The British Insurance Brokers Association (BIBA) addresses the significant increases in the Financial Services Compensation Scheme (FSCS) levy.
How does the FSCS set its levy?
The FSCS is designed to compensate customers in the event of the failure of their financial services provider/intermediary.
The FSCS comprises of five separate ‘pots' of compensation, or classes as the FSA refer to them. Insurance is one class and this is divided into two sub-classes - insurers in one and ‘intermediaries' in the other.
The insurance intermediary sub-class has suffered from a number of firms that have mis-sold PPI (payment protection insurance) being forced to close because they cannot afford to pay compensation to affected customers. When this happens, the FSCS steps in to pay the compensation.
The FSCS has set a budget of £61m to cover likely compensation costs in the insurance intermediary sub-class in the 2010-11 financial year - almost a nine-fold increase on the previous year. This is reflected in the significant year-on-year increase in the FSCS levy.
Why has the FSCS increased the budget so dramatically?
In previous cases of mis-selling, such as pensions and endowment mortgages, a large number of complaints were made to the ombudsman. The ombudsman found heavily in the customers' favour but firms were unable to afford the costs of compensating all affected customers and so closed. This is a pattern we are seeing again with PPI. Remember though that no bank has failed as a result of mis-selling PPI - the problem has largely been created by credit brokers (they have permissions to sell insurance as an intermediary, hence they are in our sub-class).
The level of PPI complaints now dwarfs anything the ombudsman has seen previously. The recently published FOS annual report shows a 58% increase in PPI complaints over the past 12 months, with over 49,000 new PPI complaints received. Of these complaints, the ombudsman upheld 89% of them.
As a result, the FSCS has set an annual budget for our sub-class of £61m.
When did the current FSCS funding model come into place and what was the process?
The FSA first issued a Discussion Paper, DP06/1 in 2006. This suggested changing the old arrangement of 19 different sub-classes into just 5 and offered 4 alternative funding models.
The FSA's preferred option would have created an insurance class with no separation between insurers and intermediaries. BIBA was most concerned with this proposal, remembering the collapse of Independent and the almost £500m impact on the FSCS. In the 5 years prior to the current FSA regime, BIBA established that for every £1 of broker failure, there had been £1,000 of insurer failure. For this reason BIBA employed consultants Europe Economics to prepare an economic study of the FSCS and to propose an alternative.
In our formal response to DP06/1, BIBA submitted Europe Economics' report and suggested that the FSA's preferred option be adjusted to split the insurance class into the two sub-classes we now have.
FSA considered all the replies to DP06/1 and created an industry advisory group to assist in developing and challenging its policy thinking. The group comprised:
Association of British Insurers, Association of Independent Financial Advisers, Association of Private Client Investment Managers and Stockbrokers, British Bankers' Association, British Insurance Brokers' Association, Building Societies Association, Council of Mortgage Lenders, Investment Management Association, London Investment Banking Association, Financial Services Practitioner and Consumer Panels and the FSA Smaller Businesses Practitioner Panel.
The FSA published Consultation Paper CP07/5 in 2007 where it announced that it was proposing to change its preferred option to mirror the suggestion made by BIBA. BIBA submitted a formal response to this paper.
Following the consultation process, FSA announced their final decision in Policy Statement SP07/19 which was published late in 2007.
It is worth bearing in mind the two following important points about the consultation process:
1. The FSA made it clear at the start of their discussions with the industry advisory group that there would be no discussion regarding cross-subsidy - they were going to adopt it regardless.
2. At no stage did the FSA consider creating a specialist sub-class for ‘insurance brokers'. The previous model already had insurance brokers grouped with other firms with insurance intermediary permissions.
What can be done about this?
The FSA has undertaken ‘due process' to arrive at the current funding model and so in the short term there is no quick solution.
However, the FSA has now commenced a fundamental review of the FSCS funding model which we hope will lead to changes in the future.
What is happening with the fundamental review?
Following pressure from BIBA and a number of other trade associations from across the financial services sector, the FSA has now commenced a fundamental review of the FSCS funding model.
The industry advisory group has been recalled, with the addition of LIIBA and has met on three occasions already, BIBA has also met separately with FSA to raise our various concerns. These include:
1. The current funding model is unfair on insurance brokers. The current model is unique to the UK - there is no other state in the EU that exposes insurance brokers to compensate for failures of insurers, let alone failures in other sectors.
2. No insurance broker has closed as a result of mis-selling PPI - indeed most insurance brokers do not sell the product.
3. There must be a viable way of separating our sector from the ‘secondary' players..
4. The nearly 9 fold increase in the FSCS levy is putting a considerable strain on insurance brokers.
As well as considering the make up of the various classes, the review is also likely to consider issues like cross-subsidy, pre-funding and risk-based levies.
Will the FSA consult on this and if so, when?
The FSA hope to be able to publish a Consultation Paper by the end of 2010. When they do, it is very important that members engage with the consultation process - read the paper and formally reply to the questions the paper will raise. BIBA will alert members to the publication of the Consultation Paper and will co-ordinate an appropriate response.
Any new rules are likely to come into effect from April 2012.
As the FSA are being abolished, will the FSCS go with it?
No!
The FSCS will come under the control of the newly created Consumer Protection & Markets Authority (CPMA) as part of the recently announced changes to the regulatory infrastructure.
Furthermore, a banking guarantee scheme directive and an insurance guarantee scheme directive are both in the European pipeline and will introduce minimum arrangements in all the 27 EU States for the first time.
BIBA's advice on what members can do to ensure they are not being overcharged by the FSA?
The FSA base their fees and levies bill on the information firms provide in answer to Section J on the RMAR return. Section J allows firms to provide their ‘eligible claimant income' and it is this figure the FSA use to calculate a firm's FSCS levy.
Eligible claimant income has three component parts:
1. Commissions and fees earned in respect of individuals;
2. Commissions and fees earned in respect of businesses with a turnover of under £1m (if you are not currently recording turnover figures then it might be a good idea to start); and
3. Commissions and fees earned in respect of the two compulsory classes (third party motor and employers' liability).
Whilst the FSA are not necessarily looking for penny-accurate figures, they would expect a reasonably scientific approach to the calculation. So, in respect of number 3 above, we suggest that members do the following:
1. Contact their 3 largest commercial motor insurers in writing (or email) and ask them, as an average, what proportion of the commercial motor premium is made up of the compulsory third party element.
2. Take an average of the 3 replies and use this average figure against your total commercial motor premium to establish the eligible claimant income.
3. Make sure you keep a formal record of this process.
4. Repeat the above steps in respect of commercial combined insurance.
Steve White is head of compliance ands training at BIBA
