APPENDIX 1
GOVERNMENT RESPONSE TO THE FIFTH REPORT OF THE
TREASURY COMMITTEE, SESSION 2003-04 (HC 394)
This memorandum sets out the Government's response
to the Treasury Committee's report on Endowment Mortgages.
2. The Government thanks the Committee for bringing
to public attention the serious issues for large numbers of people
arising from endowment mortgages. The Government welcomes the
actions being taken by the Financial Services Authority (FSA),
and the industry, to resolve these issues.
Endowment mortgages
3. Buying a home represents the largest single
financial transaction most people undertake. The Committee's report
provides a valuable assessment of the development of the market
for endowment mortgages and the influences and practices that
led such products to be sold in large numbers to consumers during
the 1980s and 1990s.
4. As with all financial transactions, it is
an important principle that consumers fully understand both the
risks involved and the protections they are entitled to. By their
nature endowment mortgages carry the inherent risk that the policy
might not repay the mortgage at the end of the term. The decline
in inflation and interest rates through the 1990s has resulted
in many endowment policies underperforming against what have proved
to be over optimistic projections. It is clear that while some
consumers understood the risks involved, many did not or were
not fully informed of the risk involved.
5. In considering the extent to which consumer
detriment has occurred, it is important to differentiate between
those consumers who purchased an endowment mortgage in the full
knowledge that the product's performance was dependent on the
stock market, and those who did not have the risks in the product
properly explained by providers or advisers or were wrongly advised
about their suitability for them.
6. The Government recognises the vital role played
by the financial services industry in the UK economy and the need
to maintain justifiable confidence both in the market as a whole
and firms and consumers who are active in it. The Government's
approach to the financial services sector as a whole is premised
on the twin convictions that industry should treat its customers
fairly and consumers should secure a fair deal.
7. It is for this reason that the Government
brought forward legislation in 1997 creating a single regulator,
the Financial Services Authority (FSA). The FSA's statutory objectives
include maintaining confidence in the market, promoting public
awareness and the protection of consumers. Key aspects of the
FSA's responsibilities are to protect consumers from mis-selling
while ensuring the management of financial services firms have
responsibilities for treating consumers fairly. In order to meet
its statutory objectives, the FSA has founded its approach to
regulation on analysis of risk, that seeks to balance the sometimes
competing needs of industry and consumers. The Government welcomes
this approach, in particular that it seeks to recognise the proper
responsibilities of consumers themselves and of the industry's
own management.
8. In this context, the Government supports the
FSA's proposals in CP 207 for the fair treatment of with-profits
policyholders. The proposals, which seek to improve transparency
for policyholders, include rules and guidance on the management
of funds, payouts, surrender values and market value reductions.
Consumers can have confidence their interests will be considered
and that firms have met their obligation to treat customers fairly.
9. The Committee believes that the tax system
operating at the time of high sales of endowment mortgages enticed
many consumers to purchase these products rather than comparable
but simpler products such as repayment mortgages. The Committee
endorses Ron Sandler's call for reducing complexity and distortions
in the taxation of savings products. The Government has accepted
the recommendations in Ron Sandler's report, in particular, his
emphasis on minimising tax-generated distortions and of the desirability
of a more level tax playing field for retail financial products.
The Government will continue to look at Sandler's tax proposals
in the wider context of tax issues affecting the market for life
insurance and other pooled investment products such as unit trusts.
10. The Committee questions the effectiveness
of appointed actuaries in their approach to investment issues,
calling for more proactive and independently minded actuarial
advice within the insurance industry. The Government supports
the FSA's proposed reforms in this regard. In response to Lord
Penrose's report of the Equitable Life inquiry, the Government
announced an independent review into the actuarial profession.
The review is being conducted by Sir Derek Morris, the former
Chairman of the Competition Commission. The terms of reference
for the review are to consider what professional and/or other
regulatory framework would best promote recognised, high-quality
and continuously developing actuarial standards, openness in the
application of actuarial skills, transparency in the professional
conduct of actuaries, accountability for their actions and an
open and competitive market for actuarial advice in the UK. The
review commenced on 1st May 2004 and is due to report by Spring
2005.
