Seven o’clock on a Friday evening is not a time most business owners want to be told they may need to change their entire model due to regulatory changes.
But that is the situation advisers found themselves in a couple of weeks ago. The Financial Conduct Authority (FCA) sent an email warning they needed to check they had compliant cover in place when the amount the Financial Ombudsman Service (FOS) could pay out rose from £150,000 to £350,000.
The fact advisers were warned about this just two days before the rules came into force on 1 April was no laughing matter for advisers. ‘A shambles’ is what Dominic Thomas, director of Wimbledon-based Solomon’s IFA, described the situation as on Twitter upon receiving the regulator’s email.
You can see his point. Timing of the email aside, advisers have faced serious challenges trying to sort out PI insurance in recent months, particularly if they have advised on any defined benefit (DB) pension transfers.
At a premium
Now FOS limits are rising, many advisers are being forced to stop offering DB transfer advice, as insurers are unwilling to take on the risk of what they perceive to be a high-risk market. One such firm is Derbyshire-based Red Circle Financial Planning.
The firm’s PI insurer Liberty Mutual increased its premiums, including a £2,000 extra bill for three British Steel Pension Scheme (BSPS) transfers it had advised on. When Liberty said it would not be able to cover DB claims under the new FOS limit of £350,000, Red Circle Financial Planning had to stop accepting new DB business.
‘I was already considering pulling out of DB transfers, because it is costing a lot of money and I’ve only had three enquiries this year, only one of which would even be worth a discussion with the client,’ said Red Circle director Darren Cooke (pictured above).
The source of insurers’ concern is obvious. Now FOS claims will not be limited at £150,000, PI insurers have to reconsider whether it is worth offering insurance to cover potentially very high value claims. The average transfer size is £400,000, according to the FCA, so it may no longer be worth insurers’ while to offer advisers protection against claims.
This increase in premiums has not been uncommon for advisers since steelworkers’ plight brought the nation’s attention to DB transfers. Brokers acting on behalf of advisers have seen large increases in the amount insurers want in premiums if firms have been conducting DB transfers.
‘Insurers consider that without their £150,000 cap on FOS awards, they potentially have significantly increased exposure on the IFAs they cover,’ said Julian Brincat, head of IFA practice at insurance broker Protean Risk. ‘While they have made it clear to the regulator in their consultation that this could potentially increase their rates if they were to offer full cover, this may well prove to be unaffordable for many firms.’
One way of doing this is to raise premiums, but another is to increase the levels of claims excess – the contribution a policyholder is expected to make toward a claim. Doing this means firms agreeing to pay more of their own money if a successful claim is made against them.
‘We are seeing excess levels increasing for DB transfers,’ Brincat said. ‘Whereas a couple of years ago firms carrying a £25,000 excess was not that normal, it is now a relatively common starting point for DB activities.
‘Obviously this will have capital resource implications as well, which we see as a significant barrier for most small firms. Many firms are well capitalised and are able to cope with requirements but many are simply unable to.’
Red Circle Financial Planning’s excess levels tripled from £5,000 to £15,000 for DB transfers when it last renewed. As a result Cooke had to put another £10,000 into the firm in the form of back-up capital.
In some cases excesses have risen even further. Bridgend-based Future Asset Management’s excess for DB transfer cases hit £50,000 when it renewed in January. The firm has not stopped offering DB transfer advice, but is now considering increasing charges for future clients.
‘It’s very frustrating,’ said Graham Wingar (pictured above), a partner at Future Asset Management. ‘It’s not a great position for anyone to be in, especially the end consumer. We already charge a fortune for DB work and if that needs to go any further, it will make it more costly and less likely that people can get the good advice that they need.’
Rising excess levels also pose a problem for the Financial Services Compensation Scheme (FSCS). Earlier this year Alex Kuczynski, chief corporate affairs officer at the FSCS told New Model Adviser® the lifeboat fund was ‘not making enough recoveries’ from PI insurers when advice firms collapse.
For firms that collapsed before 1 January 2017, the maximum FSCS pay-out will be £50,000. For firms that failed after that date the maximum is £85,000.
Even if a firm has collapsed, the FSCS is still entitled to pursue a PI insurer for the money it would have paid out. But the higher the excess, the less money there is to collect from the insurer under the cap.
Kuczynski (pictured below) said excess levels on PI contracts can be set ‘too high’ to make it worthwhile chasing for the FSCS. ‘If you have a £50,000 excess per claim, we obviously only pay out at £50,000. Not many of our claims go above £50,000, so there’s actually no commercial value in the policy for us.’
DB days are numbered
If excess levels for DB transfers rise, the FSCS will face more problems making recoveries from collapsed advice firms. As the FSCS is funded by a levy on advisers, firms that are paying increased premiums could also end up paying higher levies to compensate clients of collapsed firms.
Even when PI premium and excess increases are manageable, smaller advice firms have been pushed to slow down their DB business. Another adviser, who wished to remain anonymous, said they had been given so many exclusions and clauses, it was impossible to see the firm continuing to offer DB transfer advice.
‘Our experience of premium increase was closer to 40%, but with a massive restriction on what we can do, to the extent we are pretty much out of the pension transfer market,’ they said. ‘If we do more than a handful of pension transfer cases, we’ve got to get individual permission from the underwriter, so we’ve just pulled out of that marketplace really.’
The FCA was warned increased FOS limits could stop firms offering DB transfer advice. When it published a consultation paper on the subject, the regulator was told by insurers that PI premiums could rise by as much as 500% when the new rules come into force.
The regulator rejected the insurer’s evidence, its own calculations suggested there would only be a 140% rise in PI premiums as a result of increased FOS limits.
Brincat said insurers were not convinced by the FCA’s numbers. ‘We are not sure insurers necessarily agree with the figures quoted by the FCA. Many of them are currently assessing the situation to be in a position to offer this cover, albeit at a likely cost.
‘It is still at a very early stage and it will take a while for insurers to settle down and give us a steer on how they will be assessing this increased risk going forward. It is safe to say insurers need to feel reassured the FOS is the appropriate forum to assess and provide a resolution for larger, more complex claims.’
Advisers are also unconvinced: on the day the paper was published David Penney, director at London-based Penney, Ruddy and Winter, questioned why the FCA used data based on the number of advisers firms have, rather than a firm’s turnover.
When New Model Adviser® asked the FCA about its calculations we were told the figures came from the Retail Mediation Activities return all advisers have to file. But this data was not in the public domain. The paper did state these figures covered firms with between two and five advisers.
As the table (below) shows, when the FCA looked at this information in 2017, the average PI premium for a firm generating up to £100,000 in revenue was £2,412, and for a firm generating between £101,000 and £500,000 this figure was £4,889.
But what those figures do not show is the difference between businesses that offer DB transfer advice and those that do not. As the FCA noted ‘we assume insurers will price their premiums according to the risk profiles of the individual firms’. The problem many advisers have noticed is any firm that offers DB transfer advice is now considered high risk.
‘It’s frustrating when you carry out all the best practices, yet still struggle to convince insurers that you’re the good guys and not the bad guys,’ said another adviser who did not wish to be named.
Clearly increasing the FOS limit is a good move if it allows consumers to receive higher compensation when they have been poorly advised to transfer out of a DB pension. But the FCA has been too complacent with its view that only ‘high-risk’ firms will lose out.
After all, when good advisers are struggling to obtain PI cover, consumers will also suffer.