12.1 The Financial Services Compensation Scheme

The FSCS — Compensation of Last Resort

The Financial Services Compensation Scheme (FSCS) is the UK's statutory compensation scheme of last resort for customers of authorised financial services firms. It was established under Part XV of the Financial Services and Markets Act 2000 (FSMA 2000) and is operationally independent, although it works closely with the FCA and the PRA. The FSCS is the body that pays compensation to consumers when an authorised firm is unable, or likely to be unable, to pay claims against it — in other words, when the firm has failed and there is no realistic prospect of it meeting its obligations from its own resources.

Quick Answer: The FSCS pays compensation when an authorised firm has failed. It does not pay compensation for a bad outcome (a claim wrongly denied by a solvent firm) — that is a dispute for the Financial Ombudsman Service (FOS). The FSCS is free to the consumer and is funded by levies on authorised firms.

FSCS or FOS — Knowing the Difference

IF1 exams routinely test the distinction between the FSCS and the FOS, and students who blur them lose easy marks. The two bodies sit side by side under FSMA 2000 but do different jobs:

A useful memory hook: FOS = fight; FSCS = fail. If the firm is solvent and the issue is conduct, the route is the FOS. If the firm has gone bust, the route is the FSCS. A consumer can complain to the FOS first; if the FOS upholds the claim but the firm cannot pay, the consumer can then turn to the FSCS.

How the FSCS Is Funded

The FSCS is funded by levies on authorised firms. It is free to the consumer. Each year the FSCS calculates the amount it expects to pay out and the costs of running the scheme, and it sets a levy on the relevant classes of authorised firm (insurers, brokers, banks, investment firms). The levy is divided across funding classes so that firms carrying similar risks contribute together. In insurance, both insurers and intermediaries can be levied, depending on which funding class the failure falls into. The FSCS can also borrow from the National Loans Fund if it needs to pay compensation before levies are collected.

The 100% / 90% Insurance Protection Rules

The level of protection depends on the type of insurance and on when the failure occurred. The current rules, set out in the FCA Handbook (COMP 10) and on the FSCS website, apply to failures of insurers (or firms acting as insurers) occurring on or after 8 October 2020. The key change on that date was the addition of building guarantee policies to the 100% protected categories, following PRA Policy Statement PS21/20.

100% protected claims (firm failed on or after 8 October 2020)

For these categories the FSCS pays 100% of the claim, with no upper limit on the amount:

• Compulsory insurance — for example, motor third-party liability under the Road Traffic Act 1988 and employers' liability under the Employers' Liability (Compulsory Insurance) Act 1969.
• Long-term insurance — whole-of-life assurance, term life and critical illness, insured personal pensions, annuities and income protection policies.
• Professional indemnity insurance.
• Claims arising from death or incapacity of the policyholder caused by injury, sickness or infirmity.
• Building guarantee policies (BGPs) — structural defect cover for new-build homes, added to the 100% category from 8 October 2020.

90% protected claims (firm failed on or after 8 October 2020)

For all other (non-compulsory) general insurance, the FSCS pays 90% of the claim, again with no upper limit. This category includes most voluntary insurance: motor first-party (own damage), home, contents, travel, pet, private medical and dental, warranty, and non-compulsory public liability and property insurance.

The 8 October 2020 Boundary

The 8 October 2020 date matters because the rules before that date were different. For failures between 3 July 2015 and 7 October 2020, 100% protection applied to compulsory insurance, long-term insurance, professional indemnity and death/incapacity claims, but building guarantee policies were only 90% protected. For failures before 3 July 2015, only compulsory insurance was 100% protected. For IF1, the current position (8 October 2020 onwards) is the focus, but the existence of the boundary is itself a common exam point.

How a Claim Works in Practice

When an insurer fails, the FSCS typically arranges for policies to be transferred to another insurer (a "run-off" arrangement) where possible. If no transfer can be arranged, the FSCS pays claims directly. For outstanding claims under existing policies, the FSCS pays the relevant percentage (100% or 90%). For unexpired premium (the part of the premium for the remaining policy period), the FSCS generally refunds the consumer. The FSCS does not pay for losses that are not covered by the policy itself — it stands in the shoes of the failed firm.

Worked Scenario

A small UK general insurer goes into administration on 1 March 2024. It wrote a mix of business:

• A motor third-party policy for a driver who has just caused a serious injury to a pedestrian — the third-party claim is for £500,000. This is compulsory insurance, so the FSCS pays 100%: £500,000.
• A home buildings and contents policy where the policyholder's house has been damaged by fire and the claim is £80,000. This is non-compulsory general insurance, so the FSCS pays 90%: £72,000.
• A building guarantee policy on a new-build flat where a structural defect has appeared. Because the failure is after 8 October 2020, building guarantee policies are 100% protected, so the FSCS pays the full cost of the remedial works.
• A whole-of-life assurance policy where the policyholder has died. This is long-term insurance, so the FSCS pays 100% of the sum assured.

Limits and Exclusions

The FSCS protection rules for insurance have no monetary cap on the amount of the claim (unlike the deposit protection limit, which is £85,000 per person per authorised firm). The protection is about the percentage applied, not a cap. However, the FSCS only protects consumers and small businesses; very large commercial policyholders may fall outside the scope of compensation depending on the size and nature of the business. The FSCS also only protects claims against authorised firms — a person who bought cover from an unauthorised "insurer" has no FSCS protection (and may have recourse against the broker who arranged it, depending on the circumstances).

Key Takeaways

• The FSCS is the UK's statutory compensation scheme of last resort, established under Part XV FSMA 2000, funded by levies on authorised firms, and free to consumers.
• The FSCS pays compensation when an authorised firm is unable, or likely to be unable, to pay claims — i.e. the firm has failed; the FOS resolves disputes where the firm is still trading.
• For insurer failures on or after 8 October 2020, the FSCS protects 100% of claims for compulsory insurance, long-term insurance, professional indemnity insurance, death/incapacity claims from injury/sickness/infirmity, and building guarantee policies.
• For the same failures, the FSCS protects 90% of claims for all other (non-compulsory) general insurance, with no upper monetary limit.
• The 8 October 2020 change (PRA PS21/20) added building guarantee policies to the 100% category; before that date BGPs were 90% protected.