Certainly, there seems to be an urgent need to find a better way to fund consumer compensation for ‘inappropriate (bad) or unsuitable advice’ and/or failure of product.
But if this is not found, the only way to get access to advice will become so expensive only the very rich will be able to seek it out.
This would create further problems to those provider firms who rely almost totally on intermediated distribution. So what might be a better way?
The problem
As I see it, regulation and the so-called 'compensation culture', based on consumer expectations, fraud and entitlements has presented the financial services industry as providing an opportunity for limitless cash calls. There are some consumers always seeking to claim compensation - some of whom one may argue should take some responsibility for their own actions.
Be that as it may, financial products are predominately ‘purchased’ as a result of an adviser recommendation. Pretty much all life, pension and investment product providers rely on third parties to distribute what they manufacture and that third party is the adviser community, whether tied, restricted or whole of market. And this distribution method became predominantly fee-based on 31st December 2012.
Adviser firms are not always financially well-resourced to compensate, thanks to the Financial Services Compensation Scheme levy, rising Professional Indemnity insurance and a smaller pool of firms still left standing.Many argued this date - the date on which the Retail Distribution Review came into effect - spelled the end of mass-market access to financial advice and the beginning of a more professional era where, if you could not pay, or were not deemed financially worthy, you would end up segmented and perhaps end up with little or no advice at all.
Since then, any blame for any advice or recommendation at all has been laid at the advisers' door. In some cases, the blame may be correctly placed, but adviser firms are not always financially well-resourced to compensate, thanks to the Financial Services Compensation Scheme levy, rising Professional Indemnity insurance and a smaller pool of firms still left standing.
Poorly, yet still compliantly capital adequate firms often collapse after a big call of money from the FSCS. Even a single successful complaint could lead to unaffordable compensation payments.
Smaller IFA firms often do not use limited liability protection options, instead using their personal assets to satisfy capital adequacy. And even for many established firms adequate, affordable and operationally functional PI to ride out a bad advice claim award is difficult to get because of a restricted pool of insurers and a slew of claims for unregulated products being distributed by a regulated entity.
As PI cover is arranged a year at a time, any claim or notification of a claim in the current year could mean 'curtains' at renewal in the next year. And no PI equals no business.
This in turn causes a reduction in adviser numbers., which means fewer firms must pay ever-increasing liabilities for other firms as they fail.
All this is really not helped by a consumer perception, as noted above, that all financial products and advice present an opportunity for a ‘refund’ many years later if what was suitable at the time of the advice is not seen that way, say, 15 years later due to changed client circumstances, changes in their aims and aspirations that applied at the time of advice. Simply put, because there is no long-stop to limit the adviser's liability.
In the summer of 2018 Panacea ran a FOS survey, in which 83 per cent of respondents felt that FOS complaints process places them in an automatic position of guilty until proven innocent.
It is all well and good suggesting that the polluter pays from a compensation point of view, but the reality is they cannot because the pollution has proved so toxic they just died along with everything else in that murky pond. In other words, the death of the polluter means they can never pay.
A bit of history
In 1970, I started working in the Lloyds marine re-insurance market. My area of expertise was around reinsurance and claims, very specifically on the ‘Torrey Canyon disaster’ of March 1967, as the claims were still being worked on three years later.
As any insurer will tell you, you need to spread the risk base you hold. To do that you need to reinsure to protect yourself as a ‘name’ and your business. This is commonplace with life assurance products.
In the 60s and 70s, Lloyds syndicates (the collective of insurers) operated in what was at the time the biggest open space room in the world opposite the current Lime Street current location. Their individual ‘office space’ was referred to as a ‘booth’, and each booth contained specialist underwriters who took a view on a risk, such as Torrey Canyon, and signed up to insure it.
But in 1967, the supertanker SS Torrey Canyon hit rocks off the coast of Cornwall. What was different about Torrey Canyon was the scale. The ship, one of the new generation of tankers, had been lengthened with the insertion of a new, larger mid-section.
She was carrying, on a single voyage charter, nearly 120,000 tons of crude oil from Kuwait to Milford Haven in South Wales. Being deeply laden, she had to catch the late evening tide for berthing. To save half an hour and avoid a wait of five days, the Italian master took a route to the east instead of the west of the Scilly Isles.
When the tanker struck the Pollard Rock, thousands of gallons of crude oil started spilling from her ruptured tanks. Detergent was sprayed continuously to disperse the slick, but it was like trying to hold back the tide with a broom.
