The UK’s Financial Services Compensation Scheme is designed to help consumers after the failure of a financial services firm. However, as the recent collapse of loan firm Wonga has highlighted, the scheme does not always work in ways that the public might expect…
In 2016, the Financial Advice and Markets Review (FAMR) found that, “the unpredictable nature of the Financial Services Compensation Scheme (FSCS) levy makes it hard [for firms] to plan effectively”. It also reported on “problems which smaller firms experience in obtaining adequate protection indemnity insurance (PII) at an affordable price”.
Two years later, as the first compensation payments start to be paid in respect of the British Steel pension scheme saga, these problems remain and there is evidence of the PII market hardening, as insurers react to their perception of the risks involved (limiting cover, applying exclusions, offering commercially unacceptable terms).
Keith Richards, CEO of the PFS, says: “Such reactions, while understandable, are leaving the adviser market exposed and, in respect of safeguarded benefits, increasingly denying the general public access to pension freedoms.”
“It is increasingly proving unfit for purpose and the growing concern over defined benefit transfers is likely to compound the level of liability placed on it, which will result in poor outcomes for consumers and the market as a whole,” Mr Richards warns. “The time has come,” he says, “to look at a more broadly-based solution, combining fair and cost-effective levies with a public financial education programme.”
The PFS believes this could be in the form of a ‘savings and investment monetary protection and education levy’ (SIMPEL), collected centrally by government and paid into a pooled, risk-based fund.
On the premise that most in the market accept the need to contribute to regulation and protection, the necessary funding could be achieved without any accusations of bias, unfairness, or punitive prioritisation that makes one sector feel it is carrying the burden for all the others.
FSCS levies stand at just under £300m for intermediaries and providers in the investment and pension sectors (the overall levy is £407m, but this includes £124 million in levies for deposit-takers, general insurance providers and general insurance intermediaries).
If we then add in the cost of the Money Advice Service and The Pensions Advisory Service (about £80m) and the £70m in premiums paid by advisers in professional indemnity insurance, we come to a figure of about £450m.
“It seems that a practical, affordable solution to the FSCS and PII problems is staring us in the face,” stresses Mr Richards. “There is no doubt that the solution is possible and desirable, given the urgent need to close the advice and savings gaps in the UK.”
The Wonga crash
The Wonga collapse has opened the lid on some of the gaps in financial protection and been a nail in the coffin for the reputation of at least one portion of the financial services system
Payday loan companies have long had a somewhat dubious reputation in the UK with, in the past, extortionate interest rates and even threats with menaces when it came to repayments.
Usually targeted at the poorest in society, these companies have had to clean up their act in the past few years but there has always been the risk of reputation contagion into the broader financial services market.
Now Wonga, which marketed itself with cool grannies and hip grandpas, has gone into administration, courtesy, it is reported, of a huge surge in compensation claims.
Financial services firms are collapsing almost daily and, for the most part, there is some protections for consumers through the Financial Services Compensation Scheme (FSCS).
The Guardian reports that Wonga’s collapse “leaves an estimated 200,000 customers still owing more than
£400m in short-term loans”.
Existing borrowers were told to continue making payments and administrators are expected to sell Wonga’s loan book to another lending firm.
After emergency talks, the Financial Conduct Authority (FCA) said it would continue to supervise Wonga and seek fair treatment for customers.
Wonga had been widely criticised for ‘legal loan sharking’ and targeting vulnerable borrowers with small loans that quickly spiralled out of control. At one point, customers faced interest rates as high as 5,853%. Even after capping by the government back in 2015, the rates stand at about 1,500%.
It had, however, been the darling of that sector of the market and The Guardian reports that it was once lined up for a stock market flotation with a price tag approaching £1bn.
But in 2014, it was censured for issuing fake legal letters to customers in arrears and was ordered to pay compensation of £2.6m. In recent years, claims management firms have targeted the company over a number of issues, and complaints to the Financial Ombudsman Service have surged.
In September 2017, the company reported a loss of £66.5m, but said costs and impairments were falling and that it remained a going concern. It said it had 220,000 customers and £430m in loans outstanding.
But in recent months, Wonga has been hit by compensation claims costing the company £550 per claim to process, whether upheld or not. Many have come from claims management companies, such as PaydayRefunds, which had entered about 8,000 claims in the last six months alone.
However, this is one instance where the FSCS is unlikely to get involved.
Since it began in 2001, the FSCS has helped more than 4.5 million people, paying out more than £26bn in compensation. The question for those owed compensation by Wonga is whether they will get anything back.
The FSCS states on its website: “We can pay compensation only when an authorised firm is in default. We will carry out an investigation to establish whether or not this is the case. We can pay compensation only for financial loss and there are limits to the amounts of compensation we can pay.”
But with regard to the Wonga case, the FCA admits: “It cannot be determined if FSCS cover would apply to this firm. Please contact the firm directly to understand whether their products/services would be covered
In its 2014 review, the FCA decided not to extend the FSCS to cover lending. At the time, it said “Consumer credit will not be covered by the FSCS straight away. We will review this when all firms are authorised by us.”
But in 2016, the FCA decided: “Having now considered the issue in more detail, we still believe that most consumer credit activities should remain outside FSCS protection because our other regulatory requirements are sufficient.”
Lenders such as Wonga have therefore remained outside the scheme.