Select Committee on Treasury Fifth Special Report


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 complaint—i.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 aim—over 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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