Retail therapy

One of the recurring themes of my blogs has been the inevitable volatility of a pay-as-you-go funding system like FSCS’.

The edition of Outlook we published at the end of November illustrates that theme again. We foresee a supplementary levy of £69 million to pay for the rising tide of pensions claims.

This is not, at least, unexpected.

When we set the levies for 2018/19 last Spring we foreshadowed that the costs of compensating victims of pensions mis-selling and of bad advice about pension transfers would exceed the annual limit on life and pension advisers (£75 million for the nine months from June 2018-March 2019).  We nevertheless held off triggering a cross-subsidy from other industry sectors until we were more certain of the scale of that excess.

In fact we were not far out. We predicted in April an excess of £63 million; we now expect an excess of £69 million. That significantly exceeds our published £20 million trigger for raising a supplementary levy.

So these costs, confirmed by the FSCS Board this week, will result in a supplementary levy on the retail pool in January.

Supplementary levies are inherently difficult for businesses to manage. They cannot readily be planned for or reflected in charges.  

But I do not honestly see a solution to this volatility unless we move to a system of pre-funding of the kind operated by many of FSCS’ sister organisations overseas.

Our US counterparts in the FDIC, for example, raise predictable levies on banks annually to build up a fund which is drawn down when FDIC protection is triggered by a bank failure.

I’m often asked by journalists if this would be a preferable system for the UK.

My answer – which I’m sure disappoints them – is that FSCS is agnostic on pay-as-you-go versus pre-funding. Either system works for us.

It is for the industry, in my view, to take a view of the trade-offs between these two approaches to funding FSCS.

Those trade-offs are easy to state.

Pay-as-you-go entails unpredictable and volatile demands on the industry for funding. How could it be otherwise when business failures are themselves unpredictable? But it means that, year by year, FSCS draws down from the industry no more than it needs to meet actual and foreseeable failures.

By contrast, pre-funding gives business predictability. But it necessarily means that FSCS will extract capital from the industry ahead of need and hold it against future eventualities. That is, in effect, dead capital.

So the industry needs to state how it views this trade-off. Is volatility a price worth paying for a funding system which is economical of capital? Or is it worth paying up-front for a predictable funding system?

Three things I can assure the industry.

First, if the preference remains for pay-as-you-go - and, in the absence of any pressure for pre-funding, that will remain the status quo - FSCS will always do its best, through Outlook and our other publications, to give the industry as much forewarning as possible of the compensations costs we foresee.

We try hard to be transparent.

Second, FSCS will continue to maximise recoveries from the estates of failed businesses. These recoveries offset the costs of the compensation we pay and so reduce the levies on the industry.

As Outlook spells out, we have already this year completed recoveries from Bradford & Bingley and paid down our standing borrowing from HM Treasury arising from the financial crisis. We have also completed a recovery of almost £20 million from PPI lenders.

And, third, FSCS will play its part – working with the regulators and the industry – to prevent future failures and so to keep the compensation bill in check.

We have made this one of the four central priorities for our strategy as we enter the 2020s. We shall make good on this priority by sharing our insights about the causes of failure with the regulators, by mobilising the intelligence we gather about the directors and advisers involved in failure and by ensuring that consumers are better informed about the risks they face and about the extent of FSCS protection.

So I acknowledge the unwelcome pressure on the industry – the retail pool so-called – imposed by the additional costs foreshadowed in Outlook. But FSCS and its partners are far from passive in the face of these costs.