Advisers say the Financial Services Compensation Scheme could successfully be replaced by private insurance on financial products, as the European parliament prepares to launch a study into alternative investor compensation schemes.
Last week, Money Marketing revealed that long delays are expected in resolving differences on the EU investor compensation scheme proposals after the European commission, parliament and council failed to agree on compensation levels and whether schemes should be pre or post-funded.
The European parliament is launching a study that will focus on possible alternatives or complementary systems to the ICS directive, in particular, the use of private insurance.
A private insurance solution could see investors pay a premium in exchange for cover in the event of a firm defaulting.
Advisers say private insurance could increase transparency on the costs of compensation and help to identify riskier products.
Anand Associates managing director Bhupinder Anand says: “Optional insurance would mean people choose whether they are covered and would echo the transparency agenda in the RDR. Someone would have to pay for it, which would be the consumer, and they should be able to choose whether to take out insurance or not.
“Similar to the way a market for insurance against tax inspections has come about, this would help develop a market for these products and the due diligence that insurers would have to carry out on products could help consumers gauge risk.”
But Anand warns it could put people off financial services. He says: “If an adviser offers insurance with a product, it could suggest there is something wrong with it and spook people.”
Philip J Milton & Company saw a 756 per cent rise in its FSCS levy from 2010 to 2011. Managing director Philip Milton says the firm introduced a 2 per cent charge on top of management fees as “insurance” against the cost. He says: “Making it compulsory would introduce economies of scale and the charges for insurance would be very small but pricing the risk would be a nightmare.”
Evolve director James Norton says the cost of the insurance would need to be kept low. He says: “If people were told there was no FSCS, they might take up insurance if the cost was low but they could be put off by higher costs.”
The FSA has delayed its review of the FSCS’s funding model while the European authorities thrash out the ICS directive. The FSA’s policy statement, scheduled for September, is likely to be delayed.
Under the ICS directive, the European Commission proposes raising the maximum guaranteed compensation from the current €20,000 to €50,000. The parliament agrees but the council only wants it raised to €30,000.
The three bodies agree that individual compensation payouts should be capped at €100,000. The council does not want schemes to be pre-funded, while the commission wants national schemes pre-funded within 10 years and the parliament within five years.
Because of the failure to agree the proposals, the directive is now stuck at the start of a second reading in which the council is supposed to publish its position and the other two institutions propose amendments to it.
However, Rickard Ydrenas, policy adviser to Olle Schmidt, the MEP guiding the ICS directive through parliament, says the council refuses to bring forward a proposal until the parliament clarifies its position, while the parliament cannot publish its position before the council lays out a proposal. In an attempt to break the deadlock, a group of academics charged by the European parliament will now look at alternative funding models and structures. It will meet for the first time next week to set out its terms of reference.
The finalised directive will help inform how the FSCS is funded and the level of cover it offers, thought the FSA has said it could push ahead with its review without clarification from Europe if delays continue.
The FSCS’s compensation limit is currently £50,000 for investments.
Anand says: “The current funding methodology is wrong. Ultimately, consumers should fund the compensation scheme as they are the ultimate beneficiaries.”
Investor compensation scheme directive
- The European Commission proposes raising the maximum guaranteed compensation level from the current €20,000 to €50,000, the parliament agrees but the council wants it raised to €30,000.
- The three bodies agree that individual payouts should be capped at €100,000.
- The council does not want schemes to be pre-funded while the commission wants national schemes funded within 10 years and the parliament within five years.