CSLR recommends change to AFCA’s ‘but for’ approach

The Compensation Scheme of Last Resort (CSLR) has acknowledged that the “but for” methodology being used by the Australian Financial Complaints Authority (AFCA) is unsustainable in some circumstances.

The CSLR submission recommends that the “Scheme should only compensate for capital losses”.

In its submission responding to Treasury’s post-implementation review of the CSLR, the Scheme said that whilst AFCA’s interpretation “is based on a widely accepted and agreed legal definition, there are circumstances where this position might be considered unsustainable”.

“We understand that there may be cases where the capital loss component represents the majority or entirety of the loss suffered by a claimant. Accordingly, several other measures and changes should be introduced to the legislative framework in conjunction with this to improve the sustainability of the Scheme,” the CSLR submission said.

It said that while it is not challenging how determinations are assessed or calculated by AFCA it it wanted to ensure the integrity of the determination process remains in place while addressing the financial sustainability of the CSLR.

“The CSLR recognises the basis of the ‘direct’ loss approach and the role it plays where determinations are made against solvent financial firms,” it said.

The CSLR submission then compared the “but for” approach to a capital loss only approach, with the outcome being $16.7 Million paid under the “but for” approach compared to just $4.78 million under a “capital loss” approach.

Elsewhere in its submission, the CSLR also raised questions about the Professional Indemnity Insurance regime, noting how little it had been a factor in the workings of the CSLR to date.

“Of the 56 financial firms against which compensation claims have been made with the CSLR, only one financial firm has made a concerted effort to access their PI insurance,” it said.

The submission then recommending the following:

• mandating AFS licensees to hold PI insurance with appropriate coverage limits and appropriate provisions for addressing AFCA complaints;
• having minimum levels of PI coverage scalable to the financial firm size;
• requiring insolvency administrators, subject to policy terms, to apply for PI insurance coverage to settle AFCA claims; and
• enhancing PI insurance coverage to bolster the financial stability of AFS licensees, thereby reducing the incidence of firm failures and the volume of claims submitted to the CSLR.

“These measures would strengthen the overall framework, ensuring better protection for consumers and a more resilient financial services sector,” it said.