James Darbyshire, FSCS's Chief Counsel

Recovering compensation costs and tackling the root causes of consumer harm

In a recent article published in the British Insurance Brokers Association (BIBA) Compliance Rules newsletter, our Chief Counsel James Darbyshire talks about the work that FSCS does to recover compensation costs and tackle the root causes of consumer harm.

With the devastating impacts of high-profile financial failures regularly making headlines, awareness that the Financial Services Compensation Scheme (FSCS) is here to help when things go wrong can provide stability and raise public confidence in the industry, particularly during volatile economic times.

FSCS protects consumers when their financial firms fail. Research from September this year shows that 82% of people who are aware of FSCS feel more confident taking out a product covered by the scheme, with 68% likely to invest more if the provider is FSCS protected. The service FSCS provides is completely free and it is able to pay the compensation customers are owed thanks to a levy that authorised financial firms pay. 

Ensuring a fair levy for industry while maintaining an effective compensation service is always a priority for FSCS, but what is perhaps less well known is the ongoing work it undertakes to reduce the levy for industry. One of the many ways in which FSCS does this is through pursuing recoveries against failed firms to claim back the cost of compensation, as well as by tackling the root causes of consumer harm that contribute to rising compensation costs.

FSCS Levy and the year ahead

In the current climate, FSCS appreciates levy payers will be looking for as much certainty as possible to plan for anticipated costs. FSCS’s regular Outlook forecast helps levy payers prepare for the year ahead. Last month’s Outlook confirmed the levy remains unchanged for the current year at £625m, with early indications for 2023/24 revealing that a lower levy of £478m is expected. Insurance brokers primarily pay levies within the General Insurance Distribution funding class, which remains at £5.3m and is likely to be the same next year.

Firms pay a levy amount relative to their size and funding class, which groups them based on the products they sell, distribute, or advise on. The limit for each class is set by the Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA).

The levy is forecast against expected management expenses, recoveries, class surpluses or deficits, and crucially how much compensation we expect to pay in the year. Compensation costs have increased year on year and are likely to remain relatively high due to complex pensions advice and general insurance claims, as well as long lag times between customer harm occurring and FSCS receiving claims relating to that harm. In 2023/24 compensation costs are expected to rise from £517m to £592m.

Should compensation costs exceed funding class limits they are shared across a wider retail pool, ensuring sufficient cover if it becomes unaffordable for a single class. The retail pool allows the whole financial services industry to benefit from the confidence and stability that FSCS protection adds to the market.

FSCS recognises that insurance brokers have concerns about the retail pool’s impact on the levy, particularly as it has primarily covered compensation for customers of investment and pensions advice firms rather than failed brokers or insurers. While FSCS does not expect to levy for the retail pool this year, rising compensation costs have triggered its use twice in the last four years.

FSCS regularly speaks with regulators and industry partners to better understand any concerns and ensure the funding model continues to add value to the industry in a fair and balanced way.

Pursuing recoveries to reduce the levy

Since 2015 FSCS has recovered more than £290m from failed firms and other third parties who have a legal responsibility. This sum helps reduce the levy on industry, placing responsibility for compensation costs back onto actors that caused harm to customers in the first place.

A recovery action is a legal claim that FSCS pursues through mechanisms including formal insolvency processes, professional indemnity claims, litigation, or some form of dispute resolution. FSCS always considers the likelihood of recovery and whether it is cost-effective to pursue. It also collaborates with other agencies like the FCA, Serious Fraud Office (SFO) and Insolvency Service to share data and insight that supports each other’s work.

The Harlequin Group

FSCS has pursued a number of high-profile, high value and complex recoveries actions that can take many years to resolve, often involving collaboration with agencies across international jurisdictions. The Harlequin Group is a recent example that has involved working with agencies spanning multiple jurisdictions across the UK and the Caribbean.

Harlequin, a collection of companies connected through the common ownership of David Ames and members of his family, marketed, sold and developed overseas properties that turned out to be largely fraudulent exposing more than 8,000 investors to huge losses.

Many invested through UK-based independent financial advisers (IFA) and Self Invested Personal Pension (SIPP) operators that subsequently failed. Victims parted with huge sums, some from pensions and life savings, believing they were investing in Caribbean holiday properties that in reality could not be delivered, leaving investors out of pocket.

Since 2014 FSCS has received valid claims against 110 firms involving Harlequin investment products, the majority of firms were IFAs or SIPP operators. It has supported more than 3,000 customers with completed claims who had collectively invested in excess of £150m.

Following an investigation by the SFO, Mr Ames was convicted in August this year on two counts of fraud and sentenced to 12 years in prison. FSCS’s role in sharing data and insight with the SFO supported the subsequent action against Mr Ames and it continues to work closely with multiple agencies to recover the costs of compensation.

Looking to the future

Tackling the root causes of consumer harm and supporting positive firm and consumer behaviour is essential to bring compensation costs down in the longer term and reduce the levy in a sustainable way.

Earlier this year FSCS published its report The Balancing Act of Compensation (pdf 4.3MB) which shares its insights into the drivers of compensation costs. It is working to strengthen its data and insight capability, with the aim of working with the FCA and other agencies to identify poor firm behaviour, pinpoint where consumer harm is taking place and support supervisory and enforcement action. An example is FSCS’s work with the FCA to uncover and act against suspected cases of ‘phoenixing’ – where someone escapes the liabilities of one company by setting up another in the financial sector.

Tackling phoenixing helps ensure bad actors are unable to cause more harm to consumers. Since 2019, FSCS has identified 390 persons of interest and approximately 16 firms have since been banned or taken off the market by the FCA due to phoenixing. FSCS monitoring of phoenixing activity has led to better identification of other behaviours that could signal the cause of consumer harm. FSCS continues to collaborate closely with its regulatory partners to monitor trends and share insights as its work around phoenixing evolves.

The FCA’s recently published response to the Compensation Framework Review also outlines the work it will be doing, in partnership with FSCS, to ensure the compensation framework remains resilient and fit for the future.

As the cost-of-living crisis deepens, consumers may be exposed to greater risks as they seek to make their money go further. Raising awareness and understanding of FSCS protection and its limitations helps consumers make more informed decisions about their money. FSCS’s regular research on consumer trends and behaviours supports the wider industry to identify gaps and opportunities to provide customers with relevant information about how their money is protected.

Collaboration across the industry is vital to improve consumer outcomes and FSCS is keen to continue open dialogue with industry partners, like BIBA, so together we can protect customers today and into the future.

Useful industry resources and further information about FSCS can be found on its website at www.fscs.org.uk/industry-resources.