The FOS: Extending Eligibility and Increasing Monetary Awards

On Tuesday (16 October), the Financial Conduct Authority (FCA) published two papers setting out major changes to the Financial Ombudsman Service ("FOS") regime.

Firstly, the FCA published "near final" new rules extending the "eligible complainant" criteria for FOS complaints to include a large proportion of small and medium sized enterprises ("SMEs"). Secondly, the FCA published a consultation paper proposing to substantially increase the monetary award limit.

Extension of "Eligible Complainant" Definition

The ability of the FOS to consider a complaint depends on a number of factors, including whether the complainant is eligible. The current definition of "eligible complainant" is limited to:

• Consumers (defined as natural persons acting for purposes outside of their trade, business or profession);
• Micro-enterprises (defined as enterprises which: (a) employ fewer than 10 persons and (b) have a turnover or annual balance sheet that does not exceed €2 million);
• Charities which have an annual income of less than £1 million; and
• Trustees of trusts which have a net asset value of less than £1 million.

Following a consultation exercise carried out earlier this year, the FCA confirmed in Policy Statement 18/21 that it has decided to proceed with its proposals to allow more SMEs to be able to make complaints to the FOS, and has published "near final" rules to this effect.  Under the new rules, an SME will be an eligible complainant if:

• It has an annual turnover of less than £6.5 million; and
•  It employs fewer than 50 persons or it has a balance sheet total of less than £5 million, at the time that it refers the complaint.

Entities satisfying the above criteria will be referred to as "small businesses" under the proposed new rules.

The thresholds for charities and trusts will also be raised so that:

• A charity will be eligible to complain if it has an annual income of less than £6.5 million at the time if refers the complaint; and
• A trustee of a trust which has a net asset value of less than £5 million at the time the complainant refers the complaint will also be eligible.

Finally, individuals who have given guarantees or security in respect of an obligation or liability of a micro-enterprise or eligible SMEs will also be eligible complainants.

The FCA estimates that, following the changes, 210,000 additional SMEs will be eligible to refer complaints to the FOS. 

The intention in publishing "near final" rules is to allow the FOS time to take the necessary steps to implement the proposals, such as hiring extra staff with the necessary skills, and it will create a ring-fenced specialist unit to handle complaints from SME customers.  It is currently expected that the rules will be finalised before the end of 2018 and then come into force from 1 April 2019.  The FCA has said that, within two years of this, it will undertake a post-implementation review to assess the impact of the new rules.

Proposed Increase in Award Limit

Since 2012, the limit on FOS monetary awards has been £150,000. Although the FOS can recommend compensation above this limit, payment of sums over the limit is voluntary and not enforceable through the courts.  However, in Consultation Paper 18/31 the FCA now proposes that:

• The FOS's award limit should more than double, from £150,000 to £350,000 for complaints about acts or omissions by firms which take place on or after 1 April 2019;
• The award limit should change to £160,000 for complaints about acts or omissions by firms that take place before 1 April 2019 and which are referred to the FOS after that date;
• From 1 April 2020 onwards, both limits should be automatically adjusted annually in line with the Consumer price Index (rounded down to the nearest £5,000).

Complaints referred to the FOS before 1 April 2019 will remain subject to the current limit of £150,000.

While the FCA estimates that approximately 2,000 complaints are upheld by the FOS each year which involve fair compensation recommendations above £150,000, it is acknowledged that this figure unlikely reflects the true number as a significant proportion of upheld complaints involve awards with unknown compensation values.  Taking the example of pension transfer complaints, ombudsman decisions usually set out a methodology for calculating the compensation, as opposed to specifying an actual amount. As such, the true figure is likely much higher.

