Select Committee on Treasury Fifth Report

3 Endowment Mortgage Mis-selling

20. The FSA has noted that "arguably, mis-selling is not a regulatory concept at all. It does not feature in our Handbook. But the term is commonly used to refer to an advised sale which does not meet the Handbook requirements for suitability….Consumers rightly expect those who advise and sell financial services products to behave with honesty and integrity and apply their skills, experience and judgement to give them a fair deal….Our Handbook, including the Principles, makes clear to firms that this is what we expect of them."[30] Using this as a guide to what constitutes mis-selling, it is clear that the problems of complexity and opaqueness discussed in Section 2 lie at the root of what may have been wide mis-selling of endowment mortgages. In many cases consumers purchasing an endowment mortgage were left with the impression that the endowment policy was guaranteed to pay off the mortgage. In fact in most cases the product carried no such guarantee.

Regulatory action on mis-selling

21. As well as industry regulators lowering the illustrative projected investment returns the industry could use, the late 1990s also saw the regulation of the selling process being tightened considerably. The Financial Services Consumer Panel told us that "in September 1999 we informed the FSA and Personal Investment Authority (PIA) Boards of our view that regulatory attention in this area was long overdue. We also stressed the importance and urgency of publicly feeding back the findings of the PIA's supervisory visits on endowment mortgage sales to the industry as a preventative measure."[31] In December 1999 the PIA issued a Regulatory Update which warned that a recent round of company supervision visits had revealed that "the general standards of selling practices and record-keeping revealed by the themed supervision visits were inadequate. Such poor practices are unacceptable and consideration is being given as to whether firms should be referred for further investigation and possible discipline."[32] As the FSA subsequently noted "At the time of the FSA's December 1999 announcement there were 44 providers active in the mortgage market. Following the FSA's requirement that insurance companies justify their marketing strategies, and the continuing public spotlight on the market, the number had fallen to 20 by September 2000. Volumes of endowment mortgage sales have halved over the year to 30 June 2000."[33] It is disappointing to note, however, that an FSA investigation over the summer of 2000 showed that "some firms are still failing to match the risk of an endowment to the needs and personal circumstances of the consumer."[34] The FSA promised a still wider programme of supervisory visits "to examine the quality of advice given on endowment sales."[35] In the aftermath of these regulatory checks, the FSA told us[36] that it had taken the following action against specific firms:

  • Royal & Sun Alliance - fined £950,000 in March 2003 for endowment mis-selling and related deficiencies in its sales systems and control functions;
  • Scottish Amicable - fined £750,000 in March 2003 for endowment mis-selling and related deficiencies in its sales systems and control functions;
  • Abbey Life - fined £1 million in December 2002 for endowment mis-selling and deficiencies in compliance procedures and controls;
  • Wintherthur Life - fined £500,000 in September 2001 for endowment mis-selling;
  • Royal Scottish Assurance plc - fined £2 million in November 2000 for serious deficiencies in their endowment mortgage product.

22. As well as facing fines totalling £5.2 million, the five companies disciplined by the FSA have been forced to pay out £227 million of compensation to 183,000 customers. The FSA also told us that another 19 firms had agreed to pay approximately £446.5 million compensation to 253,500 customers on a non-disciplinary basis.[37] In many cases, the key problem was that companies failed to keep adequate records and in such cases there is a presumption that policies were mis-sold. The insurance industry was lamentably slow to respond adequately to regulatory pressure to improve its sales process for endowment mortgages. This forced the regulator to intervene repeatedly to toughen its supervision of the industry. While the FSA can take the credit for the sustained attack it has made on malpractice within the industry from late 1999 onwards, effectively the mis-selling of endowments only disappeared once much of the industry stopped selling the product at all.

