Are FSCS Costs Spiralling out of Control?

Financial advisers are looking with mounting despair at the rising costs of their business. They have to pay to be regulated, then pay to be insured via professional indemnity cover. These costs are rising fast, but they’re not the worst problem.

Are FSCS Costs Spiralling out of Control

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The Financial Services Compensation Scheme (FSCS) is the compensation fund for clients of regulated financial advice firms. If the IFA can’t pay a compensation claim awarded against it, probably because it’s in trouble itself, then the FSCS pays the client.

Exponential Rise in the Levy

Every firm of IFAs has to pay a levy to fund the FSCS and until recently, most have seen it as a cost of doing business. But the FCSC levy for 2015-16 rose exponentially, from £267m the year before, to £319m. Out of this amount, £100m is allocated to pension and life advice businesses.

The major irony, is that while fly-by-night firms close down once trouble hits, the reputable, prudent firms have to compensate their clients. Hargreaves Lansdown for example, saw its levy leap up from £2.1m to £4.6m. It’s hard for any business to cope with a sudden rise in costs of this magnitude, although good back office systems from and others may be able to help with the planning.

Hargreaves’ boss described the costs as “crazy” and pointed to the unfairness of punishing reputable firms because of the mistakes of others. Back office systems for financial advisers will be working hard to analyse the costbase of these businesses, looking for efficiencies.

Unintended Consequences – a Death Spiral and Increased Financial Exclusion

The law of unintended consequences is hard at work too. Because of these rising costs, many IFAs are wondering if it’s worth staying in business, and the number of IFA firms is falling. The consequence is, that there are fewer firms on which to impose the levy. So each firm’s share goes up, making more firms unprofitable and leading to more closedowns, fewer contributors, higher costs for those remaining – a death spiral in other words.

Another unintended consequence is that firms decide to take on fewer run-of-the-mill clients, and to concentrate on a smaller number of wealthy clients. It is not really what the government had in mind when they set up this scheme.