Is the FCA seeking to introduce minimum terms for IFAs by the back door?
The FCA has released a consultation paper on its review of the funding of the Financial Services Compensation Scheme ("FSCS"). The consultation has put forward some interesting and significant proposals in relation to how PII in the financial services industry ought to be revised, in order to support the FSCS. DWF will be submitting a response and is looking for comment from Insurers either on a named or confidential basis to include as part of that response.
During the 2015/16 financial year, the FSCS paid out £271m in compensation to consumers and received over 46,000 new claims. The cost of maintaining the FSCS has led to the FCA releasing a consultation paper in order to review how the FSCS is currently funded and how this might be improved in the future.
The FSCS is currently funded by way of levies from the financial services industry; a management expenses levy and a compensation costs levy; the latter of which can vary significantly from year to year. The FCA note, in particular, that the cost of levies has risen sharply for some firms over recent years and has led to calls for a rethink as to how funding might be managed going forward. The consultation paper therefore focusses on how the compensation costs levies might be improved so as to ensure sufficient funding to compensate claimants in the future, based on a model wherein those firms that benefit the most from the FSCS provisions (i.e. those which give rise to a greater number of compensation pay outs), pay proportionately towards it.
However, the FCA also note that the FSCS has increasingly taken on the role of "first line of defence" when a firm fails and thus the FCA has emphasised a desire for PII to "act as a 'front stop'" and effectively pick up some of the cost of compensating claimants; costs which the FCA say are currently primarily falling to the FSCS. This follows the comments of the chief executive of the FCA, Andrew Bailey, at the ABI annual conference, wherein he called for insurers to input their ideas as to how the PII market and the FSCS might work together more effectively so as to prevent the FSCS becoming the primary line of defence.
The current PII requirements
In 2003, following many financial advisers failure to find cover, the FSA more or less dispensed with the minimum terms of cover, with the aim of making financial advisers more attractive as a risk, reducing firms' exposure to large premium increases during any price cycle in the PII market and reducing the FSA's costs of monitoring compliance with standard policy conditions. Since then, the FSA, and more recently its successor, the FCA, have only required firms to maintain certain minimum levels of indemnity cover, rather than specific terms.
However, the FCA has now raised a number of concerns with the current arrangements and the impact that the existing PII requirements appear to have on the FSCS, whereby the FCA argue that the FSCS have become the first line of defence in many circumstances. Specifically the FCA has highlighted the following areas of concern:
The FCA say that firms often find it difficult to purchase PII cover that is appropriate to their needs. Since there is an absolute requirement to hold PII, it is suggested that firms often settle for purchasing policies which are not adequate for their needs.
The FCA is concerned that not all PII policies respond adequately to claims and, in particular, often exclude the insolvency of the insured firm or the FSCS acting as a claimant (and thus recovering any compensation pay out from the insurer). The FCA has highlighted concerns that claims arising from certain types of sales / investments (those that are likely to generate a high number of claims) will often be excluded by insurers. A further concern is that insurers are able to avoid a claim where there have been breaches of the policy such as late notification of a claim by an insured.
It is suggested that firms facing a large number of claims often struggle to meet excess payments from capital reserves; the FCA rules currently require policies to have an excess of no more than £5,000, except for when firms hold sufficient capital reserves. However, when facing multiple claims the capital reserves can quickly be eroded.
The FCA are concerned that run-off cover, which needs to be renewed annually, runs the risk that the policy might not be renewed and any claims will ultimately fall to the FSCS to deal with.
It is noted that costs inclusive limits of indemnity often reduce the level of cover available for larger individual claims.
The FCA has put forward a number of proposals in relation to the funding of the FSCS going forward, including reviewing compensation limits and reviewing the funding classes which form the basis of the levies.
However, the FCA has also put forward a proposal that firms ought to be required to hold more comprehensive PII (which appears to be akin to a return to the position prior to 2003), with the overall aim that insurers would cover a larger proportion, as well as an increased value, of claims. The FCA has justified the proposal on the basis that those firms who are responsible for generating most claims will meet the cost through increased insurance premiums.
The FCA has invited views on the proposals set out within the consultation paper, which include:
A restriction on excluding the insolvency of the insured and of the FSCS acting as Claimant, regardless of the legal status of the firm.
The restriction of the use of certain limitations within the policy (for example, of particular investments / sales).
Restrictions on policy excess levels; it is suggested that this could apply to multiple or individual claims but it is unclear exactly how this would work in practice.
Further requirements for legal defence costs; again there is no further detail as to what this might involve but, given the concerns raised vis-à-vis the limit of indemnity, this could involve costs becoming indemnifiable in addition to the limit of indemnity, although this is often already the case, or could involve a ban on reduced limit for defence costs.
Restrictions on the requirements for the insured to notify insurers about "future possible liabilities" (i.e. notification of circumstances) so as to prevent insurers from avoiding claims for late notification.
Additional requirements to have in place run-off cover.
The FCA recognise that an obvious repercussion of requiring insurers to offer more comprehensive policies is that insurance premiums will necessarily rise, to take account of the increase in the number of claims that will inevitably fall to insurers. At the moment the proposals in relation to policy excess limits are somewhat vague. However, it is suggested that a limit could apply to individual or multiple claims. Due to the nature of the work carried out by financial advisers, a large number of claims often arise from the same investment / product and consequently there is usually a per claimant excess. If the per claimant excess was to be removed then the costs for insurers would inevitably rise. Annual premiums from financial advisers PII premiums currently total around £50 million; comparatively solicitors PII premiums total around £300 million and accountants reach around £100 million. Accordingly, financial advisers premiums are comparatively lower than some other professions which are already subject to more comprehensive minimum terms. It is likely that the introduction of more comprehensive policy requirements would see those premiums rise.
The PII market for financial advisers is already relatively small, with around ten to fifteen active insurers at any one time. Accordingly, whilst it is unclear precisely what impact the introduction of more comprehensive policy requirements might have on the number of insurers willing to offer such policies, we could see more insurers withdrawing from the market. Ultimately, this could mean that firms are less able to procure PII because it is either unavailable or too expensive; this could force some firms to leave the market altogether.
As set out above, the 2003 amendments aimed to reduce firms' exposure to large premium increases and reduce the FSA's costs of monitoring compliance with the standard policy conditions. It is unclear from the FCA's consultation paper how these issues might be addressed, as clearly these remain concerns for both the financial services market and the consumer, to whom these costs are likely to be passed on.
The FCA has invited comments and views on the current arrangements and their proposals to introduce more comprehensive policy requirements, including the likely consequences and possible alternatives, by 31 March 2017. It is anticipated that the FCA will consult on specific proposals further in 2017 and any amendments to the PII rules will not be implemented until the 2019/20 financial year.
DWF will be responding to the paper and requests comments by 28 February 2017. If you would like to be part of this process we would request that you submit any comments to Alexia Drew. Please indicate clearly whether your comments are made on an open basis, or whether you would prefer them to be included anonymously, for example, "an insurer client says xyz", or if you would prefer them to be considered but kept confidential.
This information is intended as a general discussion surrounding the topics covered and is for guidance purposes only. It does not constitute legal advice and should not be regarded as a substitute for taking legal advice. DWF is not responsible for any activity undertaken based on this information.