The scale of mis-selling

23. While sales of endowment mortgages wound down sharply through 1999 and 2000, a very large outstanding book of endowment policies remained in force and do so to this day. At the start of 2000 the FSA told us that its first major mailing exercise to consumers on endowment policies went to 6 million policyholders with, between them, 11 million policies.[38] The evidence suggests strongly that a large percentage of these 11 million policies may have been mis-sold. The Financial Services Consumer Panel told us that they had conducted a survey in 2000 in which 50% of respondents replied that they "recalled being told at the point of sale that their endowment policy 'would definitely' or 'was guaranteed to' pay off their mortgage—which suggests a mis-sale."[39] The Consumers' Association told us that they too had conducted a survey in 2002 which suggested that 61% of those with endowment policies said that they were "told their endowment 'would definitely' or 'was guaranteed' to pay off their mortgage."[40] While John Tiner, Chief Executive of the FSA, has stated that "we have not observed systemic mis-selling of endowment mortgages"[41] he agreed with the Committee that "the reality is that there has been widespread mis-selling of endowment mortgages."[42] The available evidence suggests that between 50% and 60% of holders of endowment policies believe their policies were mis-sold. If correct, this would be a significantly high figure.

24. Many may feel that the distinction the FSA draws between 'systemic mis-selling' and 'widespread mis-selling' is a fine one. The FSA did indicate in a 2001 press briefing that its own survey evidence indicated that 60% of policyholders "say they were told the policy was guaranteed or would definitely pay off the mortgage"[43]. But when the Committee asked for an updated estimate we were told that "in order to answer this question, it would be necessary for the FSA to have mandated an industry-wide review, requiring all firms to review the specific circumstances of each case. We decided that this would not be a proportionate approach and could not be justified on cost-benefit analysis grounds."[44]

25. The Financial Services Consumer Panel told us that they originally concurred with the FSA's judgement that a formal industry-wide review of endowment mortgage mis-selling would be disproportionately expensive, but they were concerned that "there was, and is still, an absence of information to help consider the costs and benefits of different redress mechanisms in various situations."[45] The Consumers' Association expressed similar views, telling us that "the fundamental problem is that if you do not estimate the size of the problem, then how do you measure the effectiveness of the strategy you put in place to tackle it?"[46] Many of the consumer bodies told us that they, like the Committee, had pressed the FSA for clearer figures, so far without success. The Financial Services Consumer Panel, for example, told us that "it is a very confusing picture and one of the things that the Panel has called for is for the FSA to do their level best to get a much more accurate calculation of the number of policies that were sold to the number of households, and what proportion of these are likely to have been mis-sold… Until we get the best effort at a clear factual calculation it is impossible even to judge whether the mis-selling compensation exercise has been anywhere near successful or not."[47]

26. We asked the FSA if it felt our provisional conclusion that, based on survey evidence, between 50%-60% of endowment policies may have been mis-sold was reasonable. We also asked the FSA if it had any plans to commission further research on the subject. The FSA told us that while the surveys we cited in paragraphs 23 and 24 were "generally helpful and informative….we know that consumers' perceptions of events perhaps ten, fifteen or more years ago do not always provide a reliable indication of the extent of past mis-selling… We do not believe it is safe to conclude from this evidence that, in [the Committee's] words, 'between 50% and 60% of all mortgage endowment policies were very possibly mis-sold'." [48] The FSA went on to reiterate, however, that "we do not intend to commission research focused particularly on mis-selling". We recognise that estimates of past mis-selling, which depend on the memory of what was said 10 to 15 years ago, must involve a wide margin of uncertainty.

Changes needed in the regulatory environment

27. The track record of the industry raises questions about a business model used in much of the financial services industry that seems to have the effect, however unintended, of encouraging mis-selling. The FSA has itself expressed its frustration at the level and persistence of mis-selling. As he left the FSA, Sir Howard Davis told the FSA annual meeting that "The biggest disappointment of my time at the FSA has been the failure of firms, and particularly their senior managements, to learn the lessons of past mis-selling."[49] Some expert witnesses have suggested therefore that it might be useful to extend the current regulatory approach, which focuses on punishing firms for breaking the rules, so as to also punish the managements of firms breaking the rules. Mr Watts of the Financial Services Consumer Panel, argued that while the FSA has imposed fines on firms for endowment mis-selling "what about the individuals who were responsible for that? What has happened to them? Should not individuals be targeted as well as firms."[50] Mr Myners, author of a major report on institutional investment for HM Treasury, [51] expressed similar sentiments and drew an analogy with health and safety legislation, telling us there "must be merit"[52] in moving to a system that holds corporate officers responsible for ensuring that firms conduct their affairs in accordance with the regulations.