Based on an FOS analysis of 40 high value complaints (which related predominantly to business loans, interest rate hedging products (IRHPs), portfolio management and self-invested personal pensions (SIPPs)) the mean compensation value was found to be around £305,000 with a range of £150,000 to approximately £921,000.  It is this mean calculation which has guided the setting of the proposed new limit, but consideration has also been given to the average compensation figures for IRHP and pension complaints within that sample, together with data from other sources regarding estimated average values of buildings insurance, life and critical illness and business interruption claims. The FCA has estimated that the shortfall for such complaints between £150,000 and the proposed new limit could be around £113 million per year. 

Discussion

These proposals will be of interest to insurers on two fronts:  firstly as respondents to complaints to the FOS by their own insureds and, secondly, it will be particularly relevant to professional indemnity insurers whose insureds' activities fall within the FOS's jurisdiction.   

The proposed changes appear to have been very much informed by the IRHP mis-selling debacle which predominantly hit the SME sector. The FCA has also placed weight on research prepared by the Legal Standard Board, amongst others, which concluded that it is not only micro-enterprises but also larger SMEs that can struggle to resolve disputes and receive redress through the courts due to insufficient financial and legal resources.   It is assumed that if SMEs are struggling in this regard, so too will consumers, hence the proposal to extend the increased award limit to all eligible complainants.

While increased value does not automatically mean increased complexity, it would be fair to observe that these changes, when viewed together, will undoubtedly mean that an increasing number of more complicated and high value disputes will now fall within the jurisdiction of the FOS.  This is particularly so given the comparative cost/benefit analysis of utilising the FOS regime over pursuing litigation even for disputes that appear to have a value some way in excess of the proposed new £350,000 limit. The FOS is fee-free to the complainant and the respondent may need to pay  a case fee (there is no charge for the first 25 complaints, but a fee,  currently set at £550 for each complaint, must be paid thereafter). The attractiveness of the FOS process is further heightened for complainants by the fact that the FOS is not bound by established legal principles relating to loss causation and quantum assessment. Instead, an ombudsman is required to determine the complaint according to what, in his opinion, is fair and reasonable in all the circumstances of the case and, in doing so, is able to depart from the relevant law (although must take it into account).   As such, it is often viewed as providing far more favourable compensation to complainants than that which they might achieve through the courts, and a more unpredictable outcome in respect of the merits of a complaint more generally.  This can be concerning for respondents in circumstances where the only avenue of challenge is by way of judicial review (which can be fraught with difficulty given the breadth of the FOS's discretion).  Increasing the scope of eligibility and also the monetary limit serves only to heighten the impact of these issues for respondents. 

Looking particularly at the insurance sector, the FCA notes that the FOS has said legal standards will be particularly important when it decides what is fair and reasonable for complaints from large businesses and others with a more sophisticated knowledge of insurance.  However, and as pointed out by a number of respondents during the consultation process, there is no judicial consideration of the Insurance Act 2015, which further enhances the unpredictability. While it is possible under the existing rules for an FOS complaint to be referred to the courts if it raises an important or novel point of law with significant consequences (DISP 3.4.2R), this provision is rarely utilised and, in any event, cannot be demanded by the parties.  

Concern has also been voiced for some time about the FOS's capability to deal with complex disputes (particularly in the investment portfolio management and pensions sphere) and the FOS still has some work to do in this area following the findings of the independent Lloyd Review, although the delay in implementation of these proposals is intended to allow the FOS to get to grips with those issues.   

 While no further representations are invited in respect of the SME proposals, the consultation in respect of the proposed increase to the award limit remains open until 21 December 2019. Depending on the responses received it may be that the FCA looks to amend (either up or down) the level of the proposed increase, albeit we think it unlikely that the proposal will be abandoned altogether.

One specific area on which the FCA is inviting comment is the potential impact on professional indemnity insurance (PII) premiums. Clearly the FCA anticipates that the likely impact will be to increase premiums, possibly to unaffordable levels for some smaller regulated firms, and it could be that this consideration has a significant bearing on the FCA's proposals depending on the receipt of further evidence.  

We will be monitoring these developments and providing more detailed commentary in due course.