The Financial Services Compensation Scheme
21 September 2021
22 September 2021
Roger Flaxman, Michael Wilson
Flaxman’s consider the Financial Services Compensation Scheme and looks at the scheme’s limitations.
Anyone who issues blanket assurance to the effect that a policyholder’s interests will be fully protected by the FSCS is likely to be wrong. Insurers have paid out millions for BI claims that had never been expected. Some brokers’ clients might question the solvency of some insurers. What assurances should a broker or insurer provide? Should a policyholder simply be advised that they will be protected through the FSCS if the worst happens and the insurer becomes insolvent? Does the FSCS apply to businesses as well as consumers? We look at the scheme’s limitations below.
The Financial Services Compensation Scheme (FSCS) is a compensation fund of last resort for customers of authorised financial services firms. The FSCS pays compensation if a firm is unable, or likely to be unable, to pay claims against it. This is usually because it has stopped trading or has been declared in default. The FSCS was established under the Financial Services and Markets Act 2000, becoming operational on 1 December 2001. The maximum level of compensation for claims against firms declared in default on or after 1 January 2010 is 90% of the claim (except as shown below) with no upper limit. The FSCS is funded by the financial services industry through a compulsory levy.
Which policyholders qualify?
The protection under the FSCS is primarily intended for individuals/consumers. There are circumstances where a business will qualify, but this is considered on a caseby-case basis. The intention is that any protection for business is only provided to a small business, generally with an annual turnover of less than £1m. This will come as a surprise to many. In particular, it is noted that this limit has never been increased – unlike the increase for SMEs with a turnover of up to £6.5m in relation to the Financial Ombudsman Service (FOS). Under the rules a “small business” is defined as: a partnership, body corporate, unincorporated association or mutual association with an annual turnover of less than £1m. When the FSCS replaced the previous Policyholders Protection Scheme in 2001, business policyholders were excluded altogether with the exception of compulsory insurance – see below
Which insurance policies qualify?
The FSCS website sets out the policies that qualify. (We have not included the life and pensions policies here). See www.fscs.org.uk The following are entitled to 100% compensation:
- Third-party motor
- Employers’ liability
- Income protection insurance – also known as permanent health insurance or long-term disability insurance*
- Professional indemnity insurance*
- Claims arising from the death or incapacity of a policyholder due to injury, sickness or infirmity (e.g. a death or disablement benefit of a personal accident policy or similar benefit on a motor policy.) *
- Building guarantee policies for firms that failed on or after 8 October 2020. Prior to this, 90% of the value of eligible claims will be repaid.
* If the firm failed on or after 3 July 2015. If before, claims are 90% protected.
The following insurance claims are entitled to 90% compensation:
- Motor first party
- Public liability
The following are excluded all together:
- Goods in transit
- Credit insurance
- Contracts of reinsurance for insurance firms or brokers / financial advisers
Readers will be surprised to note the seemingly arbitrary exclusions, especially for goods in transit and marine. We expect the exclusions arose from the fact that these are covers often provided through Lloyd’s, which provides its own guarantee for underwriters’ liquidity. However, there will be small businesses that place these covers outside the Lloyd’s market. We asked the FSCS if there was likely to be an initiative to bring these covers within the scope of FSCS, to which they responded, “We are not aware of any plans to extend the scope of FSCS protection to cover these types of risk at the present time.”
Claims for unexpired premium
The FSCS website states:
The policy wording will state the circumstances in which policyholders can cancel a policy and when a refund of premium can be paid. This may not be possible in all circumstances, and you should check your policy wording.
In certain circumstances FSCS might be able to help with return of premium claims. Where the policy allows a return of premium and the policy is properly cancelled by an eligible policyholder or the provisional liquidator (on behalf of the firm), then FSCS can protect the value of the unexpired premium. However, FSCS can only assist where eligible policy-holders cannot recover what they are owed by the firm.
Historically, the FSCS protects policies taken out in the UK in respect of EEA risks and policies taken out in the EEA (such as Gibraltar and Iceland) in respect of UK risks. Policies issued in the Channel Islands or the Isle of Man are not included in the FSCS scheme. The situation has been complicated following Brexit. Even if a policy issued in an EU state shows the policy is protected by the FSCS, the best way to check this out will be to contact the company concerned and seek written confirmation of its status. The insurance provider in question must be authorised by the Financial Conduct Authority (FCA) or the Prudential Regulation Authority (PRA) in the UK. You can check the firm’s authorisation status along with its FSCS protection status on the FCA’s financial services register at https:// register.fca.org.uk/s/ .
Assume nothing. Make no blanket assurances.
It is no simple matter to establish the extent of protection under the FSCS, especially for business policyholders. The rules are complex and not widely publicised. And there are some situations in which a policyholder’s claim can, theoretically, be written down prior to the insurer becoming insolvent as a way of preventing an insurer insolvency event (which triggers the FSCS protection). This is complicated and obscure although the Treasury has announced a consultation on revising this aspect of insurer insolvency and there is an open consultation until 13 August 2021.
Amendments to the Insolvency Arrangements for Insurers: Consultation - GOV.UK (www.gov.uk)
A broker shouldn’t imply that the FSCS will pick up any problems of insurer insolvency as a replacement for being satisfied as to an insurer’s rating/solvency. Applying for compensation after the event through the FSCS is no easy matter
Flaxmans – Straight to the heart of the matter
Flaxmans are internationally recognised specialists in Claims Mediation and Resolution for Commercial and Business sector clients. Necessary and essential to a business, insurance is all too often purchased on price and or without a detailed understanding of the cover provided, rather than as a valued and thought through requirement, inevitably leading to conflict when a claim is disputed or when insurance is declined. Flaxmans negotiate and settle business insurance claims, and act as expert witnesses to the judiciary and courts on matters of insurance and broker practice. For more information visit www.flaxmanpartners.co.uk
This document is believed to be accurate but is not intended as a basis of knowledge upon which advice can be given. Neither the author (personal or corporate), Society of Underwriting Professionals or Chartered Insurance Institute, or any of the officers or employees of those organisations accept any responsibility for any loss occasioned to any person acting or refraining from action as a result of the data or opinions included in this material. Opinions expressed are those of the author or authors and not necessarily those of the Society or Chartered Insurance Institute.