APPENDIX 2
RESPONSE BY THE FINANCIAL SERVICES AUTHORITY
Introduction
1. This note is submitted in response to the
Committee's fifth report of the 2003-04 session on mortgage endowments.
A number of recommendations were directed at the FSA. In response
to these we refer to the relevant paragraphs in the report.
With-Profits policies (paragraph 12)
2. We agree with the Committee's conclusion that
the development of simpler, more transparent products is a big
challenge for the industry. In terms of our actions, we are introducing
a series of changes which will benefit with-profits policyholders.
One of the key components of the programme of reform for with-profits
is for firms to articulate and publish the degree of discretion
that they are allowed to exercise in the management of funds and
to disclose how discretion has been exercised.
3. Improving transparency for existing and potential
policyholders and treating customers fairly are the cornerstones
of the changes being introduced. These include:
- giving informed users, including
those who advise consumers on their investments, a better understanding
of the way in which the with-profits fund is run, through the
production of a document called the Principles and Practices of
Financial Management (PPFM). We will also require firms to produce
consumer friendly PPFMs later this year ;
- giving policyholders greater confidence in how
firms will meet, and have met, the obligation to treat customers
fairly through, for example, the report that firms are required
to give to policyholders on their compliance with PPFM obligations;
- providing clearer and more transparent information
for customers atand postpoint of sale on the nature
and risks of their investment, and how it is performing, in relation
to the published principles and practices applied in managing
the fund; and
- providing informed users, including those who
advise customers on their choice of investment, with improved
access to information on the financial condition of firms and
their with-profits funds (including the firms' ability to meet
discretionary benefits such as terminal bonuses) through the publication
of realistic balance sheets.
The Role of Actuaries (paragraph 18)
4. The Committee states that it is important
that the FSA's reforms of the actuarial process within insurance
companies are effective. We believe that they will be and we have
already sent the Committee evidence on our reforms of the role
of actuaries in life insurers, which will come into effect at
the end of this year. The advisory and reporting duties being
placed on the actuaries performing both of the new actuarial functions
should produce more proactive actuarial input to the firm's decision-making
and earlier warning of any emerging problems. More independent-minded
actuarial advice should also be encouraged by the steps we have
taken to address the potential for conflicts of interest arising
from these actuaries holding certain other positions within firms
(for example, in future neither will be permitted to be chairman
or chief executive, and the with-profits actuary must not sit
on the board).
Paying for financial advice (paragraph 30)
5. Our work on the new disclosure regime to accompany
depolarisation is aimed at aligning the interests of customers
and advisers in terms of paying for financial advice. In the past,
advice has normally been paid for out of the commission paid on
sales via intermediaries, or from an equivalent margin for a direct
sales force. Our research indicates that customers think that
paying a fee for financial advice is the best way of avoiding
the potential for the advice being biased by commission. However,
the research also shows that few customers are prepared to pay
by fee instead of commission.
6. Our proposals for a disclosure document entitled
'Key facts: A guide to the cost of our services' - also commonly
known as the 'menu' - make clear to customers that both fee and
commission options are available. They also include prescribed
wording explaining the pros and cons of each. We propose that,
in future, advisers who want to call themselves 'independent'
must offer advice across the whole market and must always give
their clients the opportunity to pay for the advice by fee (though
they may offer a fee/ commission choice).
Asset Allocation (paragraph 33)
7. The Committee recommends that 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 is added to, or
detracted from, the performance of the investment fund. Under
our existing rules, policyholders are already provided with a
range of information and we believe that the further disclosure
required under the new 'Principles and Practices of Fund Management'
(PPFM) documents will enhance the information available to policyholders'
advisers (as well as policyholders themselves through consumer
friendly PPFMs). There will be increased disclosure on, for example,
a firm's investment strategy, charges to asset share, approach
to payouts and how the with-profits fund is managed.
"Red" reprojection letters (paragraph
38)
8. We have agreed with the ABI that the revised
ABI Code on mortgage endowment reprojection letters will include
a recommendation that firms use red ink or other similarly striking
means to draw to attention the key risk warning in "red"
reprojection letters. For "red" letters, the risk warning
should also be headed up with the words "Red Alert: High
risk of shortfall".
Realistic reprojection rates (paragraph 41)
9. We agree that it is important for customers
to receive realistic reprojections of the likely future value
of their policy. We have made clear that it is the responsibility
of firms to ensure that the reprojection rates used are a realistic
reflection of the nature and composition of the underlying funds
and of the asset share of any particular policy in those funds.
This is a complex judgement, and so we expect firms to keep the
assessments and assumptions they use under constant challenge
and review. This is the message we communicated to them in our
Dear CEO letter of June 2003. We highlighted a range of factors
that we expect firms to consider when deciding their reprojection
rates. These include the ratio between equities and non-equity
assets in the underlying funds and any guarantees or bonuses attached
to a particular policy that may impact upon its value.
