Financial Services Compensation Scheme
The failure of a few insurance companies in the early 1970’s lead to the legislation called the Policyholders Protection Act 1975. The protection is for policyholders who suffer as a result of an insurance company who does business in the UK financially failing so that it can not meet policyholders’ claims.
Under section 212 of the FSMA 2000 the Financial Services Compensation Scheme (FSCS) was established and the 1975 act repealed. The FSCS replaces the 1975 act and the deposit protection scheme for banks and building societies, and the Investors Compensation scheme under the Financial Services Act 1986.
In order to obtain compensation from the FSCS for long term business the claimant must be an eligible claimant. Eligible complainants are persons with the exception of,
1. Directors and managers of the relevant person in default. However, this exclusion does not apply if:
- the relevant person in default is a mutual association which is not a large mutual association; and
- The directors and managers do not receive a salary or other remuneration for services performed by them for the relevant person in default.
2. Close relatives of persons excluded by (1) above.
- Bodies corporate in the same group as the relevant person in default.
- Persons holding 5% or more of the capital of the relevant person in default or of any body corporate in the same group.
- the auditors of the relevant person in default, or of any body corporate in the same group as the relevant person in default, or the appointed actuary of a friendly society or insurance undertaking in default.
- Persons who in the opinion of the FSCS are responsible for, or have contributed to, the relevant person’s default.
- Persons whose claim arises from transactions in connection with which they have been convicted of an offence of money laundering.
The FSCS must decide if a firm is unable to (or likely to be unable to) meet their liabilities. In order to do this the FSCS can request documents, records, information for this purpose. This power extends to requests against any insolvency practitioner.
If the FSCS concluded that a firm is unable to meet its liabilities then it must pay compensation to all eligible claimants affected by the default. The compensation is 100% of the first £2,000 and then 90% of the remaining value of the life policy with no maximum limit.
The cost and exposure of the FSCS will vary with the size and type of company that went into failure. A small IFA handing no client money might represent only a small exposure, whilst a large life insurance office would represent a much larger exposure.
The costs to the FSCS are funded by a charge on the authorised firms. Authorised firms are divided into contribution groups depending on the financial market they are in (insurance, investors, banks). Each contribution group/sector covers the cost of the compensation fund required to protect that sector and the fund is based on the expected call for contribution.
Protected insurance contracts are those issued through a UK office, another EEA state, the Channel Islands or the Isle of Man if the risk is situated in one of these countries. For life and pensions the risk is situated where the policyholder is habitually resident at the date the policy is affected.
The FSCS can also make arrangements for business to be transferred to another life office for the protection of long term insurance policy holders. This equally applies to policyholders of insurance companies in financial difficulties.
The FSCS can request that a claimant who they are compensating, sign over their rights to the FSCS. The FSCS are due to make payments to claimants as soon as possible after the amount of claim has been calculated. Payment can be made to pension schemes where that has a tax advantage for the claimant.
The FSCS can reduce the compensation payment if there has been contributory negligence on the part of the claimant or if full payment would be more than the claimant could have otherwise expected to receive. If the FSCS believe that the benefits under a long term policy are excessive and an actuary agrees with this then the FSCS can reduce the amount payable.