Endowment Mortgage mis-selling
11. There have clearly been problems in a significant
number of cases with the sale of endowment mortgages. The Government
considers the response of the FSA has been both proportionate
and consistent, with the primary focus of its efforts being on
securing fair treatment for consumers. It is important that the
FSA continues to act based on an assessment of risk and full cost
benefit analysis, while balancing its statutory objectives to
maintain market confidence and protect consumers.
12. Given the passage of time since the majority
of endowment policies were sold and the lack of contemporaneous
records of the advice given at the time, the Government shares
the Committee's view that it is difficult to be certain of the
number of consumers who were mis-sold their policy. The Government
supports moves by the FSA to take forward a programme of research
to form a better understanding of the size and extent of the shortfalls
facing consumers. It is vital to ensure there is accurate information
of the number of policies still in force that are linked to a
mortgage; action taken by consumers to address shortfalls, particularly
in light of the increased numbers of policies with a projected
shortfall and the characteristics of those affected; and the proportion
of consumers who have complained and their reasons for complaining.
13. Where the FSA has been able to identify specific
examples of mis-selling of financial services it has acted in
a proportionate manner, while seeking to maintain market confidence.
FSA action to date has resulted in 24 firms having paid or set
aside £673.5m to go to those 430,000 consumers who it has
been shown were victims of misselling.
14. It was as a direct result of the FSA's actions
that the industry issued 'reprojection' letters to all policyholders
informing them whether or not the policy was likely to fall short.
This has resulted in over 450,000 complaints being made about
the misselling of endowment mortgages (as at March 2004).
15. The Government also welcomes the efforts
of the FSA to raise awareness among consumers both of the need
to take action to deal with projected shortfalls and of their
rights to complain if they believe they were mis-sold the policy.
The steps agreed by the industry to provide clear messages to
consumers will help. The Government urges the FSA to maintain
and increase these efforts if its research finds that this information
is failing to reach consumers.
16. The Sandler review recognised the need for
closer alignment of consumer and provider interests in the area
of financial services. The Government believes that many of the
problems that arise subsequently can be addressed through the
timely provision of information to consumers before and at the
time of purchase.
17. The forthcoming suite of stakeholder products
will have the necessary safeguards and will be sufficiently transparent
to ensure consumers understand what they are paying for and how
much they are paying. The selling regime in combination with the
existence of regulated products, with a clear ceiling on the charges
applied, will increase consumer confidence in savings in general
and equity-based products in particular. The absence of exit penalties
will act as a strong incentive to the industry to retain customers
by ensuring that they are treated fairly, while setting the charge
cap at an appropriate level will encourage providers to compete
for business.
18. The FSA's proposals to remove polarisation
restrictions and the development of the menu approach for disclosing
commission costs will provide a much more transparent regime than
exists currently, and should encourage consumers to shop around
for advice.
19. The Government also looks forward to the
results of the ABI's initiative to look at the way in which long-term
savings are sold, and particularly the role of commission. It
is encouraging that the ABI intends that this will be an objective
and fact-based analysis of how the present system performs and
how it might develop in the light of regulatory and commercial
changes.
Shortfalls
20. As the Committee recognises, any product
linked to equities carries an element of risk, and this applies
in respect of endowment policies. The expectation of a shortfall,
therefore, is not an indication the consumer was mis-sold or that
compensation is due. That said, it is an important principle that
consumers or investors of whatever type should expect to be informed
at regular intervals of the performance of their investments.
This is essential so that consumers can consider fully or seek
advice on the options available to maximise their returns.
21. The performance of the stock market in recent
years, together with a period of low inflation and low interest
rates, does mean that many consumers who purchased endowment policies
in the 1980s and 1990s will not receive the returns they expected.
