24 Jan 2019
Being responsible is what the financial industry should be about.
Sadly we have now reached a stage that the responsibility now falls on all as the few who mess it up never have the resources to put things right, previously referred to as ‘the polluter pays’.
There is an urgent need to find a better way to fund the ever-increasing costs of regulation and redress as well as delivering confidence and developing consumer protection. At its core, is funding the seemingly endless liabilities for consumer entitlement to compensation whether or not from ‘inappropriate (bad) or unsuitable advice’ and/or failure of product.
If not found, the only way to even think about evaluating the worth, let alone seeking access to advice, will become so expensive only the very rich will be able to seek it out and the entry of new firms impossible.
That in turn creates big problems for almost all provider firms, almost all, who rely totally on intermediated distribution.
A leading provider CEO observed only this week that: “The truth is that we currently have a mixed economy in terms of compensation for mis-selling, product flaws, etc. Individual firms have primary liability for their actions and the wider FS industry carries the costs of systemic regulation and systemic failures (FSCS). Whilst everyone grumbles about this it is pretty sensible. Firms have real incentive to ensure that their activities are meeting standards, but the overall system has a backstop to maintain public confidence”.
He is quite right, but how regulation and consumer protection is funded is what I see as the problem and not the responsibility focus where the ‘who pays’ door has slammed shut.
Financial products are predominately ‘purchased’ as a result of adviser recommendation, this can now include sales attached to products such car purchase. This distribution of intangible products is often referred to as intermediated distribution. The latter outlets, although regulated, are rewarded by way of commissions.
Pretty much all life, pension, protection and investment product providers do not sell or distribute what they design and build and have not for decades. Instead they rely on third parties. That party is the adviser community, tied, restricted or whole of market. That distribution method became predominantly fee based on 31st December 2012, excluding protection products and mortgage related advice.
Many argued that this date spelt 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, customer segmentation by advisers ensured advice was not coming your way any time soon, or at all.
Segmentation does not mean that IFA firms are always financially well-resourced to compensate for when things go wrong. This simple fact is the cause of the big problem the FSCS, PI insurers and firms left who pick up the cost of the clear up face.
Poorly, yet still compliantly capital adequate firms often collapse after a big call of money from the FSCS or even a single successful complaint and unaffordable compensation payments.
The regulatory year 2018/19 with just over 3 months to go, has seen the FOS refer 273 cases from around 74 companies to the FSCS. For these firms, Sipp’s accounted for 39% of FOS casework, PPI 28% and portfolio management 9%. This in turn will see more complaints against those firms hit the FSCS as the FOS will wash their hands of them as they will be placed in default.
Smaller IFA firms often do not use limited liability protection options, instead using their personal assets to satisfy capital adequacy. For many established firms operationally functional PI to ride out a bad advice claim award is difficult to achieve because of a very restricted pool of insurers and a continuing slew of claims for unregulated products being distributed by regulated entities.
Limited liability protection actually increases the risk of firms failing. And phoenixing can follow.
As PI cover is arranged a year at a time, any claim or notification of a claim in the current policy year, with a diminishing pool of reinsurers and huge premiums, could be curtains at renewal in the next year, no PI = no business.
Although there are always exceptions in commercial life, very, very few businesses set out to disadvantage clients for their own gain. It seems in today’s world of financial services that the collapse of firms can often be brought about because of a failure to get compliant PI, a big (even small) FOS redress order, or a flood of unexpected FSCS calls for cash from the misdemeanours of others. This in turn sees reducing adviser numbers that in turn presents fewer firms to pay ever increasing liabilities of others as they fail.
Many advisers have reported fraudulent claims in our regular FOS surveys. All this is really not helped by the culture of compensation that has encourgaged no win no fee lawyers (CMC.s) to boost consumer opportunity perception, as noted above. All financial products and advice presents 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.
