A new Federal Government paper on compensating consumers has called for a scheme to be established to reduce the reliance on professional indemnity insurance.

The comprehensive paper by corporate governance expert Richard St John has come up with a number of ways existing stand-alone compensation schemes can be strengthened, while also looking at a comprehensive compensation scheme for the whole financial services sector.

“There is an apparent shortfall in the delivery of compensation under current arrangements,” Mr St John said in his paper.

“In some cases retail clients, while entitled to compensation from licensees with whom they have dealt, are not in practice able to recover that compensation.”

He says the consumer’s ability to recover compensation depends on the licensee having sufficient funds to pay any claim or having adequate professional indemnity cover.

Financial Services Compensation Scheme consultant Alan Mason says the discussion paper is the next step towards creating such a scheme.

“The current compensation arrangements have a lot of weaknesses in them, and Mr St John has outlined the weakness of relying on just professional indemnity insurance,” he said.

“Professional indemnity is there to protect the licensee and not the consumer.

“It is also driven by commercial considerations and that is the problem of relying on compensation through an open market.”

Mr St John says improved surveillance of financial services providers to reduce the number of disputes is one option for the future, but he has also raised the prospect of creating a scheme similar to the UK model.

“The [UK] Financial Services Compensation Scheme provides a fund of last resort for consumers who suffer losses and are unable to recover compensation because the service provider in question has stopped trading, has become insolvent or has insufficient assets,” he said.

“The scheme offers ‘second tier’ protection for claims which slip through the ‘first tier’ protection, which is based on a mix of professional indemnity insurance and minimum capital requirements.”

Mr Mason, a former CEO of the Insurance Council of Australia, says the Financial Ombudsman Service (FOS) submission to the paper has also called for a scheme similar to the UK model.

“We now have to see whether the FOS model needs to be refined, and that will be the next debate,” he said.

The Federal Government is now looking for formal submissions on the paper during the next six weeks.