FSCS funding model attempts to bring certainty but at higher adviser cost

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The Financial Services Compensation Scheme has set out how it plans to calculate industry levies based on expected claims over the next three years.

In a paper setting out its approach for the new funding model, published today, the FSCS says from April 2014 it will raise levies based on either the compensation costs expected in the 12 months following the date of the levy; or one third of the compensation costs expected in the 36 months following the levy, whichever is higher.

Based on the models worked up by the FSCS, they suggest investment advisers would have been hit with the maximum levy of £150m for 2013/14, instead of the £78m actually levied on them under the current model.

The FSA first put forward plans to project potential compensation costs over three years rather than one last July, as part of its review of the way the FSCS is funded.

The review has already seen the annual claims limit for investment advisers rise from £100m to £150m, and the creation of a “retail pool” which would be triggered if one class breaches its annual claims limit.

The FSCS will use a five step process to determine levies based on three year compensation costs:

  • Assess the average figure paid by each class in compensation costs and FSCS management expenses over the last three years;
  • Adjust for exceptional costs that are not expected to reoccur, or declining claim trends. In its examples (see below), the FSCS has included the cost of Keydata claims in its three year average as they are “not considered exceptional”. The FSCS says although the costs of Keydata were high, they were not beyond the “usual level of costs” that had to be met by investment advisers;
  • Add costs of known or expected defaults in the next three years. The FSCS admits this is likely to push up average annual compensation costs for relevant classes;
  • Factor in new or current upwards claims trends;
  • Account for opening balances for each class. Surplus amounts will be used to reduce the three year amount, before it is divided into yearly periods. Deficits will be added to the next year’s levy.

Levies will be capped at annual class thresholds.

The FSCS says: “By taking a longer view of potential compensation costs the FSCS may be able to offer levy payers greater certainty. The FSCS favours a relatively simple and transparent approach, which will avoid unnecessary expense to the industry.”

Feedback on the plans for a three year funding model should reach the FSCS by 31 July.

Example of average FSCS costs over three years that would have been used to set 2012/13 levy:

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Example of average FSCS costs over three years that would have been used to set 2013/14 levy, including 12 month forecast:

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Source: FSCS