Simply put, every regulated firm should pay a simple percentage of turnover to the FCA each year as a new type of regulatory fee structure to cover the cost of regulation.Eventually the RAF and Royal Navy bombed it, using it as target practice. The idea was to burn the wreck and oil still on the surface as a final solution.
But beaches were left knee-deep in sludge and thousands of sea birds were killed in what remains the UK's worst environmental accident and the minimal quantifiable cost, in other word insurance claim, was £14.24m, in today’s terms that would be some £249m. The losses were incurred on the hull, the cargo and the consequential losses a disaster can cause.
This massive claim threatened to put some Lloyds syndicates out of business, as Lloyds always paid claims. If an individual member, (a ‘name’),’ could not pay, their personal worth, along with all those others who invested in the risk-carrying syndicates, were expected to pay. If you could not, your business faced closure.
But, unlike IFAs, syndicate members' risk continued for a specified period and a specified amount.
Most syndicates would reinsure (spread) the risk on big bits of kit, like a tanker. A spread of risk with others who were not directly involved in insuring the vessel. But the complexity and size of the risk and the claim meant that reinsuring saw the risk spread back to the original insurer syndicates, with the reinsurers reinsuring their risk. So the risk was more manageable.
Learning from history
So how can we learn from history, spread the 'risk' fairly, avoid a flawed 'polluter pays' model and create more simplicity and certainty for firms?
Simply put, every regulated firm should pay a simple percentage of turnover to the FCA each year as a new type of regulatory fee structure to cover the cost of regulation as well as building a financial services fund to pay for when things go wrong (similar to the Pension Protection Fund?). The complete opposite of the polluter pays and in complete harmony with the Lloyds model of spreading the risk.
This clearly defined cash ocean is locked, and if need be in the beginning underwritten by the Treasury, rather like the FSCS is today. It should not see the Treasury doing a cash grab on surplus funds as it has done with fines. This would be to specifically deal with consumer detriment for regulated products and advice only.
Claims could only be arbitrated at no cost by the FOS with the outcome being determined by the FOS with a low-cost form of appeal for each party.
Tear up the current protocols, the status quo and think a bit differently.Next, the Financial Ombudsman Service should operate by assessing claims on the basis of evidence available and/or the balance of probability and not by way of retrospection.
There should be no FOS fees as these should be absorbed in the regulatory fees.
In the case of ‘guilt’ there should be an element of affordable excess and redress payable by the firm, again set as a percentage of turnover. This should mean that firms do not go out of business because of a claim or a claim against others.
There should be a bad behaviour ‘one strike and you are out’ standard, or where redress amounts are above a certain level and you are out ruled out, possibly first time.
There would be no need for individual PI as the FCA should/ could, rather like huge corporates, self-insure by way of the fund and as a last resort, in the event of a ‘Torrey Canyon’ style event, the FCA could have in place a reinsurance pool made up of as many insurers, PI or otherwise to remove any doubts of being selected against.
In other words, tear up the current protocols, the status quo and think a bit differently. Think self-insure as a regulated group and think re-insurance.
The maths
Let's look at some of the figures involved to see how this might work in practice.
- In 2017 £22.1bn of revenue was earned by retail intermediary firms in 2017 from insurance, investment and mortgage mediation activities, compared to £20 billion in 2016. Source: FCA
- Over £300m was paid by firms in PII premiums in 2017. Source: FCA
- The FSCS paid in claims to the year ended March 2017 £375,262,000 (£130,362,000 was recovered). Source: FSCS Financial review page 47
- The biggest single cost to the FSCS in that year was £306,246 in interest. Source: FSCS Financial Review page 47.
There are some 50,000 firms across many business areas that are registered with and regulated by the FCA. Therefore, if every firm regulated by the FCA paid 0.5 per cent of their turnover, based on the above numbers some £1.1bn would be raised.
There would be no need for PI cost and a sum could be set aside to reinsure firms, which would be easily covered within the 0.5 per cent cost.
Money is being made in the ‘industry of compensation’ that would be better used by ploughing it back to the pot. This mean confidence would be restored, bad businesses would be put out of action very quickly, and all that money saved on a firm level basis could be put towards providing lower cost, easier access to advice.
It could also help pay for better regulated products and services, created with foresight to benefit the consumer rather than action carried out in hindsight to compensate them.
I hope that this very brief summary could be the basis of a simple, but effective, new way to deal with compensation.
Derek Bradley is chief executive of PanaceaAdviser
