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Basic instinct

The Financial Services Compensation Scheme compensates customers of insolvent financial services firms. It gives customers confidence that most of their capital is secure and so helps encourage saving and investment. It has a small staff and resolved nearly 26,000 cases last year.

The FSCS is paid for by the financial services industry, through levies. These levies are split between groups of companies, each consisting of different types of firm. Each group is responsible for covering the cost of defaults in its own sector.

These arrangements pose two potential problems. First, in the event of a run on its funds, there is no safety valve permitting the FSCS to defer payments. Second, high levies on particular groups of firms may be more than those firms can afford to pay. For example, the FSA is concerned that IFAs may not be able to afford to cover their own default costs. These problems need to be addressed. The question is when, and in what order.

Some people have argued that, for example, insurers should be required to cover some of the costs which would otherwise fall on IFAs – as has happened on a voluntary basis in the past. The Association of British Insurers does not favour this.

The FSA has proposed a number of possible solutions. Each would spread the cost of the levies across bigger and broader groups. The FSA’s favoured option is that levy costs would first be shared between all members of the relevant group and any shortfall would then be spread over all groups.

Of the FSA’s options, the ABI would prefer a division of the market into five main groups, each further sub-divided as appropriate, but with no additional general pool.

The FSA’s proposals have generated debate but no consensus. The ABI believes the question of the funding mechanism cannot be dealt with sensibly until other, more fundamental, issues have been sorted out.

The real problems facing the IFA sector are under-capitalisation, the age profile of the market and the reputational challenges which affect the financial services industry as a whole.

There are also major changes in the market – including depolarisation – the results of which are, as yet, far from clear.

We face the danger that by changing the FSCS funding mechanism now, we will find we have partly solved today’s problems without considering tomorrow’s landscape. We need to make progress on the more fundamental issues first.

The FSA will have a major part to play in dealing with these. It has just started a major review of where the distribution market is heading. It also has work in hand on the division of regulatory responsibilities between providers and distributors – work in which the ABI and Aifa are jointly involved through the ABI’s new customer impact scheme. The FSA can also sensibly take a look at how capital adequacy in the IFA sector could be enhanced, which would reduce failures and the cost of the levies.

Others are contributing. For example, the Chartered Insurance Institute recently launched its life and pensions faculty, which the ABI fully supports. This aims to boost the professionalism and status of advisers, which should enable the profession to attract and retain able people who will build the reputation, and profitability, of the industry.

The work that the ABI is doing jointly with Aifa to improve service to intermediaries and clarify responsibilities ought to help productivity. The ABI also plans new research on consumer savings’ behaviour and persistency so we can understand customers’ service needs better.

All this work needs time. We need a clearer view of where the intermediary market is heading. To try to change FSCS funding now would be to put the cart before the horse. Simply sharing a high levy in a different way could lock in some of the dysfunctional aspects of the system, including unnecessarily high costs. This would suck value out of the industry which would have been better invested in reforms to reduce the rate and scale of company failures in the first place.

Let us pursue these reforms first, and then redesign the funding system to build on success.

Stephen Haddrill is director general of the Association of British Insurers


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