Select Committee on Treasury Fifth Report

Conclusions and recommendations

Endowment mortgages as a savings product

1.  Buying a home is the largest single financial transaction most people undertake in their lives and the financial services industry owes a particular duty of care to its customers in the marketing and subsequent management of relatively complex financial products such as endowment mortgages. Unfortunately, the reality is that in selling low-cost endowment mortgages the industry often failed to provide homeowners with a suitable product for their individual circumstances or a product that was fit for the purpose it was being used for. The performance of the financial services industry in providing reliable and effective products to those looking to fund a house purchase is likely to be crucial in shaping consumers' views of the industry. The failures in respect of endowment mortgage policies are a contributory factor towards the low consumer confidence in the industry. (Paragraph 9)

2.  Many of the basic problems identified in endowment mortgages are shared by other with-profits products sold by the life insurance industry. The Committee is concerned by evidence that even after the FSA's proposed reforms, buying any with-profits policy will still be little more than an "act of faith" for the consumer. Developing cheaper, more transparent products offering the same smoothing benefits to the saver as the traditional with-profits product is now a key challenge for the long-term savings industry. (Paragraph 12)

3.  It seems clear that it was undesirable for the tax system to be so slanted as to entice consumers into one relatively complicated financial product rather than a broadly comparable, but much simpler, product such as a repayment mortgage. The Committee believes that this is an important lesson for the future and strongly endorses Mr Sandler's call that "the overriding policy goal in this area… should be one of reducing complexity and distortions in the taxation of savings products". (Paragraph 14)

4.  The events surrounding Equitable Life raised questions about the effectiveness of the pre-existing actuarial regime, but the insurance industry's approach to endowment mortgages through the late 1990s also demonstrates an inadequate approach to investment issues by appointed actuaries. The Committee considers it important that the FSA's proposed reforms of the actuarial process within insurance companies are effective in providing warnings and a more proactive and independently minded actuarial advice. (Paragraph 18)

5.   It seems clear to the Committee from its review of endowment mortgages that generally more needs to be done to ensure that financial products and the tax system surrounding them are simplified as much as possible, that officials whose role is in part to protect and re-assure the consumer actually discharge that function effectively and, above all, that when complex financial products are sold to consumers they accurately fit the purpose for which they are bought. (Paragraph 19)

Mis-selling of endowment mortgages

6.  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. (Paragraph 22)

7.  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. (Paragraph 23)

8.  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. (Paragraph 26)

Future action to address mis-selling

9.  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. (Paragraph 28)

10.  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. (Paragraph 30)

Development of shortfalls in endowment policies and communication with policyholders

11.  Given the central role of asset allocation in determining investment returns, the FSA should make it a basic principle that all investors in long-term savings products are given regular information on the asset allocation policies of the product provider and how this has added to, or detracted from, the performance of the investment fund (Paragraph 33)

12.  The net result is that the shortfalls policyholders are now suffering only partially reflect the fall in the equity market between early 2000 and spring 2003. In many cases the major problem is rather that as the economy has settled into an era of low inflation and low nominal interest rates, it has become increasingly improbable that the underlying investments underpinning endowment policies will deliver the nominal returns assumed when the policies were written in the late 1980s and 1990s. This is particularly so given that many with-profits funds have now switched from risky, but potentially higher growth, equities into safer, but lower growth, bonds. Recent signs of an equity market revival thus do not herald the end of the problems for policyholders. (Paragraph 35)

13.  To help the process of alerting as many policyholders as possible to the shortfall problem, the Committee recommends that "red" reprojection letters, warning policyholders of a high probability that their endowment policy will fall short of its target, should always have the key section printed in red, analogous to the format used in overdue bills from utilities and others. (Paragraph 38)

14.  The industry's track record ahead of FSA intervention in failing to keep the customer informed about the deepening problems surrounding endowment policies is a matter of serious concern. It is, to use the term employed by Standard Life in its submission to the Committee, the "crux" of the endowment mortgages issue, both because of the problems it subsequently caused as the shortfalls confronting policyholders spiralled, but also because of what it reveals about the industry's attitude to the post-sale care of its customers. (Paragraph 40)

