Fiona Kidy: FSCS plans to take Covid-19 learnings forward

Despite Covid-19 complicating financial forecasting for Financial Services Compensation Scheme (FSCS), the pandemic has helped the service create a blueprint for future unforeseen events. 

Fiona Kidy, chief financial officer at the FSCS, tells Insurance Times: ”You do what you can with the information you have at the time. Have we learned lessons? Absolutely and we will be taking those with us through the next cycle. 

”We still haven’t fully yet understood the impact of the government support schemes, so there is still a huge amount of uncertainty around the impact of the pandemic. We are more than willing to listen, learn and inform.” 

She admits that the FSCS did not have enough data points around the pandemic to help inform its financial decision-making. Plus, because forecasting for the following financial year starts soon after previously published forecasts, the scheme was also not able to factor in government supports schemes and extensions to its planning process.

Kidy adds: “For us, that pushed out when the failures would occur. That was part of the reason the levy forecast came down. The second reason was [that] some failures we expected to come in during 2020/2021 didn’t come in as quickly.”

May 2021 saw the FSCS’s levy forecast at £833m, down from January 2021’s initial forecast of £1.04bn.

The service said this amendment was due to two key factors. Firstly, that firms which looked likely to fail this year could now fail in the 2022/2023 financial year or beyond due to the government extending its support schemes and secondly, that lower claims volumes and associated pay outs have led to a surplus for the 2021/2022 financial year – this has been used to offset the previously suggested £1.04bn levy amount.

The £833m levy is still £133m more that the £700m that was set for 2020/2021.

Brokers, we hear you

The FSCS is making sure to engage with brokers as the UK emerges from the pandemic.

Kidy continues: “I have met with all the trade bodies.

”We hear [brokers] concerns and we are working together, with input from the FCA, looking at how we can reduce the levy, how we can continue with recoveries to bring the levy down and [address] consumer harm.

“The rising levy is absolutely at the forefront of our minds – we understand that it is a very big number and we need to work towards reducing [it].”

Following conversations with industry trade bodies, the FSCS is aware that some firms are experiencing cashflow issues as a result of pandemic backlash -  therefore it has been looking at making the timings for the levy a bit more “friendly”.

More broadly speaking, other aims of the FSCS at the moment include preventing consumer harm – which incorporates misunderstood and bad advice - sharing data, promoting the FSCS to consumers, making recoveries from failed firms, tackling consumer scams and recommending reforms. 

Breaking down the levy

There are four elements to the FSCS’s levy:

• Compensation costs: What the FSCS pays to customers, which forms the vast majority of the levy.
• Management expenses: The cost of processing the claims and cost of the scheme.
• Offset recoveries against those costs: The FSCS has a statutory duty to try and recover as much money from failed estates as possible.
• Surpluses or deficits of cash: As the FSCS forecasts annually, if it has unused cash or needs slightly more, it does a true up by class as part of the levy process. A true up is a payment made post-closing to adjust for any difference between the purchase price determined on a transaction’s closing date, based on estimated financial metrics, and the actual purchase price calculated using financial metrics that become known only after the closing date.

“We are forecasting the money that we think we are going, during the year, to need to process customer claims and pay compensation costs,” Kidy says.

Regarding compensation costs, two pieces of data are needed – claims expected and cost per claim.

The FSCS looks at what failed estates a business already has and how claims have been paid each year, as well as horizon scanning for firms that could fail.

The scheme works closely with regulatory and trade bodies, as well as the broader industry. For example, the FSCS, FCA and Financial Ombudsman Service (FOS) share insights from various surveys. The FSCS also draws on its own historical claims data.

“This all builds up a picture of where claims could come from, which helps us pull together an internal population of what we think the volumes are going to be,” Kidy adds.

For management expenses, the FSCS uses the same claims volumes and assumptions used to calculate the cost per claim. It further considers the size of its organisation, running costs and salary costs - this budget process is reviewed by the Prudential Regulation Authority (PRA) and the FCA.

Meanwhile, for recoveries, the FSCS tries recovering as much as possible - where cost effective - from failed estates. “This is a crucial part of our strategy to keep the levy down,” Kidy says. ”Since 2015/2016, we have recovered around £280m.” 

Forecasting recoveries is “incredibly difficult” however, according to Kidy, because it’s not certain when they will come in. For example, recoveries pertaining to the 2008 financial crash took the FSCS 12 to 13 years to recoup.

“If something is very likely to come through in the next financial year, we will forecast it. If not, we will leave it out. If it comes in, it’s a nice surprise,” she says.

For class surpluses and deficits, the FSCS forecasts well in advance – but if claims are slow, there might be a surplus to offset against the forecast.

Kidy explains: “[Sometimes], you end up paying more than you forecast. As long as it doesn’t go beyond £20m, we leave it and true it up in the following year. If it does go over [£20m], we raise a supplementary levy. We give as much notice as we can - 30 days if not more.”

A supplementary levy is raised when funds are needed to cover any additional compensation costs following the original forecast levy.

Retail pool

The retail pool is a separate pot that other FCA classes are required to contribute to when they have not reached the maximum levy limit. It is only used when a class exceeds its annual levy limit and invoicing for this is deferred until later in the year, when the amount is more certain.

The FSCS’s £833m levy includes £116m for the retail pool, for example.

“If you are forecasting claims compensation above that limit, the retail pool will come into play – other firms will have to contribute to failures that are not necessarily in their class,” Kidy says.

Usually, companies will only pay levies for failures in their own classes - classes are effectively nine groups of companies, each with a limit, created by the PRA and FCA.