The regulator is considering ways to raise the amount of compensation that can be awarded by the Financial Services Compensation Scheme (FSCS) to better protect consumers in the wake of the pension freedom reforms.
In its FSCS funding review, out on 14 December, the Financial Conduct Authority (FCA) said it was keen to overcome "potential issues" in the differential limits awarded on life insurance and investment contracts.
Under current rules, consumers who invests via a life insurance contract, such as an annuity, will receive 100% of their money back if the provider firm fails. A consumer who makes a non-insurance investment, such as drawdown, however, can only receive a maximum of £50,000 per failed firm.
Investment-based products such as drawdown surged in popularity following the government's pension reforms, which gave savers unfettered access to their pension pots from age 55.
According to FCA data, in the period July 2015 to March 2016, annuities accounted for less than 14% of the total number of pots accessed for the first time to take an income or fully withdraw money as cash (44,640 out of 324,537).
The regulator said: "There may be a potential issue with these differential limits, especially given the changes in the pensions environment.
"The pensions freedoms have resulted in a clear movement in the market and more consumers invest their pension funds on retirement in drawdown products instead of insurance-based annuities."
"With only the lower compensation limit in place, pensioners could potentially be placed in financial difficulty with little or no chance to replenish their savings."
The FCA is examining several options as part of the review, in particular:
* leaving the limits as they are;
* increasing the limit for all investment business from £50,000 to £75,000;
* increasing the limit for all investment business from £50,000 to £100,000;
* increasing the limit for all investment business from £50,000 to £150,000;
* increasing the limit for all investment business from £50,000 to £1 million;
* differentiating between investment provision and investment and life and pensions intermediation, and increasing the limit for investment provision claims only;
* seeking to identify pensions-related claims as distinct from those made for ‘traditional' investments, and introducing higher limits for claims for investment arrangements or services used purely for retirement planning.
A cost/benefit balance
The regulator said it was mindful of the potential cost involved to the industry in changing the compensation limits on investments.
It estimated that, prior to pension freedoms, between 2010 and 2014, had the compensation limit for investment been £75,000, total compensation costs in the period would have been almost £79m (6.3%) higher than they were.
For a limit of £100,000, compensation costs would have been £123.2m (9.8%) higher. With a compensation limit of £150,000, compensation costs would have been £167.7m (13.3%) higher.
At the same time, with a limit of £75,000, all claims in the investment provision class would have been fully met, alongside 96.7% in investment intermediation and 95.4% in life & pensions intermediation.
The FCA said: "We recognise that to introduce a higher limit of protection, particularly one that applied to all investors, could increase the risk to the FSCS's costs becoming unsustainable due to potentially high-value future claims.
"We must therefore find an appropriate balance between providing protection for consumers and ensuring FSCS funding is sustainable and affordable for firms. We are interested in views on where this balance should be struck."
Meanwhile, the FCA has also proposed forcing providers to contribute towards advisers' FSCS costs, saying it recognised the burden of funding the scheme did not currently fall equally on product providers and advisers.
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