15.  The assumed rates of returns being used in reprojection letters are central to the FSA strategy for warning policyholders about potential shortfalls. It is essential that the FSA closely monitors the assumptions used and ensures that they are realistic. While it may be useful to call in outside bodies in an advisory capacity in this process, the responsibility of setting the rates used and ensuring that they are realistic should rest ultimately with the relevant insurance company, which knows the nature of its own portfolio. (Paragraph 41)

Levels of shortfalls

16.  The Committee concludes that the best available evidence suggests that mortgage endowment policies are currently showing a collective shortfall of around £40 billion. Looking just at policies still being relied upon to repay a mortgage, the collective shortfall is at least £30 billion. Around 80% of policies are currently unlikely to generate enough funds to pay off the mortgage they were originally sold to meet and the average shortfall is currently around £5,500. The balance of probabilities is that both the percentage of policies showing a shortfall and the average size of the shortfall per policy will worsen over the coming years. Without remedial action endowment policies maturing but failing to meet their targets are likely to be an increasingly common problem until 2013, 25 years after the peak in endowment policy sales in 1988. (Paragraph 46)

17.  Mortgage endowment shortfalls are a multi-billion pound problem. The shortfalls are a problem that could have a particularly serious impact on the elderly and some of the more vulnerable sections of society. It is particularly important that these individuals get timely and accurate advice on how to tackle this problem. (Paragraph 49)

Policyholders in closed funds

18.  The treatment of policyholders in closed funds is unfair. The insurance industry seems to be unique in preserving to itself the right to sell a customer one product and then substitute it with another product which is inferior in key respects. The FSA should examine the case for a regulatory requirement that solvent companies closing the with-profits elements of their operations to new business should, on request, transfer their customers without penalty to another supplier offering a product broadly similar to the one the customer originally bought. (Paragraph 51)

Aligning the interests of savers and product providers

19.  There is an urgent need to align the interests of savers and product providers more closely, not just in areas such as endowment mortgages but in other areas such as the forthcoming Sandler suite of products. From the consumer's perspective, it is perverse that most companies are still charging their full fees on endowment policies when 80% of policies will fail to meet the product's original objective of paying off the mortgage. A structure in which the fees charged by product providers were tied to the product meeting set investment targets would serve the consumer better, and we recommend that the FSA together with the industry investigate this issue, with a view to developing proposals for reform. (Paragraph 53)

Advice on dealing with shortfalls and on financial services generally

20.  Advice on endowment policy shortfalls from insurance companies is both widely distrusted and frequently found to be unsatisfactory by consumers. Some 'red' letters imply that increased premiums will be sufficient to restore the product to its previous promises. Letters should refer to the possibility of contacting the mortgage lender to discuss ways of addressing the shortfall and to give advice on the rights of policyholders to make a complaint. Policyholders without access to an IFA are being left in an advice vacuum, with no access to any effective advice on what to do about the situation. (Paragraph 58)

21.  The issue of endowment mortgage shortfalls has exposed significant gaps in the advice framework available to consumers that require urgent corrective action. The Committee endorses the call of many consumer groups for a mechanism to deliver low cost or free generic advice to consumers. We welcome the establishment by the FSA of the Financial Capability Steering Group and look forward to its findings on the promotion of financial education. The FSA should play a more active role in encouraging companies to ensure basic financial advice is available to consumers on key issues such as how to respond to endowment mortgage shortfalls. (Paragraph 60)

Levels of complaints

22.  The available evidence suggests that 80% of endowment mortgage policies are now showing a shortfall and that 50%-60% of holders of such policies believe they were probably mis-sold. However, we note that in many cases there is a lack of any contemporaneous record of what the sales person said to the client and vice versa; this will make it difficult to determine reliably what a client's attitude to risk was at the time the contract was entered into. Against this background, under 6% of policyholders have so far complained. Urgent action is needed to ensure that the complaints process is better understood and more accessible to policyholders. (Paragraph 63)

23.  The FSA should include a fact sheet explaining in what circumstances policyholders have a valid complaint, and how to make a complaint, with all reprojection letters. (Paragraph 64)

