With massive compensation disparities for consumers, Andrew Paddick argues that the Financial Services Compensation Scheme urgently needs an overhaul
The FSA will shortly be issuing a consultation paper on the future funding of the Financial Services Compensation Scheme (FSCS) and
I am very pleased that the IIB has persuaded the FSA to incorporate product/services levies as one of the options for consideration.
As it currently stands, the so-called scheme is completely inconsistent, created by just throwing all the previously independent schemes into a filing cabinet and naming it the FSCS.
Just consider the following scenarios:
•Your £500,000 house burns down but the insurer has gone into liquidation. You will receive 100% of the first £2,000 plus 90% of the residue, with total compensation at £450,200. This means a personal loss of £49,800.
•Your £500,000 house burns down but your broker forgot to renew the policy. They also forgot to renew their own PI and have no assets. The total compensation will be £450,200, with a personal loss of £49,800.
•You sold your house for £500,000 and put the money on deposit, awaiting completion of your new house. In the meantime a rogue trader causes the bank to collapse. You will receive 100% of the first £2,000, plus 90% of the next £33,000 - total compensation £31,700. This is a personal loss of £468,300.
•You effected a 100% interest-only mortgage on a £500,000 house and were advised, as a higher rate taxpayer, to link this to a personal pension plan, using the tax-free lump sum to discharge the outstanding capital balance. The risk warnings were grossly inadequate, especially as the mortgage/investment adviser (now a departed firm) had utilised volatile global commodity funds, which crashed just weeks before the time they were needed, becoming virtually worthless. You will receive 100% of the first £30,000 and 90% of the next £20,000 - total compensation of £48,000 and a personal loss of £452,000.
How can these enormous disparities ever be justified from a consumer perspective?
My above scenarios do not include examples of the unlimited liability underwritten by general insurance brokers and imposed upon them by the FSA. Just suppose that a cover note had not been issued for the vehicle which caused the £75m+ Selby rail crash and, worse still, that the train coming the other way had not managed to stop in time.
With unlimited liability, even doomsday- type scenarios need to be considered properly, because they are always a possibility. It is just not good enough for the regulator to adopt a myopic 'fingers crossed' attitude - indeed it is downright irresponsible to do so.
The only way a harmonised, consistent and sustainable FSCS can be operated in the consumer interest is to fund it via product/services levies charged at the point of sale, as a type of premium for the extra protection provided. The product providers already cost the various industry levies into their pricing structures. So in reality they are already paid for by consumers - not directors, staff or shareholders. However, intermediaries are unable to do this because they do not produce, control or price the actual product. All contributions paid for by intermediaries come straight off their bottom lines - in effect the income they need to support themselves and their families.
The current FSCS thinking is perverse, because it is based on the notion that, for example, if an IFA has a large number of low-cost endowment mortgage shortfall claims they cannot pay, then it is the responsibility of all other IFAs to compensate the victims.
This is akin to saying that if a radical member of a religious group caused massive damage, then all other innocent members of that particular faith should pay restitution. In the UK, this would be considered morally and politically outrageous, yet is exactly what the FSCS does at present to entirely innocent IFAs and brokers.
For these reasons, it is my very strong opinion that the FSCS needs a complete overhaul, in addition to just looking at the funding options. There are historic rules within what are now the old schemes, inherited and maintained by the FSCS without a thought of sensible amendment to take more modern business practices into account. For example, brokers picking up the full premium liability for failed insurance companies (such as Independent) where premiums were paid by credit card. This was not envisaged when the Policyholders' Protection Act was written.
I am not personally suggesting what the individual compensation limits should be in future, but as illustrated by the earlier scenarios, consumers and those representing them are bound to be very concerned once they appreciate the scale of current anomalies. However, I do not like the idea of unlimited compensation, because it could prove unaffordable at a certain point.
Would it be justified for the owner of a grade 1 listed Elizabethan stately home, which burned down with a restoration cost of £500m, to obtain unlimited compensation due to a broker's error or omission, or should individual compensation be limited to £1m to cater for the majority of ordinary consumers?
I am only asking the question, because these will be important considerations, especially if the compensation entitlement for deposit accounts and investments are to be equalised with general insurance (and there is no logical reason why they should not) - which would result in substantial increases.
It may well be that the limit arising from general insurance advising/arranging should be reduced from unlimited to, say, £1m, except in respect of legal liability arising from compulsory classes of insurance. These could be third-party motor and employer's liability for domestic and small firms. There is bound to be much consultation on these issues, if the FSA is bold and responsible enough to formally raise them. Not to do so would be a dereliction of its duties outlined in the Financial Services and Markets Act.
After robust lobbying by the IIB, the FSA will be considering FSCS product levies in its forthcoming consultation and I do hope that we will have the support of both Biba and AIFA in pursuing this vital option to a satisfactory outcome. However, I believe that the consultation should go much further than just funding in isolation. IT
Andrew Paddick is IIB director general