'A substantial step forward': How FSCS bills could fall by over 60%
Advisers could see their Financial Services Compensation Scheme contributions cut by as much as 66 per cent under options set out in the FCA’s consultation on overhauling the scheme’s funding.
The FCA published the long-awaited consultation in December after confirming it would conduct the review in the Financial Advice Market Review last year.
The consultation also includes options for strengthening professional indemnity insurance and updating compensation limits following pension freedoms.
Money Marketing has dug into the proposed funding class options as well as the challenges a risk-based levy presents. Should advisers feel optimistic about the options being considered? Could they stand to benefit from both lower levies and better protection?
Assessing the options
The FCA consultation puts three funding class options on the table and calculates potential cost implications for firms based on claims data from 2011 to 2016.
Advisers would see their contributions reduce under all the options.
Option one is to merge the four current intermediation classes – general insurance, life and pensions, investments, and home finance – with provider contributions.
It is estimated this would lead to a 66 per cent drop in investment adviser bills from £81m to £27m.
It would also see life and pensions advisers’ contributions drop from an average of £44m to £23m. Life and pensions providers, meanwhile, would see their contributions increase from £8m to £22m and investment providers – who currently don’t contribute to any pool – would pay £12m.
Option two suggests merging the life and pensions and investment
intermediary classes but keeping the home finance and general insurance intermediation classes separate. Providers would also contribute
under this option.
Investment advisers would see a potential 45 per cent drop in contributions from £81m to £44m, while life and pension advisers’ levies would decrease from £44m to £37m.
Option three suggests keeping the current intermediary class structure of four separate classes but with increased provider contributions on top. Under this option, investment advisers would see their average contribution reduce by 29 per cent to £57m and life and pensions advisers would see a drop in their average contributions from £44m to £26m.
The FCA also calculates the levy as a proportion of firm’s “annual eligible income”. For investment advisers, options one, two and three would end up at 0.73 per cent, 1.22 per cent and 1.57 per cent respectively.
Apfa director general Chris Hannant says the options in the consultation paper represent a “substantial step forward” for advisers’ levy contributions.
He says: “That is what we have been working over the past year to achieve. We need to take soundings from members but I have a strong suspicion that [option one] would be the one that would be most favoured.
“The reason I hesitate is that some members before have expressed a reluctance not to blur the lines between the classes and some say they don’t want to be in with other advisers because it could turn around and you end up paying for something completely alien.”
Hannant adds any reduction in adviser contributions would be offset against other potential proposals, for example, extending pension compensation limits and possible changes to professional indemnity insurance.
Personal Finance Society chief executive Keith Richards says the options are encouraging and show the regulator has conducted a detailed investigation.
He says: “The discussions were around reorganising the levy and changing the level from various contributors. The FCA has been looking at the cause of the claims versus the population who do not contribute in the first instance.”
In a note sent to members this week, SimplyBiz compliance officer Richard Nuttall says provider contributions will benefit advice firms.
However, he adds because some classes will see an increase in levies, “the cycle of these discussions” could start all over again after the new funding blocks come into effect.
Towards a risk-based levy
The consultation confirms a risk-based levy is under review. The regulator is proposing advisers record sales data about higher risk investment products on their Gabriel returns to find out which firms recommend those products and how much income they earn from them.
In the consultation, the FCA says it explored the relationship between FSCS claims and the sale of specific investment products. It found that between 2013 and 2016, one-third of all FSCS claims were linked with the sale of what it calls “non-mainstream pooled investments” by regulated advisers, including unregulated collective investment schemes, securities issued by some special- purpose vehicles, and units in qualified investor schemes.
The regulator says it intends to investigate this relationship further.
A spokesman says: “We have determined that up to now NMPIs have accounted for a significant volume of FSCS claims but we would want to keep this under review while we collect data from firms on NMPI sales as proposed.
“Once we have the data from firms on NMPI sales, we will then look at whether a risk-based levy would be practicable.”
Tenet group regulatory director Mike O’Brien says it will take time for the data to yield meaningful results.
He says: “The extra reporting requirements are not that onerous but it will take a substantial amount of time for that to be useful in terms of historic sales because a lot of what they capture are new sales.”
Hannant urges the regulator to only collect the data for as long as it needs to; if the data is no longer useful, then advisers should not be made to report it.
Asked if this data should already have been collected by the FCA, Richards says: “What it is saying is that it had not been as apparent to them to examine certain data in the past and reviews like this crystallise thinking to look at what may have been available or to get an increased level of detail. It would be too easy to say they had access to this before why weren’t they paying attention, but it is not always apparent at that point in time.
“There is enough data that the regulator now has, together with the FSCS, to determine where the highest risk of future claims occurs. The difficulty is the extent to which a risk-based levy can work fairly, rather than disproportionately. It depends what products they end up determining as high-risk and then it becomes a question mark on why they allow regulated firms to recommend those products.”
Financial Services Compensation Scheme chief executive Mark Neale
Many advice firms feel FSCS levies are unfair, and they have a point. Our analysis shows around 53 per cent of the £1.4bn we have paid in compensation as a result of the failure of advisers since 2010 was down to a small number of idiosyncratic failures.
Typically, the firms concerned promoted or recommended unregulated and risky investments such as overseas property or bonds secured on second-hand life policies, so-called “death bonds”.
The great majority of advisers would not touch such investments and wonder why they should pick up the bill for firms that do. So why not reflect the risk that different firms present in the levies they pay?
There are, after all, some perfectly good precedents. Most obviously, the Pension Protection Fund rates the risk profile of schemes when
determining its annual levies. There are good reasons for doing this. Fairness is one.
The firms paying our levy support the job the FSCS does in protecting consumers and maintaining public confidence. But they also need to feel the costs are equitably shared.
Good economics is another. Imposing a higher cost for risky behaviour creates the right incentive on firms to act prudently.
I am delighted to see the FCA’s consultation document on FSCS funding, published last month, seeks views on risk-based levies. The key, of course, is to find an objective and acceptable basis for reflecting risk. To command confidence, any method also needs to be straightforward and easily explained. The idea, outlined in the consultation, of charging a levy premium where firms distribute higher risk products such as non-mainstream pooled investments looks to fit these criteria.
Another option might be to discount the levy for firms with fit-for-purpose professional indemnity insurance policies which reduce the risk of insolvency in the face of misselling claims. In any event, the ball is now in the industry’s court. If you support risk-based levies, this is your opportunity to make your voice heard.