The Financial Services Compensation Scheme (FSCS) has blamed poor financial advice for driving up its soaring annual levy.

With the cost of the levy heading towards £1bn a year, the FSCS said bad advice, often given several years ago, was responsible for a large part of its growing compensation bill.

Many claims are also related to unauthorised and unregulated introducers, especially in relation to SIPPs.

The body has also said that it accepts the cost of the compensation levy is too high and needs change. But it also warned that the long timescale in resolving bad advice claims meant the FCA may struggle to reduce the compensation bill by 2025 as it hopes.

The FSCS comments come as the FCA opened an industry debate this week on the future funding and scope of the FSCS.

The FSCS, the government’s main consumer compensation body when financial firms fail, said its data showed that much of the compensation it pays out is due to poor financial advice.

Some 73% of the bad advice also took place 5 years or more before a customer claimed on the FSCS, the body said.

In a statement the FSCS said: “A significant proportion of our compensation is paid out in relation to poor financial advice, and 73% of that advice took place 5 years or more before a customer makes their claim. This lag in the system means the FCA's aim to stabilise the levy by 2025 carries risk.

“The different actors at play in our customer's decision making when they are taking out new investment products is also eye opening. For FSCS to be able to consider a claim for advice, a regulated firm with the right permissions needs to have been responsible - however, in a recent study of our SIPP operator claims, many of the names we saw mentioned by customers were unauthorised introducers. Not regulated, and not contributing to FSCS's compensation costs through the levy.”

The FSCS £85,000 compensation limit is also failing to help many pension customers with larger claims, it said.

The FSCS added: “Whilst compensation costs have been rising, the amount of money FSCS has not been able to put back in customers' pockets has risen too. Last year (2020/21) this equated to £194m, or £68,000 per person that we couldn't pay simply because of FSCS's compensation limits. £104m of this, or £108,000 per person was against pensions advice and switching claims, where our customers can often be close to retirement with little time to recover their financial situation which they had worked hard to build.”

FSCS says it supports the development of a “fair protection model” which offers the right protection for consumers at a sustainable cost to the industry, and believes more needs to be done to ensure the system is “fit for the future.”

The FCA has this week published a Compensation Framework Review discussion paper which has been welcomed by the FSCS.

The FSCS says it will review how the costs of compensation are distributed across the industry and whether this can be done in a more fair and sustainable way.

Caroline Rainbird, chief executive of FSCS, said: “Against a backdrop of rising consumer harm driving a year-on-year rise in compensation costs, I believe it is an important time to consider the composition of the compensation framework and whether it still functions in the most efficient and appropriate manner. We are working in a rapidly evolving marketplace and reviewing what and who FSCS can protect through our compensation service is an important discussion to have - both for today and into the future.

She added that FCA proposals to potentially reduce compensation arrangements for some types of investor was not something the FSCS could agree with.