28. While it may be possible to reinforce the regulatory environment surrounding the financial services industry, the Committee has heard evidence that the repeated regulatory interventions needed over policies such as endowment mortgages are adding considerably to the industry's costs and that ultimately this has consequences for the consumer. Mr Sandler, for example, told us "the more the system is tightened up—which is in many respects a desirable thing—the more cost is added to the process and the more saving is made uneconomic for the smaller saver."[53] The need to place increasingly tight regulatory constraints on the financial services industry to ensure satisfactory behaviour on the part of companies is imposing significant costs that risk pricing the less affluent out of the long term savings market.

Tackling the underlying issues that encourage mis-selling

29. Many witnesses suggested to the Committee that the fundamental problem exposed by the history of endowment mortgage mis-selling is a sales-led culture within the industry. Mr Watts, of the Financial Services Consumer Panel, told us that the "industry is sales-based, and that is what it makes its money from, and that is a huge, fundamental problem. The FSA, I think, needs to address the problem of how to achieve cultural change within the industry to stop mis-selling."[54] Several witnesses went on to suggest that the only effective way to deliver the needed cultural change is to wean the industry off its current commission-driven approach to business. Mr Sandler, for example, told us that "a commission-based system where the front-line is effectively rewarded on the basis of how much product it delivers to the market—and that is true irrespective of whether we are talking about a tied sales force or an independent financial adviser—such a system is always going to be prone to the more enthusiastic or perhaps the less ethical choosing to circumvent the process and deliver a product which may, with the fullness of time, not be suitable for the recipient."[55] Mr Myners noted that while the current sales process is entirely rational "for the people who are paying for it, who are the product providers… it may not be in the best interests of the product purchaser, who is not paying for it."[56]

30. Professor Davis of Brunel University told us that "a question for the industry and financial services generally is, why does the commission have to come up-front and therefore make it so attractive to sell certain products and not others? Could not the commission somehow go over the life of the product and be related to its performance? Then there would be in a sense sharing of the pain and much more care in terms of the sales."[57] Mr Sandler endorsed Professor Davis's views, telling us "I think that anything that reduces the up-front cost is to be welcomed and anything that has a performance-related dimension is further to be welcomed because it aligns the adviser more closely to the consumer, which is the state of affairs that we are seeking to create" although he went on to warn that "it is classically the area where the FSA is not going to take any steps, and the industry left to its own devices has no incentive to take steps."[58] Action is needed to better align consumer and product provider interests in the area of financial services. The current commission structure within the industry rewards potentially inappropriate and short-term sales practices. Sometimes this is at the expense of the saver's long term interests. It is unacceptable that the industry's current commission structures rewards the industry irrespective of the investment performance of the products it sells.

30   Clarifying 'mis-selling': a note by the FSA, 17 July 2003 Back

31   Ev 114 paragraph 19 (HC 275) Back

32   PIA Regulatory Update Number 72, December 1999 Back

33   Progress Report on Mortgage Endowments FSA, October 2000, page 4 Back

34   ibid page 5 Back

35   ibid Back

36   Ev 97 paragraph 15 (HC 275) Back

37   ibid paragraph 17 (HC 275) Back

38   Ev 95 paragraph 5 (HC 275) Back

39   Ev 114 paragraph 17 (HC 275) Back

40   Ev 78 paragraph 2 (HC 275) Back

41   Speech to SOFA Update Conference 27 November 2003, paragraph 7 Back

42   Q 208  Back

43   Mortgage Endowment Communication Research-Summary of BMRB omnibus findings for the Financial Services Authority, June 2001  Back

44   Ev 110 paragraph 22 (HC 275) Back

45   Ev 115 paragraph 23 (HC 275) Back

46   Q 131 Back

47   Q 128 Back

48   Ev 192 (HC 275) Back

49   FSA annual meeting, 17 July 2003 Back

50   Q 181 Back

51   Institutional Investment in the UK, HM Treasury, March 2001  Back

52   Q 281 Back

53   Q 281 Back

54   Q 181 Back

55   Q 278 Back

56   Q 276 Back

57   Q 104 Back

58   Q 326 Back

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