» consultation paper - June 2006 rules for the new consumer credit jurisdiction - chapter 6 funding

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consultation paper - June 2006 rules for the new consumer credit jurisdiction - chapter 6 funding

background

6.1 The legislation provides for the CCJ to be funded by businesses. It does not contain any provision for the ombudsman service to require complainants to pay an application fee or deposit. The same principle already applies to the CJ and VJ, which are also fully funded by businesses. Having considered the responses to its consultation on alternative dispute resolution for consumer credit complaints, the government decided that the ombudsman scheme should be free for consumers. Businesses are ultimately the beneficiaries of the ombudsman service, as the existence of the service underpins consumer confidence in the industry, irrespective of whether a particular business has a case with the ombudsman service or not.

6.2 The legislation provides that the CCJ may be funded by a levy and/or by case fees. A levy would be an amount paid at regular intervals by all businesses covered by the CCJ, while a case fee would be an amount paid by a business for each complaint about them that is handled by the ombudsman service. The Act allows for any levy to be collected from businesses by the OFT, which would then pass this to the ombudsman service. And the Act allows the consumer credit rules to provide for case fees payable directly to the ombudsman service.

6.3 Any funds collected under these arrangements would be ring-fenced for the CCJ - they could not be used for any other purpose. The same applies to funds currently collected for the CJ and the VJ which are similarly ring-fenced. The effect of this is that, if there were a shortfall in funding for the CCJ, we could not draw upon funds from elsewhere in the ombudsman service to make up the shortfall. It is therefore important that the funding arrangements we put in place are sufficient to cover the full costs of the CCJ.

6.4 The CJ is also funded by a combination of levies and case fees. The balance between the levy and the case fee in the CJ is being reviewed and is currently the subject of a discussion paper produced jointly by the FSA and the ombudsman service.

6.5 The outcome of the CJ funding review, following a formal consultation in the autumn, will be implemented in the future funding arrangements for the CJ. Although there is no requirement or presumption that the funding arrangements for the CJ and the CCJ should be similar, the timetable for decisions on them (in parallel) means that it could be possible to reach decisions about them at around the same time.

factors to consider

6.6 In order to determine the most appropriate funding arrangements for the CCJ, a number of factors must be considered:

(a) caseload Given that there has never been a centralised dispute-resolution scheme for consumer credit before, it is inherently difficult to forecast the likely caseload that the ombudsman service will receive. A number of estimates have been made, based on an analysis of the information that is currently available (including the consumer credit complaints we currently handle under the CJ and the complaints experience of consumer credit businesses). These estimates range upwards to a maximum of 20,000 eligible complaints a year under the CCJ.

(b) cost per case The current unit cost of handling a case under the CJ is less than £500. But this figure has been reduced by economies of scale in dealing with large numbers of similar complaints (such as mortgage endowment complaints) against a limited number of firms. These are expected to tail-off. For the purposes of forecasting costs over the next five years, therefore, it would be prudent to assume there will be a modest rise in the average cost per case.

(c) number of businesses There is some uncertainty about the number of currently active consumer credit businesses. The uncertainty arises partly because, although each consumer credit firm currently has to renew its licence with the OFT every five years, a number of firms will move out of consumer credit before their next renewal is due. Some businesses may exit consumer credit because of increased obligations under the 2006 Act. An uncertain proportion of consumer credit businesses are also regulated by the FSA. These will continue to be covered by the CJ alone and its funding arrangements, and so will not be subject to the CCJ funding arrangements. For planning purposes we are assuming that there will be around 75,000 businesses which would be subject to the CCJ funding arrangements.

(d) structure of the industry In order to assess the relative appropriateness of the levy or the case fee, it is important to take into account the structure of the consumer credit industry. Given the diversity of the industry and the number of businesses involved, this is hard to characterise. That said, we do know that there will be around three times as many businesses in the CCJ as in the CJ, yet those in the former cover only around 30% of the UK consumer credit market by monetary value. We can conclude therefore, in very broad terms, that small businesses (each with a limited number of customers) will be a more prominent feature of the CCJ than of the CJ.

(e) distribution of cases In the CJ, only 15% of businesses have any ombudsman cases at all; only 5% have more than 2 ombudsman cases per year; and 95% of ombudsman cases come from only 3% of the businesses - mainly large organisations. Based on this, we expect that in the CCJ, with a higher proportion of small businesses, those with any ombudsman cases will be an even smaller proportion.

(f) levy collection procedure The Consumer Credit Act provides the CCJ levy to be collected by the OFT. The funds raised are then passed to the ombudsman service. The OFT currently collects a licensing fee when a business applies for a licence and, thereafter, every five years as long as the business wishes to renew its licence. The most cost-effective option for collecting the CCJ levy is therefore for it to be collected from businesses every five years, at the same time as the OFT licensing fee. This would make maximum use of existing systems and thus minimise collection costs. By contrast, the option of collecting the CCJ levy annually from each business would require separate systems to be put in place, as well as five times as much collection activity - which would make collection costs a disproportionately high percentage of the levy. Collection of the CCJ levy from businesses every five years is therefore the preferred option. Under this option, it would be prudent to take a five year view of the funding arrangements so that, as far as possible, businesses are subject to broadly similar funding obligations irrespective of when during that five year period their licensing fee is paid. However, the ombudsman service must remain free to adjust amounts each year, particularly if the caseload is outside expectations.

