Predictable unpredictability

Every year at about this time we publish Outlook to update our levy payers on how the assumptions we made about compensation payments and management costs at the beginning of the year have turned out.

This matters because FSCS is funded on a pay-as-you-go basis. We raise levies in the spring to finance the costs we expect to incur in the year ahead.

If we under-estimate those costs, we may then need to raise supplementary levies. We cannot turn to a fund like many of our sister organisations internationally.

What’s more, the inherent unpredictability of FSCS’s workload makes forecasting demand very difficult. We must pay eligible claims for compensation. To do anything else would undermine the confidence and stability that FSCS protection ensures. But eligible claims do not always follow predictable trends.

That unpredictability is well illustrated this year. It can have a number of causes.

We may, for example, be faced with a major failure of which we had no visibility when the levies were set.

Enterprise, a Gibraltar-based insurer, illustrates this phenomenon perfectly. FSCS had no more than a few days warning of Enterprise’s failure in July. But it’s no exaggeration to say that, since July, protecting Enterprise’s policy holders has been our dominant preoccupation and a major source of unforeseen compensation and administrative cost.

Enterprise insured a wide range of risks in the UK – from motor risk, to teacher absence risk, to furniture, jewellery and white goods guarantees to guarantees of building work under the Green Deal.

Since the summer, we have been meeting claims against these policies at a cost that runs into the millions.

Where policies have been disclaimed by the appointed insolvency practitioner – as the motor policies and some others were on 26 October – we have worked with brokers to put in place new insurance where we can and to return premia where we cannot.

The uneven quality of much of the data has made this a time-consuming and expensive task.

The eventual compensation bill for Enterprise is likely to be more than £94m. Today we publish our industry newsletter, Outlook, which includes more information on the financial impact of the failure.

Unexpected failure is not, however, the only kind of unpredictability we face.

The full dimensions of known issues are not always easy to foresee.

This is exactly the position we face with what we call SIPP-related claims. These are claims against failed advisory firms. The claims arise from bad advice to move money out of occupational pension schemes into SIPPs and to hold in SIPPs very risky, unregulated assets.

Of course, this is not a new issue. FSCS has been compensating investors for losses arising from these SIPP-related claims since 2014.  We raised a supplementary levy on life and pensions advisers in 2015 and fully expected claims to rise again this year.

We under-estimated, though, the velocity of this growth. We have now received claims against 171 advisory firms and currently estimate that we shall face a deficit by year-end of about £28m.

If that estimate is borne out by claims volumes in the remainder of 2016, we will have to raise a supplementary levy again. And because life and pensions advisers have already paid a levy of £90m this year against an annual limit of £100m, there is the possibility that a supplementary levy will trigger a cross-subsidy.

We are also forecasting a deficit in the home finance intermediation class and may also need to raise a supplementary levy on the firms providing mortgage advice.

We shall announce our final decision in January on the supplementary levies and update you then.

Of course, unpredictability can work for the industry as well as against it.

Claims against investment advisers have been significantly lower than we forecast and so we expect a surplus in this class this year of around £60m. We plan to apply this as a credit to firms in the class, either against next year’s levy or to offset any supplementary levy costs, or both.

So dealing with the unexpected is an inescapable part of FSCS’s job.

The only predictable thing about FSCS’s workload is its unpredictability!