The level of individual shortfalls and the impact on individual
consumers is difficult to calculate as some of the projected losses
may be mitigated by other factors, such as increases in house
prices, and the current circumstances consumers find themselves
in. This may explain in part why some consumers, who believe they
were missold an endowment policy, have not complained. However,
the Government accepts that many consumers may not realise they
need to act. We therefore welcome further initiatives announced
recently by the FSA and industry to raise awareness.
22. That some consumers are prepared to carry
the shortfall or do not consider they were mis-sold the endowment
policy, does not mean that all consumers will be able to cope.
The Government has asked the FSA, as part of its further research
into the effects of mortgage endowments, to identify those vulnerable
consumers who may be particularly hard hit by projected shortfalls
and/or unable to take action to correct these. With greater clarity
of the extent of shortfalls and the numbers of consumers who may
face significant hardship as a result, the Government, the FSA
and industry will be better able to assess the most appropriate
method of dealing with these problems.
23. In dealing with all consumers who face a
shortfall, the Government will look to the industry to provide
more specific information and personalised illustrations on the
options for addressing the shortfall. We would also expect the
industry to produce workable and economical solutions to allow
consumers who reach the end of the mortgage term with a shortfall
to deal with the outstanding debt, such as providing options to
extend the loan or defer repayment until the property is sold.
Advice to consumers
24. The Government agrees with the Committee
that it is important that consumers who believe they have been
mis-sold endowment policies are given adequate opportunity to
complain. It is equally important that those consumers whose endowment
policy is projected to fall short, act quickly to address this.
Recent announcements by the FSA and the ABI are welcome in this
respect.
25. As the Committee recognises, the passage
of time since most endowment policies were sold and the lack of
contemporaneous records of the advice provided mean that it is
difficult to properly assess the numbers of consumers who might
be affected. The Government supports the efforts of the FSA both
to raise awareness among all endowment policy holders of their
rights to complain and to conduct research to provide a more accurate
assessment of the position of different groups of consumers.
26. Figures from the FSA suggests that while
consumers have higher awareness of endowments than other financial
issues, levels of complaints are currently around 6% of all policyholders.
While the proportion of policyholders who have so far complained
appears low, there may be further factors other than low awareness
affecting the propensity of consumers to complain. Many endowments
policies sold in the early 1980s will, typically, be smaller than
the average because house prices were lower. This may result in
lower than average shortfalls, which when offset against a tripling
of the average house price since 1988, may lead many consumers
to decide to that the shortfall is manageable in face of other
factors.
27. The Government welcomes the ABI's recently
revised code of practice which sets minimum standards for providers
to inform consumers of their rights to complain and insists that
all reprojection letters must include the relevant FSA factsheets
on entitlement and method of complaining. This is an important
and welcome step in ensuring consumers are aware of the steps
they can take in addressing a shortfall or making a complaint
against possible mis-selling. The Government also welcomes the
rule change which the FSA has introduced which means that, in
future, consumers will not face the time barring of their complaints
unless they have first been explicitly told of the time they have
to complain before they face being time barred.
28. Where no clear indication of a time limit
has been given previously, the Government supports the FSA suggestion
that firms either not invoke the time limit or voluntarily extend
it and commends the attitude of some providers who have decided
that they will not seek to time bar complaints from consumers
concerning endowments. It is a fundamental principle that consumers
should be made clearly aware and in timely manner of their ability
to complain if they believe they were mis-sold an endowment policy.
29. To ensure consumers who need to take urgent
corrective action receive the advice and guidance they seek, the
Government fully supports and is working collaboratively with
the FSA to develop a national strategy for raising financial capability.
The Government welcomes the recent FSA publication "Building
financial capability in the UK" which sets out the initial
priorities to improve financial capability among consumers. A
key aspect of this work will be to find innovative ways of delivering
advice and information to consumers. The Government is also currently
consulting on changes to the regulatory regime to clarify the
position of advice centres. Our intention is that advice centres,
such as Citizens' Advice will be confident that they are allowed
to give financial advice and information to help endowment policyholders
and other investors.
