behavioural point that the way that energy efficiency investments are framed to energy users can affect whether they are likely to be taken up.
Incentive Incompatibility 16. Mismatch of tenure/repayment period: A number of years‟ worth of bill savings are often needed to cover the capital costs of an energy efficiency investment. Occupants may not expect to remain in 15
Cabinet Office and Institute of Government (2010) “MINDSPACE influencing behaviour through public policy”, cites a range of studies that describe situations where people tend to stick to default behaviours, adhere to “norms” of behaviour and respond differently to information that comes from different sources. 16 Individuals‟ discount rates are not consistent over time and can be described by hyperbolic discount functions, where the rate of pure time preference is initially very high but declines over time (Frederick, Loewenstein and O‟Donoghue 2002). 16