Beware, the Big O is also watching you

The FSA handbook is the bible of regulation, and a good knowledge of it will see brokers home and dry, and safe from the sharp end of the FSA's arrows. But is that enough?

Anyone who has seen the handbook will appreciate how detailed it is. There are 11 basic principles ranging from conducting business with integrity to taking reasonable care to control affairs responsibly and effectively with adequate risk management systems.

Breaching the principles can lead to disciplinary action although, in itself, a breach won't necessarily lead to a civil claim for damages.

But, in terms of insurance contracts themselves, the 'insurance conduct of business (ICOB) rules apply. And this is where the customer becomes involved.

ICOB recommends that a comprehensive set of information is given to the customer. For instance, information should be presented "clearly, fairly and in a way that does not mislead", taking account of the customer's knowledge.

No one can criticise these requirements. A consumer can expect nothing less than clear, fair and non-misleading information. But how does an intermediary know on which side of the line they fall? They probably can't, at least not with any certainty.And this is far from ideal.

The general nature of the obligations gives consumers ample grounds to complain if things don't go as they expect.

And who does the consumer turn to if things aren't all they wish them to be? Unless the broker and the consumer can resolve their differences, it's the Financial Ombudsman Service (FOS).

FOS has been known to financial advisers for some time. It is less well known to the general insurance market - but it won't be for long.

The organisation was set up to provide an independent, quick, informal and confidential forum to resolve disputes. It is free to the consumer and non binding, but if the consumer accepts FOS' decision it becomes binding on all parties. If not, the consumer is free to move on to court.

How then, does the system work for the brokers and their insurers?

Getting a clear picture of the decisions before FOS is difficult as they are not published. They certainly act as a filter to unmeritorious claims. Of the initial inquiries made to it, only around 18% were converted to cases, but that is still around 110,000 per year, and growing.

So how do you deal with claims that pass the FOS filter?

This is where the general nature of the FSA obligations and the informal nature of FOS may cause a problem.

The FOS does not determine disputes by applying the doctrines of duty, breach and causation in the way a court would.

Its overriding obligation is to determine what is "fair and reasonable" - to the adjudicator and to the ombudsman.

No precedents
No doubt the FOS does all it can to try to approach cases consistently, and summarise some decisions in its publications, but there is no bank of precedents to consider.

Take for instance IFG v The Financial Ombudsman Service (2005).

The clients had money to invest and sought advice from IFG. They would accept a medium level of risk. IFG advised them to invest in two separate funds. Both were high risk investments and both turned out to be a mistake. One of the schemes proved to be particularly disastrous.

The investment manager was dishonest. He charged the scheme's funds to a creditor, causing substantial loss. The clients agreed that IFG could not have anticipated the investment manager's dishonesty and IFG accepted they should not have recommended the investments.

IFG relied upon the conventional principle of causation. It said the losses caused by the dishonesty fell outside the scope of IFG's duty. FOS, for the purposes of the claim itself, accepted IFG's view to be correct.

Nevertheless the ombudsman found the advice to invest was wrong.

He concluded it was neither fair nor reasonable in all the circumstances of the case to reduce the clients' compensation by the amount attributable to the fraud.

IFG sought a judicial review. Permission was refused. How can this be, considering the fact that the FOS did not apply causation principles?

Fundamentally, the ombudsman has to determine the complaint "by reference to what is, in his opinion, fair and reasonable in all the circumstances of the case".

The matters to consider are extensive. However, as appears from the IFG case, so long as the ombudsman takes account of those factors, including English law, the ultimate decision is one for the ombudsman. This is even where an application of English law would result a different decision.

By definition, FOS's decision is subjective. The only effective challenge is by judicial review which will only succeed where the decision is irrational.

Matter of judgment
As the judge said: "What is fair and reasonable will often be a matter of judgment. It may be difficult to articulate where one result is considered to be fair and another to be unfair or insufficiently fair."

This result is probably right.

If the scheme becomes more sophisticated it will lose its informality. That is one of the main reasons it was established. The payback is that FOS can only make a binding award for a maximum of £100,000 - far less than might be awarded by a court. Even that is not clear cut. The FOS can make a direction for a firm to take particular steps. The direction is not caught by the £100,000 limit.

Consider a claim where a client has his house insured.

It burns down and the client seeks an indemnity for the value of the reinstatement with associated costs; much more than £100,000. The insurer declines indemnity. The FOS considers this and concludes the insurer has failed to follow the claims handling rules in ICOB.

The FOS directs the insurer to reconsider the issue of indemnity. Almost certainly that will result in an indemnity being given. The cost to the insurer is much more than the £100,000 limit, but they are required to pay it effectively because of the FOS decision.

The FOS would probably say the dispute before it did not relate to the amount of the indemnity, so the money limit is irrelevant. It is probably right. To the insurer, the only relevant issue is the value of the claim. There is little it can do and it seems to be caught by the informal scheme without the comfort of knowing its exposure is not going to exceed £100,000.

The message to those regulated after 14 January 2005 is to strive to comply with the FSA rules. Be able to demonstrate you can. If you don't you may come under the glare of the FOS. It may be less sophisticated than the court, but that is its aim. It has as many teeth as a court and it can bite hard. Beware. IT

' Niall Innes is a partner at Weightmans in Manchester dealing with professional indemnity claims including proceedings before the FOS