Complaints and compensation
30. The ability of consumers who believe they
were mis-sold an endowment policy to make complaints depends on
a number of factors: when they purchased the policy, from whom
and when they first became aware the policy is likely to fall
short.
ENDOWMENT SALES PRIOR TO 29 APRIL 1988
31. Regulation of the selling of financial services
began on 29 April 1988, with the Financial Services Act 1986.
The Financial Services and Markets Act 2000 did not extend jurisdiction
retrospectively beyond 29 April 1998. Complaints about endowment
policies sold directly by providers such as banks and building
societies pre-1988 are eligible for consideration by the FOS if
these firms were part of a voluntary scheme.
32. Pre-1988 there was no voluntary code or scheme
covering the activities of IFAs and other intermediaries. Consequently,
the FOS is unable to consider complaints from consumers who were
mis-sold endowments policies by IFAs and other intermediaries
before 29 April 1988.
33. Initial FSA research estimates that of the
8.5 million endowment policies currently (as at December 2003)
in force 2.7 million of these were sold before 29 April 1998.
Around 45% of all endowment policies were sold through an IFA
and so are not subject to the pre-1988 jurisdiction of the FOS.
This gives a total of around 1.2 million policies sold by an IFA
pre-1988. Further factors to be considered in respect of pre-1988
IFA-sold policies and the propensity of consumers to complain
include:
- Pre-1988 endowments will, typically,
be smaller than the average because house prices were lower. Average
house prices rose from £17,000 in 1979 to £29,000 in
1984[2]
- The pre-1988 period can be cut into two halves.
Early policies (sold from 1979 to 1984) have a lower incidence
of shortfalls, and where there are shortfalls these are typically
much smaller (up to around £500)[3]
- 1/3 of all pre-1988 policies still in force were
sold in 1984 or earlier and so are unlikely to have a significant
shortfall.
- The average house price has now risen to around
£160,000[4], a further
tripling on 1988 levels.
- Mortgage interest rates are now only half the
level prevailing in the 1980s, substantially reducing the cost
of servicing a mortgage loan.
34. While the number of consumers who were mis-sold
an endowment policy pre-1988, which is forecast to shortfall,
may be smaller than initially thought, there will still be a significant
number of consumers for whom there is no avenue of redress. The
Government has discussed this issue with the FSA and welcomes
the FSA's plans to conduct further analysis to establish a clearer
picture of the numbers of consumers affected. It is also important
to assess the relative abilities of consumers in this group to
cope with a shortfall.
35. The options for extending existing avenues
of redress or seeking voluntary agreement from industry to deal
with such complaints are limited. Under its own rule-making powers
the FSA cannot extend, retrospectively, the scope of the regulatory
regime (and hence the FOS's jurisdiction) to cover this group
of consumers.
36. Many of the IFA firms who mis-sold endowment
policies have departed the industry since the late 1980s, which
further reduces the scope of consumers to complain. While the
policy provider could agree to look voluntarily at such complaints,
as these are not responsible for the misselling, this will depend
on the attitude of individual providers. The FSA is aware that
seeking to impose such a solution on providers is legally unjustifiable.
The Government supports the efforts of the FSA and industry to
explore the scope for voluntary action to help consumers in this
situation.
37. The Government does not believe it is appropriate
to introduce retrospective legislation.
ENDOWMENT SALES AFTER 29 APRIL 1988
38. Consumers who believe they were mis-sold
endowment policies linked to mortgages after 29 April 1988 can
rely upon the complaint mechanism introduced by the Financial
Services and Markets Act 2000. This allows for the consumer to
refer the complaint to the Financial Ombudsman Service (FOS),
after the firm has had opportunity to consider the case, up until
either:
- within six years of the date
the policy was sold; or
- within three years from the date when the consumer
ought reasonably to have become aware that they had grounds for
believing they were missold
whichever is the later.
