A long-awaited set of reforms to the Financial Services Compensation Scheme is set to shake up how redress for bad advice will be paid for.
However, the future of how the scheme is funded is still up in the air as the industry has been asked to come back with further feedback to the FCA. While some believe that the proposals could radically cut adviser bills, others are concerned that reform will end up just tinkering around the edges of the lifeboat fund.
Providers to pay out
One of the key proposals put out to consultation would require product providers to contribute around a quarter of the bills that fall across adviser funding classes.
This has received a particularly warm welcome from the advice community.
Last year the FSCS paid out £375m in compensation, responding to almost 37,000 claims. The figure included £50m paid out for the failures of insurance companies like Enterprise and Gable, which affected more than 730,000 policyholders.
For the 2017/18 financial year, the FSCS has levied firms a total of £363m. Of that, life and pensions advisers will pay £100m, investment intermediaries £88m and general insurance intermediaries £18m.
As Personal Investment Management and Financial Advice Association director of regulation Ian Cornwall notes, “product providers also benefit from the increased consumer confidence that a compensation scheme provides to investors”.
Investment Quorum chief executive Lee Robertson says: “Providers are queuing up at advisers’ doors with their products, but when they don’t perform as expected they are nowhere to be found and advisers carry the can. There has to be a sharing of responsibility.”
Shore Financial Planning director Ben Yearsley agrees: “Some of the higher profile claims against the scheme have been due to poor products from groups so I do broadly agree they should be doing more.”
Those close to the review say the proposal comes despite vociferous campaigning by provider representatives. One senior FCA staffer described the idea of upping provider contributions as “going down like a lead balloon” when it was raised with them.
Association of British Insurers director general Huw Evans says: “The FCA’s proposal gets the balance wrong and seems to go against the fundamental principles of FSCS funding – that those responsible for the failures are the ones who pay.”
He says asking providers to contribute to the scheme when they do not control how products are sold is “entirely misplaced”.
Adviser trade body Apfa had lobbied in favour of provider contributions before merging with the Wealth Management Association to become Pimfa earlier this year. It has not had things all its own way though.
Investment Quorum chief executive
People complain when the regulator is too prescriptive, but then they don’t like it when its scant on the detail. We know there is a problem or the scheme wouldn’t be paying out so much, and this is an opportunity for the industry to come up with the ideas of what to do about it.
As Apfa did, Pimfa will continue to campaign for unregulated investments to be taken out of FSCS coverage completely, even as FCA policy director David Geale suggested this was not on the regulator’s mind when going through the review when he spoke to Money Marketing last week.
Richmond House Group managing director and Pimfa board member Paul Beasley says: “Pimfa is not letting this drop. Unregulated investments should mean exactly that, with no compensation, or no compensation by the back door if you like. We will continue our lobbying in the strongest possible terms.”
PI dodges the pain
Professional indemnity insurers are one group that seems to have made a success of its campaigning.
In its original consultation in December last year, the FCA said its analysis had shown that strengthening PI by introducing measures like mandatory terms, additional requirements to have “run-off cover” in place or restricting excess levels and limitations would be justified. This would mean that professional indemnity insurers would end up covering more of the claims that are currently fielded by the FSCS.
However, the only proposals now consulted on surround whether advisers should have to pay into a trust account or purchase a surety bond to improve coverage, and a possible requirement to stop some PI policies having a specific exclusion for insolvency which would discount the FSCS from making a claim.
Geale told Money Marketing that while the regulator’s concerns had not gone away, further analysis had suggested a more radical overhaul could force providers out of the market, running the risk of firms being left without cover or with more expensive policies.
This is a point that had been made by a number of professional indemnity insurers in meetings with the FCA, Money Marketing understands.
Shuffling the deckchairs?
Some of the other thoughts put out to discussion also address areas that may not seem core to the FSCS’s operation. However, these could still put downward pressure on IFA levies.
Currently, there are a number of separate funding pools for advisers. Investment intermediation is split from pensions advice, for example, so adviser fees are calculated on how much business they do in each area respectively and then added together for a total.
The FCA plans to merge these two classes so advisers are billed only on overall revenue.
Yellowtail Financial Planning director Dennis Hall notes: “As an adviser, business is business, and doing that sum each year is a complete pain.”
The future of FSCS: Where we stand
Changes coming into force
- introducing FSCS coverage for debt management firms
- extending coverage in respect of fund management
- applying FSCS protection to advice and intermediation of structured deposits
- requiring the Society of Lloyds to contribute to the retail pool
- introducing additional reporting requirements which will potentially enable the FCA to introduce risk-based levies in the future
- amending payment arrangements
Changes out to consultation
- merging the Life and Pensions and Investment Intermediation funding classes
- requiring product providers to contribute around 25 per cent of the compensation costs which fall to the intermediation classes
- moving pure protection intermediation from the Life and Pensions funding class to the General Insurance Distribution class
- increasing the FSCS compensation limit for investment provision, investment intermediation, home finance and debt management claims to £85,000
While it may not appear to be a significant change, it could save small investment advisers £1,500 a year, and medium-sized investment advisers £28,000, the FCA calculates.
