The Financial Conduct Authority may have underestimated the impact of increasing the Financial Ombudsman Service's compensation limit on professional indemnity (PI) insurance premiums, experts have warned.
Last week the regulator confirmed it would increase the compensation limit available under the ombudsman from £150,000 to £350,000 on April 1, despite insurers forecasting it could push up PI insurance premiums by 500 per cent.
Focusing on the defined benefit pension transfer advice market, the FCA has estimated the price of PI insurance premiums for specialists in this area could increase to an upper limit of 140 per cent in a "worst-case" scenario.
However, insurers predict this increase could be between 200 and 500 per cent.
Under the FCA's calculations, a 140 per cent increase would see the median PI insurance premium for a firm with two to five advisers increase from £3,400 to £8,000 and under a 500 per cent increase, median premiums for the same size firm would increase to £20,100.
Former pensions minister Ros Altmann said she welcomes the increased compensation limit as being more in line with the values for DB transfers, but warned it is of "great concern" that the FCA may have under-estimated the impact on PI insurance costs for adviser firms.
She said: "It is really important that scheme members have access to professional expert independent advice.
"Already it is the case that many firms have pulled out of DB transfers and this move is likely to further accelerate the trend of consolidation and mergers, with large firms better able to handle rising PI costs."
When approached with Ms Altmann's concerns, the FCA pointed to the workings outlined in its policy statement.
Keith Richards, chief executive of the Personal Finance Society, said unintended consequences of the compensation limit increase could see more consumers left to fend for themselves or becoming victims to scams - something he said is "clearly in conflict" with the government's objective to increase access to advice.
Mr Richards said: "The concerns surrounding DB transfers has sent some PI Insurers running for the hills, which has already left many advisers facing increased premiums, increased excesses and in some instances, no ongoing cover.
"The market continues to harden with increased costs being experienced across the sector and this latest move by the FCA will serve to compound the issue."
He added: "Providing protection for consumers is a key mechanism to support confidence in the market but the operating cost and risk associated with regulated advice was already making it less accessible.
"The additional unintended consequences of this latest proposal will not be good news for the public and sector alike."
Steve Ray, director of professional indemnity at insurer Howden, said he had predicted the regulator would not go ahead with its proposals as insurers had made it "pretty clear" the increase would be unwelcome.
Mr Ray said the increase comes at a time when the market is already unbalanced by the dual issues surrounding DB transfers and capacity issues occasioned by the Lloyd's Franchise Board’s review of syndicates.
Barry Strathearn, compliance manager at Lowes Financial Management Ltd, said he had assumed the FCA would reach some form of "half-way house" in its proposals, as it seemed "natural" that an indexation increase of some level was due since the last increase in 2010.
While the FCA confirmed it does not expect its predictions of a 140 per cent increase in PI costs to materialise, it suggested an outcome of this kind could see up to 1,000 "higher risk" personal investment firms stop providing defined benefit transfer advice under the new £350,000 award limit.
The regulator said these firms would leave the defined benefit pension transfer advice market because they would be unable to afford PI insurance cover, but did not anticipate them leaving other areas of the advice market.
Under this scenario the City watchdog predicted 1,500 "lower risk" personal investment firms would still provide DB transfer advice, a number it said was sufficient to meet demand given indications activity of this kind had already "peaked".
Mr Strathearn said: "We certainly can see a crisis upon the industry in regards to the new figures and increased costs which the regulator concedes could lead to around 1000 advice firms pulling out of the pension transfer market, while at the same time stating this will only benefit around three quarters of 500 high value complaints that would be covered by the new limit."
Mr Strathearn said he believed the compensation increase would have wider reaching issues not just limited to firms involved in the pension transfer market, although he said it would be safe to assume these advisers will "bear the brunt" of the rise.
He added: "When the FCA state their own worst case scenario shows premium increases of 140 per cent and the insurers are disagreeing and arriving at 200 per cent - 500 per cent - and this is combined with the rule change in November which is also predicted to increase premiums - it paints a very poor picture for firms who will be looking to renew their policies.
"It may not just force some firms out of the pension transfer market, it may force some firms out of business."
Pensions provider Aegon criticised the regulator's suggestion that activity in the DB transfer market had "peaked" and warned the hike in compensation could mean "bad news for the many thousands" of consumers seeking advice on whether it is in their interests to transfer out of a DB pension.
Steven Cameron, pensions director at Aegon, said: "The FCA highlights that the number of people building up defined benefit pensions is diminishing. But there are still huge numbers who have previous entitlements which they might be considering transferring, for example to access pension freedoms.
"While there has been a recent drop in transfer activity, this is at least partly down to the lack of supply of advice, and shouldn't be interpreted as a decline in demand.
"Well-intentioned action to compensate customers who've lost out as a result of poor advice could unfortunately create real problems for the vast majority of highly professional advisers wanting to meet their clients' needs for advice on DB transfers.
"It is vital that the FCA monitors closely the impacts of their decision and how PI insurers react. Otherwise, there could be widespread consumer detriment with thousands of individuals unable to get advice on what’s best for their retirement provision."
Alistair Cunningham, financial planning director at Wingate Financial Planning, said he saw a positive in the changes as previously there have been cases where serious harm had been caused, most commonly around DB transfer advice, but the Fos limit allowed "woeful" compensation.
He said: "However I do not hold that premiums should rise: exclusions and maximum sums per claim, and in aggregate reduce the risk to insurers, and whilst the tide is tending to tighten cover, which is right and proper, there is no guarantee that someone made the higher level of Fos award can enforce it where there is serious failings by a single firm.
"My take on this is that the regulator and Fos do not want smaller firms giving advice in these high risk areas, and whilst I am not convinced they will achieve this aim, it does seem like a sledgehammer to crack a nut: more effort should be spent on weeding out the rotten apples."
rachel.addison@ft.com