39. In general, the three-year time limit is
deemed to run from the time the consumer first received a 'red'
reprojection letter warning that there is a high risk of shortfall.
The time limit is extended so that it ends six months from the
date when the complainant receives a second 'red' letter.
40. The ABI's revised code of practice calls
for greater prominence and clarity in the letters to consumers
warning of projected shortfalls. The Government welcomes this
initiative and urges all parts of the industry to adopt this approach,
including the use of red ink for headline messages such as "Red
Alert: High Risk of Shortfall" to further encourage consumers
to act.
TIME-BARRED CONSUMERS
41. Those consumers who received two red reprojection
letters in the first two waves issued by the industry in 2000/01
and 2002/03, had until six months after the second letter was
received to make a complaint for misselling. The Government is
aware that consumers may not have been aware of the limitation
and understands that out of a total population of 8.5 million
policyholders, an estimated 700,000 could already be time-barred
if they wished to make a complaint.
42. As such, the Government welcomes the FSA
announcement of a change in its rules which means going forward
that firms will normally only be able to reject a complaint on
time bar grounds if they have first provided a warning, at least
six months in advance, to the consumer of the effect of limitation
and provided notice of a 'final date' before which any complaint
regarding the original sale of the policy must be made.
43. While this measure will provide protection
to most policyholders, it will not protect those already potentially
time barred. We strongly encourage firms to consider such cases
and to review sympathetically the circumstances of each case.
The Government supports the FSA in undertaking further discussions
with firms and the industry on this and other voluntary initiatives.
NOT YET TIME BARRED
44. As noted, the Government welcomes the rule
change made by the FSA which means that, in future, consumers
will not face the time barring of their complaints unless they
have first been given advance notice of a date after which they
would or may lose their right to make a complainti.e. "You
have until XXXX to complain". The effect of this change is
to require firms to provide this specific information to consumers
before they invoke limitation.
COMPENSATION
45. The Financial Ombudsman Service (FOS) was
set up in recognition that consumers want a speedy, fair and inexpensive
method of resolving disputes. There can be little doubt that the
FOS has and continues to meet this aimover 61,000 complaints
of all types were considered by the FOS last year.
46. The Government, however, acknowledges that
some in the industry have raised concerns about the decision making
process of the FOS. On 4 November, the Government announced, as
part of the two-year review of the Financial Services and Markets
Act 2000, that the FOS and the FSA will jointly review when regulatory
action by the FSA should replace decisions on individual cases
by the FOS and on the possibility of appeals of FOS decisions.
The review process is underway and the FSA and the FOS are due
to publish a consultation document on these issues in June.
47. The Government acknowledges that consumers
who believe they were mis-sold an endowment policy by an IFA prior
to 1988 face an additional hurdle in obtaining redress.
Lessons for the future
48. The Government is grateful to the Committee
for its detailed examination of the circumstances surrounding
the selling on endowment mortgages. The report has highlighted
a number of problems that existed in the market for financial
services. It is of fundamental importance that all users of financial
markets understand and accept the risks involved, on the basis
of all relevant information being provided and understood.
49. It is also clear that the industry owes a
continuing duty of care to its customers, which does not end at
the point of sale. This, and the ability of consumers to obtain
speedy redress when things go wrong, are essential requirements
for building trust and confidence in the UK financial services
market.
50. The Government believes that the necessary
regulatory changes have been introduced to deal with these issues
going forward. It is working with the FSA to assess more accurately
the scope of any outstanding problems caused and ensure that they
can be dealt with effectively. The Government welcomes action
by the industry to address the concerns raised by the Committee.
51. The Government will continue to work with
all parties, consumers, the FSA and the industry to ensure that
UK consumers are well served by an efficient financial services
industry.
HM Treasury
7 June 2004
2 (Nationwide figures) Back
3
(Indicative figure only from DSA data firms December 2003) Back
4
(This is an average based on figures available from rightmove-£180,000,
Nationwide £140,000) Back
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