Life and pensions advisers would see an even larger proportional drop. Small firms in the class could see their average annual levy drop from £9,000 to £5,846, with more than £60,000 saved for medium sized firms.
When it comes to provider contributions, the FCA estimates investment advisers could see their levy fall from the current level of 2.26 per cent of their annual eligible income to just 1.38 per cent if the move went ahead.
Small firms will not be subject to a new fixed levy but this could have actually increase the amount charged.
After initially posing the question, the FCA said the majority of those who responded said small firms would not necessarily pose less risk, and the reduction in levy volatility between years would have been offset by higher costs.
The FCA paper reads: “Our analysis showed the minimum levy we would have to set is higher than many of these firms have previously paid.”
The cost of the levy is one thing but it’s about how you change behaviour to get to the point where people don’t have to make a claim
However, other tweaks appear to work in favour of consumers rather than advisers.
An example is plans to increase the FSCS compensation limit for investment provision, investment intermediation, home finance and debt management claims to £85,000 from its current £50,000.
While this will have an upward effect on fees, the FCA argues it will be offset by the other measures and by better consumer outcomes and greater trust.
A data analysis shows the adviser classes would have seen compensation payouts increase by around £24m a year if the new limit had been in place in the run-up to the pension freedoms.
However, nearly half of all life and pensions advice claimants did not receive the full compensation for their claims between 2010 and 2014. This would have fallen to just 3.8 per cent, a significant benefit for consumers.
A 64 per cent drop in investment claims that were less than fully compensated would have left just 2.5 per cent unfulfilled.
Cornwall says rather than focusing on “how the compensation cake is divided and paid for” there should be a focus on “reducing the size of the cake”.
He says: “The overriding problem is the quantum of the levy and the high level of compensation.”
Hall adds: “The cost of the levy is one thing but it’s about how you change behaviour to get to the point where people don’t have to make a claim. And there’s very little in these proposals which will do that.”
Diving into the detail
Others ideas are still only loosely formed, such as the idea of a PI surety bond, so it is uncertain how big an impact they could have.
As Hall notes, setting this too high would counteract any other decreases in bills and, at its worse, could lead firms to go out of business. Set it too low, however, and there would be no discernible impact on reducing total FSCS payouts.
Cornwall says: “The consultation paper does not contain sufficient detail to gain an understanding as to how the rules would operate.”
We also still don’t know if the regulator will end up introducing a risk-based levy, though it has confirmed it will start collecting data on risky product sales through advisers’ Gabriel returns from next April, what it calls “non-mainstream pooled investments”, with “unusual, speculative or complex assets” such as unregulated collective investment schemes included.
Risk has been a feature of Sipp investments in particular. Some £105m of last year’s compensation bill was paid to those who were wrongly advised to move their retirement savings into risky assets held in Sipps, up from £78m the previous year.
Introducing risk-based levies would still divide advisers, however.
Hall says: “The compensation scheme is about bad advice. And just because an investment is perceived as riskier it doesn’t mean it is bad advice to suggest it. There is a danger this ends up restricting the market, or that the higher regulation costs are simply passed on to the consumer.”
Adviser trade body Libertatem has also previously spoken out against risk-based levies, arguing they could put the financial stability of advisers’ businesses under pressure.
Director general Garry Heath said in a letter to members last year: “For this to work, a significant number of advisers would have to be [classified as risky], otherwise why bother? Those designated as being risky are likely to face both higher FSCS charges and higher professional indemnity charges, thus compromising the financial health of their business.
“They are therefore more likely to fail, and to phoenix, so we end up with less advisers paying more FSCS charges.
“Ideas such as risk-charging are divisive within the sector and are doomed to fail.”
However, Robertson sounds a more optimistic note: “There is more work that needs to be done, but we are an industry full of bright people and I’m sure we can agree what is risky and what isn’t.”
The FCA consultation closes at the end of January 2018, in time for a final policy statement to be published in the second quarter of next year.
Expert view: You can’t have winners without losers
There is no solution that suits everyone when it comes to funding the compensation scheme. It is a zero sum game; it is not possible to have winners without there being losers. Much debate was held in relation to how best to split the proverbial compensation cake at various roundtables at the FCA, suffice to say everyone wanted a smaller slice. In practice, everyone would rather there be a smaller cake.
It was good to see a chapter focused on ‘reducing the size of the bill’. Taking steps to focus on risk areas and proactively taking steps where possible is positive. What form this monitoring will take we will have to wait and see, but increased attention is only to be expected as the regulator works its way through the value chain: asset managers, platforms, and, next year, advisers.
If you spend only a little time on the paper, do consider the first three questions that ask for opinions on ideas for reducing the compensation cake and potentially increasing the likelihood that the polluter pays.
PS: The thought of just reducing what is covered by the scheme or introducing the long stop (that is, the level of protection afforded to consumers) is a hard sell to the public and if you are an MP looking for votes, unlikely to be approved anytime in the near future. Therefore worth crossing this one out and adding something else to your Christmas wish list.
Russell Facer is managing director at Threesixty