The last resort – and how to pay for it
I very much welcome the publication last week of FCA’s consultation paper on FSCS funding. It provides the best analysis yet of the complex issues involved.
Before I turn to those issues, it may, though, be worth starting with a different question: why does it matter to FSCS how we are funded? After all, as long as FSCS gets the money it needs to meet our compensation costs and management expenses, you might expect us to be indifferent to how precisely that money is raised.
Far from it.
FSCS exists to maintain confidence in financial services. We serve a purpose, in other words, which ultimately benefits the industry. It follows that we need to retain the industry’s support.
An important part of retaining that support is ensuring that firms feel the levies they pay to finance our costs are proportionate and fair. As things stand, many don’t. Hence, the need for the review.
This is not, of course, the first review of FSCS funding – it’s not even the first review in my time as Chief Executive – but it is the first to raise in one place all the dimensions of the issue.
FSCS funding is not just about how to pool our costs across the industry, though it is about that.
It’s also about firms’ behaviour: whether they take undue risk and are sufficiently insured for those risks. And it’s about the scope of FSCS protection itself: are we protecting the right things to the right levels to protect consumers and to underpin public trust.
All these dimensions need to be thought about and addressed together because they all affect the costs which are then passed on to the industry.
So I’m very pleased to see the consultation paper ask serious questions about the fitness for purpose of much professional indemnity insurance. It’s been clear to FSCS for some time that these policies often afford firms little or no protection against claims and can exclude recovery action by FSCS after a failure has occurred.
In other words, FSCS is promoted from last resort to first resort when something goes wrong.
On the other side of the coin, I welcome too the focus on re-thinking compensation limits. There is a close link between consumer confidence and consumer understanding. As things stand, the differing compensation limits for different products work against understanding.
In the case of retirement savings, these differences are more salient than ever now that people have choice about how to invest to generate an income in retirement.
Of course, if everything else stayed the same, the harmonisation of compensation limits I have advocated for retirement savings would tend to raise compensation costs at the margin.
But not everything else does have to stay the same. That’s the great virtue of the Consultation Paper. Reform of professional indemnity insurance may help to reduce costs by bolstering FSCS’s position as the last resort.
And introducing risk into the allocation of our levies – also canvassed in the consultation – may help to ensure that firms running undue risks pay a bigger share and, in doing so, create benign incentives for greater prudence.
So, it’s important to approach the consultation by recognising the balance that needs to be struck between all these dimensions – firms’ behaviour, the scope of FSCS protection and the pooling of costs – and not just to focus on one alone.
At any event, this public consultation puts the ball in the industry’s court. I very much hope that firms and their representatives will join the debate so that we can make progress towards a funding regime for FSCS which commands wider support.