Why? A lack of longstop does not assist, something that applies in just about every commercial walk of life. After six complete years from the date of the transaction there is no redress for bad service, goods or advice as commercial law does not permit it. In the world of financial services, it is forever, although I note that the FOS is now exercising the six years plus three rule a bit more.
In the summer of 2018, Panacea ran a FOS survey whereby 83% of respondents felt that FOS complaints process places them in an automatic position of guilty until proven innocent. The outcome should be determined by the evidence available and/ or the balance of probability. Often, that is not seen by firms as being the case. No file, because the case was more than say seven years in the past, does not help. Equally so if a file is retained, data protection could come back to bite as record keeping beyond seven years could be seen as a breach.
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.
Some thoughts therefore follow for the FCA and HM Treasury to consider on how the industry should pay for regulation and at the same time protect the consumer from bad actors and product failures.
Every regulated firm, there are some 50,000, of whatever type (from car finance, to pet insurance, to funeral plans, pensions providers, life insurers etc) should pay a simple percentage of turnover to the FCA each year as a new type of ‘all inclusive’ regulatory fee to cover ALL the cost of delivering regulation, FCA, FOS but not the FSCS as this idea would see their need removed, building, quickly, a financial services fund to pay for when things go wrong (similar to the Pension Protection Fund?).
The complete opposite of the polluter pays.
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 HM Treasury doing a cash grab on surplus funds as it has done with fines. Build up surplus, rather like the three-year Lloyds of London accounting period, and use that surplus to reduce the cost of regulation along with fee and fine offsets.
This pool of cash would be to specifically deal with the cost of FCA regulation and FOS arbitration when investigating consumer detriment for regulated products and advice only. Claims should be arbitrated at minimal, even no cost to either side by the FOS with the outcome being determined by the FOS with a low-cost form of independent appeal for each party.
The FOS should operate by assessing claims on the six years plus three rule, the basis of evidence available and/or the balance of probability and not by way of retrospection or beyond that time limit.
In the case of ‘guilt’ there should be an element of affordable, turnover redress payable by the firm and the rest paid for by the accumulated fund. This should mean that firms do not go out of business because of a claim or a claim against others.
There should be a very strict bad behaviour outcome with very bad being an immediate red card then say a ‘two strikes and you are out’ standard, or, where redress amounts are above a certain level and you are out ruled out of further activities, possibly even first time.
Regulated advisers should only engage in regulated products. Unregulated products should be exactly that and excluded from the support.
There would be no need for individual PI as the FCA should/ could, rather like huge corporates, self-insure by way of the fund created and the FCA could have in place a reinsurance pool made up of many insurers, PI or otherwise to remove any doubts of being selected against.
Tear up the current protocols, the status quo needs something a bit different.
Let’s do a little simple maths:
So, if every firm regulated by the FCA paid just 0.20% of their turnover each year, based on the above numbers some £442m would initially be raised. There would be no need for PI cost and a sum could be set aside to reinsure easily covered within that 0.2% cost.
That could be a starting point for a brave new world.
This thinking is not about presenting firms with a low-cost way to be reckless in their advice, it is not about bringing advice to the masses in its purest sense. But it is a starting point.
As the leading provider CEO further noted: Your suggested approach will only affect advisory firm behaviour materially if it leads to greater socialisation of all of the risks across the sector, and so reduces risk of ruin for advice firms.
The description of my thoughts as “socialisation” is very astute.
He did add a caveat that “this in turn runs the risk of too many firms taking higher risks because they don’t have to bear the brunt of their actions to the extent that they do today”.
But I beg to differ. Money is being made in the ‘industry of compensation’ that would be better used by ploughing it back to the pot, confidence would be restored, bad business put out of action very quickly and all that money saved on a firm level basis put to providing lower cost, easier access to advice, better regulated products and services created with foresight to ultimately benefit the consumer rather than hindsight to compensate them.
I hope that this very brief summary could be the basis of a new way to deal with compensation.
Just a thought.