Budget 2017 and the “Super FOS” scheme

Labelled “Super FOS” by industry stakeholders, the government has announced in last night’s federal budget the establishment of a one-stop shop to cover all disputes in the financial system.

Arguably a diversion from Labor’s call for a banking royal commission, Super FOS – to be known as the Australian Financial Complaints Authority – will replace the Financial Ombudsman Service (FOS), the Credit and Investments Ombudsman (CIO) and the Superannuation Complaints Tribunal and will be up and running by 1 July 2018.

What is it?

The Australian Financial Complaints Authority (AFCA) will be a single industry-funded body for external dispute resolution and complaints in the financial system, giving consumers redress against banks, insurance and superannuation companies, as well as other financial services providers. Australian Financial Services Licensees will be required to be members of AFCA.

The reforms are likely to expand jurisdictional limits for consumers, raising the current ceiling on claims and compensation. Currently at both FOS and CIO, the value of the claim must not exceed $500,000 and a $309,000 compensation cap typically applies.

The low caps at FOS and CIO have been widely criticised for denying many consumers access to external dispute resolution and excluding many small businesses. Lower limits arguably have the effect of sending more disputes to the Courts, involving costly litigation, where the banks and other financial services providers are said to have an advantage in terms of their resources to fight a claim.

The government has responded indicating small business disputes related to loans of up to $5 million will be heard by AFCA, which will be able to award compensation of up to $1 million. The government is consulting with stakeholders about other compensation caps, including in relation to mortgages and general insurance products.

As an industry scheme and not a statutory tribunal, AFCA would arguably have no statutory powers and may still be ineffective in dealing with certain consumer claims. The limitations include being unable to join a third party and bind them to its decisions, subpoena a third party to produce documents or as a witness, or impose penalties.

A compensation scheme of last resort?

The budget failed to provide important insight into the highly contentious “compensation scheme of last resort”, proposed by many stakeholders to respond to claims where consumers are denied access to justice, either because there is no prospect of receiving compensation, or their successful action remains unsatisfied.

As at 1 November 2016, FOS has more than $17 million of unpaid determinations made in favour of complainants who have not been paid as the financial firm “lacks the financial resources” to pay the determination, whether due to insolvency or otherwise. In addition, FOS is often forced to resort to litigation as an enforcement measure to ensure compliance with its determinations where the financial firm is solvent and there is a good likelihood of recovery.

What does it mean for the insurance industry?

A “compensation scheme of last resort” would seek to respond to claims against financial firms whose professional indemnity (PI) insurance is insufficient to meet the claim.

Certain financial services companies are required to have adequate compensation arrangements in place to compensate consumers where losses arise from a breach of financial services or credit laws. These arrangements are generally satisfied by holding adequate PI insurance.

Stakeholders have identified significant limitations in using PI insurance as a compensation mechanism, which is not the policy intention of the requirement. This includes coverage issues in relation to the amount of compensation awarded, and the conduct leading to the compensation order.

Underwriters may need to review their policy wordings for certain financial services companies, and the availability and coverage for run-off cover, insolvency, fraud and other misconduct. This is because they relate to the type of conduct which may trigger compensation to a claimant under a proposed scheme. Such conduct may be otherwise excluded under a PI policy.

Underwriters may also consider the impact on premiums, particularly for small financial services businesses, which could fall within revised jurisdictional limits on claims and compensation.

A further report from government on a compensation scheme of last resort is expected in the second half of this year.

Whether such a compensation scheme would be industry-funded or subsidised by tax payers remains to be seen.