The Financial Services Compensation Scheme (FSCS) has called for the £85,000 compensation limit to be reviewed for pension claims.

It hopes to reduce the gap it has with the Financial Ombudsman Service (FOS).

The FSCS said that whilst it believes current limits remain appropriates for most products, the limit needs to be higher for pension claims.

The FOS can tell a firm to pay up to £375,000. The limit is adjusted in line with inflation, as measured by the consumer price index.

Jay Sheth, head of policy at the FSCS, said: “Stabilising the levy and moving into a space where it is sustainably decreasing is a tough ask. We could resort to blunt instruments such as lowering compensation limits or removing certain groups of customers from protection, but that would just be masking the real issues.

"Our data doesn’t tell us that measures like these will make any significant dent in the costs today, especially as we know we have harm that has already happened waiting to come through as claims. What we need is reform."

When the FSCS was setup in its current form in 2001 it was able to cover £31,700 if deposits and £48,000 for investment claims including pensions.

The deposit compensation limit has risen three times to £35,000, £50,000 and £85,000.

The investment compensation limit has risen twice, to £50,000 and then £85,000.

The FSCS said in its paper: “The deposit limit rise between 2001 and today has out-paced inflation, whereas pension protection is broadly worth the same as it was in 2001.”

“The limit for pensions and investments is now harmonised with deposits and most other FSCS limits, including products like debt management plans where losses are likely to be very small.”

The compensation body said that one key difference between pension claims and other products where the FSCS can pay compensation to customers is the “level of uncompensated loss”, where the money it is authorised to return to consumers is less than the total they lost due to the compensation limits.

The FSCS said the rise in such uncompensated losses has been far steeper for pensions than the average across all product types.

It said that over the past six years there has been £1bn not paid back to consumers as compensation where consumers’ losses was over the relevant limit.

Tom Selby, head of retirement policy at AJ Bell, said: “That over £1 billion of losses have gone uncompensated due to the £85,000 cap in the past 6 years sounds shocking on the face of it, with roughly half of those uncompensated losses linked to pensions advice. Given the scale of uncompensated losses, the FSCS understandably wants to see the pensions compensation cap increased above £85,000.

“However, the FSCS faces a delicate balancing act as the funds used to pay compensation come directly from financial services firms via an annual levy. In 2022/23 that levy is expected to be £625 million, and any increase in the pensions compensation cap would inevitably increase the pressure on the overall levy.

“If the compensation limit for pensions were to be increased, this should be as part of a broader review of how the FSCS is funded.”