24.  The Committee welcomes Legal & General's statement that it would not use time limits to rule out complaints, but across the industry urgent action is required to ensure that substantial numbers of policyholders do not lose their rights to compensation. It would be unfair to apply time limit rules which early mailings made little or no mention of. These rules, which have still not been spelt out explicitly to most policyholders, should be reviewed and the time limits extended. (Paragraph 65)

Companies' handling of complaints

25.  It is very disappointing that it has required sustained pressure from the FSA to ensure that companies handle complaints satisfactorily. As with mis-selling, the need for repeated action to ensure fair treatment for customers seems to confirm that the insurance industry is locked into an unacceptable culture that focuses upon short term sales rather than long term customer care. (Paragraph 68)

26.  The industry's track record, both in terms of mis-selling and in terms of handling complaints, has not been conducive to an atmosphere of trust either between the industry and its customers or between the industry and its regulator. Events have demonstrated that in the future the FSA needs to be much more rigorous in ensuring that its policies and strategies are being effectively implemented by the financial services industry. (Paragraph 69)

27.  It is unacceptable that some companies' complaints handling processes are so flawed that the Ombudsman is upholding over 50% of consumer appeals against the companies' decisions. The FSA should take swift action to ensure that these companies begin treating their customers more fairly. (Paragraph 71)

Complaints and the Financial Ombudsman Service

28.  There remain concerns in the industry about the statutory framework within which the FOS works (for example in respect of the lack of symmetry between companies and complainants over rights of appeal from its decisions) and concerns about some of its decisions. In other respects, the Financial Ombudsman Service process appears to be working acceptably as an appeals body for the consumer on endowment mortgages and providing an efficient and accessible service. (Paragraph 72)

29.  Consumers may need more help in establishing fair redress in some cases, with the main problem areas relating to policies sold via IFAs prior to 1988. (Paragraph 73)

General conclusions on endowment mortgages

30.  The evidence presented to the Committee in the course of this inquiry suggests that the financial services industry has shown significant failings in the endowment mortgages story. (Paragraph 74)

31.  Our inquiry has also identified a range of issues which the FSA has had to address and which it needs to continue to address. However, as the table at paragraph 7 above indicates, the vast majority of endowment mortgage mis-selling occurred before the FSA came into being. (Paragraph 75)

32.  Overall, it is important for the industry, the regulators and the Government all to recognise the size of the problem which has arisen. The problem is likely to worsen as increasing numbers of low-cost endowment mortgage policies mature in the coming decade. There needs to be a constructive engagement by the industry with the problem if difficulties—in some cases serious distress—for a large number of people are to be avoided. (Paragraph 76)

Lessons for the future

33.  There is an overriding need to rebuild public trust and confidence in many of the companies that currently dominate the long-term savings industry. (Paragraph 77)

34.  The picture that emerges from our inquiry into endowment mortgages is one of a long-term savings industry wedded to an inappropriate sales and commission led business model which is damaging the reputation of the industry and undermining consumer confidence in long-term savings. In this context, the current regulatory framework is left struggling to tackle the symptoms of that inappropriate business model. (Paragraph 78)

35.  Many of our witnesses have argued the case for fundamental reform of the way the long-term savings industry conducts its business. Such reform would not just serve to restore domestic consumer confidence, it would deliver world class financial institutions and help the UK claim the position of international venue of choice for savers and fund managers alike. (Paragraph 79)

36.  Whatever level the price cap on Sandler products is set at, the fee structure proposed will simply continue to bias the industry towards the aggressive pursuit of sales, since that is what it will be rewarded for. It would be preferable for the fee structure in the long-term savings industry to reward the delivery of superior investment returns and the provision by the industry of the sort of after-sales care for the saver that was spectacularly missing in the case of endowment mortgages. (Paragraph 80)

37.  Urgent action is needed from the Government, the FSA and the industry to alter a culture that has led to the multiple failures seen in the case of endowment mortgages. Central to delivering the needed cultural change is a shift from the current fee structure that rewards an often inappropriate sales process. It is disappointing that a similar fee structure has dominated the industry's thinking on the proposed Sandler suite of products. The challenge, for both the industry and Government, is to develop a fee structure for long-terms savings products that reinforces the industry's duty of care to the saver by directly rewarding good investment returns and client retention rather than simply paying out high rewards for client acquisition. (Paragraph 81)

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