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Freedom of choice

The legal challenge to the Financial Services Compensation Scheme has pushed the issue of compensation funding back into the spotlight.

If there is one thing guaranteed to reduce normally rational IFAs to blind and usually justified fury, it is the cheques they have to pay for Financial Services Compensation Scheme funding. The same applies to a lesser degree to the bills issued by the FSA to cover its costs and the costs of the Financial Ombudsman Service. Finding anyone who is happy with the system is a challenge.

The problem with our system of funding regulation and compensation is the principle that the polluter’s competitors pay. The notion of fee blocks represents different types of business to which expenses are attributed and probably had its origin in the idea that the regulator should not be allowed to fine firms in order to balance its books.

Financial instability marred the records of both Fimbra and Lautro and suspicions about an increase in disciplinary activity in the early 1990s when money was tight lie at the heart of the rule.

The FSCS is essentially an amalgamation of the Investors’ Compensation Scheme, the Deposit Protection Scheme and the Policyholders’ Protection Fund. It was decided in the run-up to 2001 to keep the funding basis for each scheme separate. Why should loan brokers pay when a hole is discovered in an insurer’s books?

It all sounds sensible but unfortunately, it is not. An IFA that does not go bust or is not disciplined is not financially or morally culpable when one of its competitors fails. Nor, since the nature of the IFA market is fragmented, do advisers benefit when their competitors fail.

An adviser in Alnwick gains nothing when a firm in Cornwall goes under. It has been suggested that the current system provides an incentive for IFAs to report each other for misdeeds or financial distress to the regulator. This rarely happen as many businesses think, there but for the grace…

The position sometimes rises to levels of absurdity. In the recent consultation about payment protection insurance complaints, it was pointed out that the loan brokers who did not sell the insurance could fail due to the FSCS levy as a result of those who did, creating an odd near-disincentive to act honourably.

Finding anyone who is happy with the system is a challenge

Sectors of financial activity can be wiped out due to the misbehaviour of a small number of their participants.

In practice, as a result of regular lobbying by Aifa and others, FSCS and FSA funding costs are negotiated annually with insurers and investment providers who usually, but not always, have most to gain from a vibrant IFA sector, stumping up some of the cash.

This ad hoc rescuing of the IFA sector is inherently unsatisfactory. The FOS, with its free cases, came up with a rather neat solution to stop small firms being bullied into conceding complaints because of the costs involved. However, this involved a subsidy from the greater number of small firms that never receive any FOS complaints.

There are reasons for subsidising the regulatory costs of IFAs. Their record at the FOS, of reduced numbers of cases and lower uphold rates allied to persistency figures, suggests a higher level of compliance. Their failures tend to have far less structural impact on the public and the economy as a whole. But it would represent progress if the annual funding negotiations started from a sounder principle.

Funding on the basis of affordability already happens through the sub-divisions within funding blocks.

The obvious next step would be to focus on affordability generally. The attitude that those who can pay most should do so already applies to a large degree. By cutting down the fee blocks except as a broad categorisation for administration purposes, one can avoid the unprincipled polluter’s competitors pay idea.

It would also do away with the absurd arguments as to whether a firm should be categorised as falling within one fee block or another for funding the costs of a clean-up.

The FSA can continue to be required to rebate annual subscriptions by reference to fines collected. However, the rebate would spread across the board. The one company that was not fined because the FSA felt it had done enough to send a message would not receive the full amount of the fee reduction it currently wins. That would not be unreasonable.

None of this provides a perfect answer but funding based purely on affordability and with no regard to fee blocks would appear to be the least worst solution. In any event, it is time for a grown-up discussion on the alternatives.

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Comments

There are 2 comments at the moment, we would love to hear your opinion too.

  1. All good stuff, but what is wrong with the idea of a product levy? Or (even better) a product levy tweaked for the producer, so the product levy would be higher where an investor bought through a bank (banks have a higher incidence of upheld complaints).

    It’s the public who want compensation and ultimately it is the public who pay for it, whether it’s through a share of an introducer’s commission, or a direct product levy.

  2. Obviously the current system is hopeless, not much point trying to tweak it, root and branch is required and as advisers we have to start making and winning this debate.
    Among many other points, 2 key ones are:
    Why cant consumers have choice?? – either to buy products/advice simply, cheaply and easily by dispensing with “protection”, or to choose the full protection process and benefit from it even though it costs them more. E.g you can pay for goods with a credit card and you have protection against bankruptcy of the vendor prior to delivery but it also usually costs a few percent more. Choice. Consumer choice is good. We are all adults.
    Secondly, those who benefit by shifting more product as a result of protection should be the ones who pay the costs of the protection – ultimately it will come from the net returns offered to the customer, who after all will always be the ones who pay one way or another. This way its just more transparent and explicit.
    E.g If I could get 3% on an FSCS protected account, or 4% on a non FSCS account, I’d prob do my homework and take the higher rate. And if my adviser could sort out investment advice for £1,500 instead of £3,000, but I’d have no FSCS protection if he got it wrong, his PI didnt cover it and also went out of business, Id have to trust him and have confidence in him, but Id prob be ok with that too. Just like I would my Doctor, or Dentist, or lawyer. Id like to have the choice available in any event.

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