Before Christmas the Financial Conduct Authority (FCA) published a raft of proposals for alternative ways to fund the Financial Services Compensation Scheme (FSCS). What is clear is that advisers should respond to the consultation.
But with 31 questions, which of the FCA’s proposals should new model advisers back?
In case December feels like a long time ago, here is a recap of some key proposals:
- Changing professional indemnity (PI) insurance to make it more comprehensive and no longer have exclusions for the insolvency of the policyholder or of the FSCS as a claimant. The FCA floated the idea of mandated policies to improve uniformity across the cover provided.
- The FCA ruled out the introduction of a full product levy, but said it hoped to tie product risk to the levy in other ways, such as via providers. The FCA said it would consider whether it could ‘more clearly link product risk to levies and whether product providers should contribute to claims involving intermediaries’. Providers could be expected to cover costs related to advice firm defaults.
- There was mention of a possible risk-based levy, which would result in firms that recommend high-risk products paying more towards the scheme. If a firm’s behaviour reduces risk it could expect to pay less towards the FSCS, the FCA said.
Ken Davy (pictured above), chairman of SimplyBiz Group, called the current system of funding ‘grotesquely’ unfair and, in the absence of a product levy, would be in favour of getting product providers to contribute more.
‘Product providers and investment houses have more information about the market, as well as which firms are placing business and of what kind, than other financial advisers could possibly have,’ he said.
Even though the FCA ruled out the product levy, Davy said it would have been the ‘simplest and fairest’ solution, as the cost per client would be ‘infinitesimal’.
Phil Melville, director of Berkhamsted-based Argyle Financial Group, said the adviser having liability for the distribution of products was a problem that had ‘plagued the industry
‘Distributors are forced to take out PI insurance to indemnify themselves over something they have no control over, or have made no contribution to,’ he said.
Pressure on providers
Chief executive of the Personal Finance Society (PFS) Keith Richards said he was upset a product levy had been taken off the table, but he would support the proposal to make providers contribute more.
‘While it is disappointing the FCA has effectively ruled out the possibility of introducing a [full] product levy, it has acknowledged there are other ways it could more clearly link product risk to FSCS charges,’ he said.
Mick McAteer (pictured above), director of the Financial Inclusion Centre, said the FCA’s proposal would align consumer and provider interests and reduce mis-selling.
‘If the product manufacturers have to contribute more to the levy they would do more to make sure advisers, or other forms of distributor, understood the products better,’
‘It could be a good way to better align the interests of the product manufacturer and the consumer, because they would exercise more due diligence to make sure the distributor understood what was under the bonnet of the product.’
The idea of a risk-based levy was floated more cautiously than other proposals because the FCA said it needed to examine additional data from intermediary firms before consulting on introducing a risk premium.
Were it to be introduced it could include higher levies for firms that recommend non-mainstream pooled investments, such as unregulated collective investment schemes. Many advisers have said this sounds sensible.
However, Davy said there could be practical impediments to factoring in risk. ‘The problem with a risk-based levy is providers do not know where the risks are until after the event in many cases,’ he said. ‘A risk-based levy is difficult to put into operation, but it should be explored and could play some part in the resolution.’
McAteer asked how the risk rating would be carried out, and who would do it. ‘Who would do the risk assessment?’ he said. ‘Would it be the FCA or would it be an independent body that would allocate different risk to different categories of products and businesses?
‘That can be difficult and there’s bound to be lots of arguments and disputes over the categorisation of different risks and products and lines of business,’ said McAteer.
Chief executive of London-based Capital Asset Management, Alan Smith (pictured above), believes a risk-based levy would redress some of the imbalance in the system.
He said: ‘It means the companies selling these higher risk products would expect to pay a higher percentage of the levy. If that was to happen we should see a corresponding reduction in our contribution. That’s more equitable.’
FCA chief executive Andrew Bailey recently said PI insurance was ‘not reliably performing’ its role to prevent IFAs going out of business. The FCA said there was justification for strengthening PI insurance, through the use of mandatory terms,
The suggestions the FCA has come up with for more comprehensive
PI insurance policies are as follows:
- Getting rid of exclusions for the insolvency of the policyholder or of the FSCS as a claimant (meaning the policy must provide cover for any FSCS claims) regardless of the legal status of the firm.
- Restricted use of limitations (policy exclusions for particular intermediated products).
- Additional restrictions on policy excess levels.
- Additional requirements for legal defence costs.
- Restrictions on requirements for the policyholder to notify the insurer about future possible liabilities, potentially widening the circumstances in which an insurance policy pays out.
- Additional requirements to have in place ‘run-off’ cover.
Shrink the stake
Russel Facer, compliance director at support services provider Threesixty, said reforming PI insurance was crucial to shrinking the total amount paid out by the FSCS each year. ‘The main one for me is getting the cake to be smaller rather than how to divide the cake, because people are always going to be dissatisfied with that [division],’ he said. ‘I think that is where the PI review will become really important.’
Richards said covering insolvent firms ‘sounds fine’ but questioned whether it was possible to force insurers, as ‘commercial entities’, to provide mandated PI insurance cover ‘which in some circumstances could cause unintended failures elsewhere’. So while the PFS chief liked the logic of mandated policies, he believes it could be ‘thwarted by a lack of availability’.
Davy recalled the time in 2002 when the PI market ‘virtually shut down for financial advisers’ and said the FCA would not want to recreate that situation. ‘Although having PI insurance was a requirement to be regulated, over 1,000 firms could not get PI insurance…because it was increasingly difficult to get the underwriter to pick up the pen to underwrite advice.’
Matt Connell (pictured above), head of regulatory development at Zurich UK Life, supported the idea of strengthening requirements to have ‘run-off’ cover.
‘There is an opportunity to have run-off insurance, to replace the current situation and make it fairer and clearer. The only issue is it is already difficult for some advisers to get liability insurance let alone run-off insurance,’ said Connell.
Connell believes advice needs a statutory-backed insurer as a last resort because FSCS has assumed this role. ‘In a lot of insurance markets, customers who cannot find that insurance have access to an insurance pool that isn’t run on a commercial basis. It offers people cover regardless of commercial underwriting considerations. The FCA should consider that kind of arrangement in PI insurance.’
Connell claimed this would address some of the issues IFAs face around indefinite liability and lack of a long-stop.
Chris Hannant, director general of the Association of Professional Financial Advisers, encouraged advisers to respond to the whole body of proposals rather than individual ones. ‘I don’t think you can take one bit out and ignore the rest when responding,’ he said.
‘The FCA said to me some areas are [at earlier stages] than others, and those are the long-term changes that will be making a difference to advisers and their firms.’
Smith said the FCA seemed to be more engaged than in previous years ‘and has come up with some sensible solutions’. He said he would be making a submission, so at the very least, he can make his thoughts known and welcome the regulator’s progress.
The FCA set out how savings could be made through a three different options for reducing FSCS bills in its paper.
The first option, to merge all intermediaries into one, would have cut investment advisers' bill from £81 million to £27 million on average between 2011 and 2016. For pensions advisers the figure would be cut from £44 million to £23 million.
The second option is to merge life and pensions and investment intermediaries but to keep other advisers separate. This would have cut investment advisers' levy to £44 million and life and pensions advisers' levy to £37 million.
The final option is to keep existing intermediary groups but ask providers to pay more. This would have cut the investment advice levy to £57 million and life and the life and pensions advice levy to £26 million.
Read the full paper here.