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Unconvinced on capital adequacy

Martin Archer, legal and claims director at PI insurer Collegiate Management Services, believes that capital adequacy is less important than a company’s reputation and calls on the advice industry to “grow up” on responsibility for rubbish products

The FSA states that there is “no agreed wisdom on which parameter is the best or even reliable predictor of misselling that would support a variable capital resource requirement”. To my mind that is the start and end of it.

Though I have had the privilege of working with many of the best underwriters in the class it is ultimately an art, not a science. Whilst you can introduce formal systems to try and sort the wheat from the chaff there are no hard and fast rules and ultimately it comes down to the individual underwriter’s skill and judgement. If it were to be carried out by a regulator and the resultant bill imposed by dictate (rather than just a competing quote in a free market), it would be impossible to justify.

The FSA suggests it could look at qualifications, areas of business, turnover, compliance systems, audit and length of tail, but how they inter-relate to risk is extremely complex and ever changing and, in my opinion, would be a wholly unsuitable way for a regulator to try and set capital adequacy.

Not only would they utterly fail in getting it right to any reliable extent, the cost of attempting to do so would be completely disproportionate to the benefit of any marginal difference in capital adequacy, which in any event bears no relation whatsoever to the likelihood of misselling.

I am a great believer in training and qualifications as a way of minimising the risk of misselling. It seems to me that there are two key factors in play with qualifications and training.

The first is simply the more you understand about the very complex area of financial advice, the less likely you are to make errors and/or gullibly believe the promotional patter of provider representatives. Second, is the pure investment of time and effort committed by the adviser.

Whilst much is made in the discussion paper of the investment by the owner in the business, to my mind the absolute key thing is the investment made by the individual advisers giving the advice. If an adviser has had to work really hard to get properly qualified to call himself a professional then he is committed to the industry and has a very significant personal stake in his own reputation.

To my mind it is this issue that explains why the product providers with all their enormous resources and capital fail to match the claims experience of independent financial advisers. It is much harder to be an IFA than it is to be a sales rep for a product provider. You cannot rely on your product provider’s enormous advertising budget to maintain your reputation. You know that your reputation in your area is down to you and you cannot be anonymous. The more a person invests in their career the less likely they are to be reckless with their reputation for short term gain.

For that reason I am not at all convinced that capital adequacy has any part to play, as the value of a company’s reputation will always be worth much more. If one was to differentiate between classes of business then giving an incentive for firms to invest in their staff through training and qualifications would at least make some sense to me.

The paper also makes mention of capital adequacy dealing with the burden of the FSCS, it has always amazed me the sheer number of sole traders and partnerships that are declared in default by the FSCS. In my experience the reality is not that the sole traders or partners are bankrupt, rather that they simply fail to return the FSCS’s form or co-operate with the FSCS’s enquiries. To minimise any inconvenience to the consumer the FSCS then declares the firm in default and pays claims.

Whilst theoretically the FSCS takes subrogation rights and can pursue the non-co-operating sole trader/partners, the practical difficulties associated with subrogated claims are such that the majority of recovery actions get written off.

If the industry was serious about wanting to reduce the FSCS levy, a good place in my opinion to start would be to refuse to consider a consumers claim against a sole trader or partnership until at least one consumer had obtained an unsatisfied judgement against the firm.

If the sole trader or firm is really without assets then the consumer can obtain this with the minimum of fuss by way of a judgement in default. However, in the majority of cases these claims would end up being defended and successfully at that. Those consumers that had good claims would more often than not be paid by the firm as the firms do have assets and often run off PI.

The FSCS pays many millions of pounds out to undeserving claimants because, being fair to them, it is very difficult to defend claims if the adviser does not provide his file or assist the defence. If the FSCS were a lot slower to declare sole traders and partnerships in default until they truly are satisfied they are not able to meet their liabilities then this would reduce significantly, in my opinion, the FSCS levy and would encourage more firms to buy run off cover.

With limited liability companies, it is much more likely that they will fall into default once they have ceased to trade. Once there is no income coming into the business, there is no good reason not to advertise for creditors and then carry out an orderly winding up, with the remaining assets returned to shareholders.

Claims will invariably come in after the winding up and fall to the FSCS. It seems to me there is a very great difference between a sole trader/partnership and a limited liability company. Any professional trading as a sole trader or a partnership is going to be very concerned about misselling claims because they know that if the system is working correctly they take those liabilities to the grave. Clearly on that basis there is some rationale for a making a capital adequacy distinction between sole trader/partnerships and limited companies.

Making a higher capital adequacy requirement for limited companies would however probably serve no purpose because on liquidation the capital would still be exhausted on fees. However, there is an argument that a limited companies contribution to the FSCS’s levy ought to be higher than a sole trader or partnership, particularly if the FSCS raised their game on who they declare in default.

Finally, the suggestion that product providers take some responsibility for their products ought not to be a serious one if advisers have any claim to being a profession.

Product providers ought to have the freedom to put toxic, dangerous, useless products out there and IFAs ought to be confident that they will not sell them. We need product providers to be innovative and unfettered. If they give advice on their products then clearly they are responsible for that, but the advice industry, if it is to be a profession, must grow up and accept responsibility for spotting rubbish products.

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