Financial Services Compensation Scheme Review

Introduction

The FSCS is the UK’s statutory compensation scheme of last resort, which can step in when an authorised financial services firm is unable, or likely to be unable, to pay claims against it. Firms from across the financial services industry pay levies to fund both the FSCS’s operating costs and the compensation it pays out.

The rules for the FSCS were last reviewed in March 2013 when the Financial Services Authority concluded a review of the scheme’s funding and published final rules. Since then, the scale and impact of FSCS levies has risen sharply for some firms.

The FCA is inviting responses on a number of options for changing both the funding of the FSCS and the coverage it provides to consumers.

These are contained in a new Consultation Paper -

CP16/42: Reviewing the funding of the Financial Services Compensation Scheme (FSCS) which was published on  14 December 2016.

This can be seen at -

https://www.fca.org.uk/publications/consultation-papers/cp16-42-reviewing-funding-financial-services-compensation-scheme

Key Points

The scale and impact of FSCS levies has risen sharply for some firms over recent years. The FSCS expects to pay out £136m in claims which is £38m more than the indicative forecast in April this year. There are a number of concerns about the size of the FSCS levies and how they are applied to different sectors. So, this has led to a review of how the scheme may be funded in the future.

Differing options have been proposed by the FCA for changing the FSCS funding model and how it may protect the customer.

Professional Indemnity Insurance

The FCA are looking at whether more comprehensive PII could increase the proportion and value of

claims that are covered by insurance when firms fail (helping to ensure that the FSCS is a fund of last resort, not the first resort).

Introducing product provider contributions

The FCA are looking at the possibility of introducing product provider contributions towards the costs of claims involving intermediary firm failures. This is to reflect the wider responsibility of product providers in this process

Are the funding classes for insurance broking activities meeting the right needs?

The FCA wants to seek views on ways to smooth costs. These include alternative class structures that merge some or all of the different intermediation classes so that investment, life and pensions, home finance and general insurance intermediation may be grouped together, depending on the option.

Risk-based levies

The FCA are looking at whether FSCS levies should better reflect the risks of specific practices, particularly for firms distributing higher risk products. The FCA are also proposing a specific rule to introduce data collection for activities linked to higher risk products to help develop a risk-based approach in future.

It may not just be limited to higher risk products, but the use of perceived higher risk providers such as unrated insurers.

The CP states –

“Recent insurance firm failures suggest that unrated insurers have a higher likelihood of failing than rated insurers. The recent failures of unrated insurers such as Enterprise, a Gibraltar based insurer, left a significant number of customers with financial losses. In some circumstances, these customers have been able to receive protection from the FSCS under PRA rules.

Given the level of risk associated with placing customers with unrated insurers, we are considering whether brokers that place business with them should pay a higher levy than brokers who only deal with rated insurers. The rationale for this would be similar to that for introducing a premium for higher risk investment products.”

This may not come as a great surprise as in addition, we are now seeing PI insurers asking in their new business and renewal processes, details of any unrated insurers used and reasons for use and details of explanations/warnings that are being given to clients.

We have frequently advised on the need for robust due diligence, reviewed on a regular basis and the need to fully explain to clients any risks so that the client can have enough information to make an informed decision.

The FCA is also consulting on some specific proposals to change the scope and operation of FSCS funding (as set out in Appendix 1 of CP16/42) and some brief details are as follows.

Introducing and extending consumer protection

Extending FSCS coverage for some aspects of fund management and introducing it for debt management and structured deposit intermediation.

Additional reporting requirements

This will potentially enable the FCA to introduce risk-based levies in the future and will form part of a larger review of the questions asked in GABRIEL returns where this will become the main means of gathering information about firms and their activities.

Lloyd’s of London

They will consider whether Lloyd’s should contribute appropriately to the pool, to be called upon if the costs in a particular intermediary funding class were so high that they breached the class’ affordability thresholds

Reviewing payment arrangements

Some firms could be asked to pay a proportion of levy on account, aligning the amount of the levy to the years that each element is charged for and enable firms and the FSCS to better plan.

It is worth noting that the FCA also explored several other options, including the FSCS using a credit facility.

Under this approach, the FSCS would use its existing credit facility or a similar facility to both spread the costs of significant levies and make levies generally less volatile and more predictable. However, they are aware that the benefits, may be limited, especially as firms themselves already have access to credit to spread their payments individually.

So, what’s next?

The FCA do not want to see a reduction in the current level of protection for consumers, bearing in mind much is driven by EU regulation, however FSCS’s levies presents a challenge to many levy payers and there has been concerns about fairness and there has long been a criticism that low risk firms end up paying the compensation for those running bigger risks.

The PPI scenario is a prime example where brokers had to “pay” for the misselling of PPI by banks and credit card companies.

As this is a consultation paper there are no immediate actions at this stage, other than to make your views known to the FCA in response to the Consultation. This is the first major review of the FSCS funding model for some time and we would urge all firms to respond to the paper

Responses to the consultation should be received by 31 March 2017. The FCA will consider any feedback and publish their rules in a Statement in 2017. The FCA will also consult further in 2017 on specific proposals in those areas where this paper sets out a range of options.

About the author

Terence is the Compliance Director at RWA. He has over 35 years' experience in the Financial Services environment, covering general insurance, investments and mortgages. Before joining RWA, Terence worked for a large PLC insurance brokerage in Manchester, overseeing some 20 acquisitions. He was made a Director of RWA in 2011 and has worked with insurance broking firms of all sizes across the UK. He has a particular interest in Financial Crime and the protecting the insurance broker. Terence is also Executive Chairman of the Association of Professional Compliance Consultants (APCC), the professional body for the compliance consultancy sector.

Terence Clark

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