(g) current and proposed CJ funding arrangements Current CJ funding arrangements include both a levy and a case fee. The amount of the levy for each business is determined by complex formulae, intended to reflect the size of the business and the amount of cases that come to the ombudsman service from the business sector the firm belongs to. The levy thus varies from as little as £50 per year for some small businesses up to several hundreds of thousands of pounds for some very large businesses. The case fee is payable irrespective of the outcome of the case. In order to minimise the impact of this case fee on small businesses, the fee is not charged for the first two cases that a business has with the ombudsman service each year. These arrangements are currently being reviewed (see paragraphs 6.4 and 6.5 above), and the discussion paper suggests a number of alternative options. These include: an updated version of the existing arrangements with two “free” cases per firm per year, with a case fee of around £405 covering 80% of costs and a levy (using the existing formulae) covering the other 20%; and 5, 10 or 24 ‘free’ cases per firm per year, with a case fee of around £480 and a flat-rate levy (ranging from about £175 to £325 per firm, depending on the number of free cases).

analysis of options

6.7 Given the factors outlined above, the key feature is uncertainty, in particular about the likely future caseload and how it will be distributed amongst consumer credit businesses of different types and sizes. The current graduated levy in the CJ is based on business data collected by the FSA, which would not be available for businesses covered by the CCJ - so that any levy in the CCJ would need to be a flat-rate one.

6.8 There are, in principle, three broad funding options to consider against that background, each of which is analysed below.

Option A: case fees only

6.9 Under this option, all the funding would be raised through case fees charged to businesses for each case they have with the ombudsman service. With nothing coming in from levy, the case fee would have to start at around £505. The advantages of this option would include relative simplicity and the relative certainty that the ombudsman service would recover the costs of the CCJ - irrespective of the number of cases received - so reducing the risk of caseload uncertainty. The significant disadvantage, however, is that small businesses which have an occasional complaint under the CCJ would risk paying a case fee of around £505, without the benefit of the two “free” cases a year available under the CJ. Were free cases to be introduced under a case-fee-only option, the case fee would have to rise correspondingly further. It is unlikely, therefore, that this option would be equitable, either with or without “free” cases.

Option B: flat-rate levy only

6.10 Calculation of this would be based on the assumptions outlined above. To cover the maximum estimate of 20,000 cases per year, this would require a five-year levy of around £735 (or around £740 after adding OFT’s collection costs). The advantages of this option include relative simplicity and ease of collection. The significant disadvantage is that the smallest businesses with the best complaint record would end up paying the same as the largest businesses with the worst complaint record.

Option C: both flat-rate levy and case fee

6.11 Under this option, there would be a flat-rate levy, a number of "free" cases per business per year and a case fee for any additional cases. There is, of course, a trade-off amongst these three factors - with the cost of any free cases having to be covered by the levy and/or case fee. Because the spread of complaints amongst consumer credit businesses of different types and sizes is currently unknown, it is difficult to predict how a specific number of free cases per firm per year would translate into a total of free cases per year. But we estimate that two free cases per business per year might produce a total of about 5,000 free cases per year. This would involve a five-year levy of around £145 (or around £150 after adding OFT’s collection costs), with a case fee of around £405 for the remaining cases. Alternatively, five free cases per firm per year might require the same levy but an increased case fee of around £480 for the remaining cases.

conclusion

6.12 Option C appears to be the most equitable for businesses, while also reducing the financial risk to the ombudsman service of receiving more cases than forecast. Firms paying the levy would, in effect, buy themselves the protection of a number of free cases per year - while the very small minority of firms that produce more cases would pay in proportion to the workload they produce. That said, significant uncertainty would still remain, in particular about future caseloads. For that reason, as well as for risk management reasons more generally, it will be necessary to review the funding arrangements for the CCJ annually, in the light of actual case numbers and trends.

6.13 In view of the significant uncertainties involved in forecasting the number of future cases under the CCJ, we would welcome feedback from consultees on the assumptions we have made above. We would welcome, in particular, any data about existing and future complaint numbers, distribution amongst businesses and trends.

Q6 Do you agree that the most appropriate funding arrangement would be a combination of a flat-rate five-yearly levy of around £150 per firm and a case fee of around £405 to £480, depending on the number of "free" cases offered?

Q7 Would you, in theory, favour two "free" cases per business per year and a case fee of around £405 for any additional cases, or five "free" cases per business per year and a case fee of around £480 for any additional cases?

Q8 Do you have any information on likely numbers of complaints under the CCJ and how they will be distributed amongst businesses of different types and sizes?