10. We will be carrying out focused periodic
reviews and sampling of firms' methods during 2004-05 on a risk
assessed basis.
Policyholders in closed funds (paragraph 51)
11. The Committee has highlighted its concern
for policyholders in closed with-profits funds. There are a number
of steps that we have taken or are in the process of taking to
help address this. It is worth noting, however, that the fact
that a fund has closed does not of itself mean that policyholders
are being treated unfairlysome closed funds have performed
well and closure has in fact been in the interests of policyholders.
Questions of fairness have more to do with the financial strength
of a firm and how the management have responded to this rather
than closure itself, although we appreciate that financial weakness
has in some cases resulted in closure.
12. Our programme of reform of the with-profits
sector addresses both closed and open funds, and some of our proposals
were designed specifically with closed funds in mind. Our recent
consultationTreating with-profits policyholders fairlymade
a number of proposals on the treatment of policyholders in closed
funds. These include better communication with policyholders (particularly
in terms of explaining why the fund has closed and setting out
policyholders' options) and better planning for the run-off of
the fund. The consultation also contains proposals that are designed
to ensure surrender values are fairboth to policyholders
surrendering their policies and those who remain in the fund.
13. The Committee recommends that policyholders
should be given the opportunity to switch without penalty to another
similar fund when their fund closesas opposed to taking
a surrender value or continuing to maturityand that shareholders
should bear the costs. As noted above, closure is not always detrimental
to policyholders' interests and similarly closure is not itself
evidence of the mismanagement of a fund for which shareholders
may be liable. It is unlikely that a shareholder could therefore
be compelled to fund the these proposals, and even if there were
a case for shareholder support it is difficult to see why only
policyholders choosing to switch should benefit from this.
14. There are a number of further considerations
that must be taken into account with the proposal of a policy
by policy move even if FSA could require it. These include, for
example, the willingness of another provider with a fund to take
on these policies and the administrative costs associated with
them, and the differences between with-profits contracts (for
example, the type of guarantees and bonus policy offered in the
fund that closes may be hard, and costly, to replicate in the
receiving fund). A policy by policy transfer would also require
clarity on any future liabilities for any mis-selling of the contract
in the first place.
15. There is, however, scope for market-based
solutions to address concerns about closed funds and we are encouraged
that the industry is actively exploring innovations in this area.
Chief amongst these is the sale of closed funds, effectively transferring
a whole fund to another firm through a sale rather than on a policy
by policy basis. This would involve firms that are interested
in divesting their with-profits business selling their closed
books to new or established players in the market. Although there
is increasing interest among market participants in developing
such solutions for some closed funds, this is not straightforward
as it requires some careful balancing between the discount the
vendor is willing to accept; the equity return that the purchaser
requires; and the regulatory imperative for companies to treat
their customers fairly.
16. The sale of an entire fund also addresses
some of the difficulties associated with the Committee's proposed
transfer solution. For example, economies of scale may be achieved
through the sale of a complete book which would not be achieved
on a policy by policy basis. This too is not without its difficulties
as with-profits contracts and the legacy systems which support
them differ across the sector and cannot simply be merged. These
are significant obstacles that would need to be overcome to derive
the full benefits. A sale may also mean that the fund is able
to maintain the same terms and guarantees for policyholders, or
alternatively the fund could be restructured. Finally, responsibility
for mis-selling liabilities could be made clear before any deal
was finalised. We cannot, however, require closed funds to be
sold.
17. In the past, the lack of clarity and transparency
surrounding the risks carried by some life funds has made them
relatively unattractive to potential purchasers. However, greater
transparency brought about by the recent introduction of PPFM
(which closed funds are also required to produce) and the new
capital adequacy reforms has meant that purchasers can quantify
and price such risks more accurately. We would expect to see some
consolidation among closed funds, with policyholders standing
to benefit even if their fund remained closed.
Aligning company and consumer interests (commission
and fees) (paragraph 53)
18. The Committee points out that a structure
in which the fees charged by product providers are tied to the
product meeting set investment targets would service the consumer
better and recommend that the industry and the FSA investigate
this.
19. We place a clear responsibility on the senior
management of firms to treat their customers fairly. We are engaged
in a series of studies with a range of companies about how best
to encourage them to deliver on these responsibilities. The Committee
will also be aware that the ABI has commissioned Charles River
Associates to look at the way in which long term savings are sold,
and in particular the role of commission. Our interest is to find
ways of encouraging and rewarding best practice as a constructive
means of making progress - a much more productive relationship
between the FSA and a regulated company than one based on failure
to comply with rules accompanied by enforcement action.
Advice on financial services generally (paragraph
60)
20. We welcome the Committee's reference to the
Financial Capability Steering Group. On 27 May 2004 it published
a document, Building financial capability in the UK, which sets
out a shared approach being taken by a wide range of national
strategy partner organisations.
21. The Steering Group has identified seven priorities
in order to improve people's ability to make financial decisions.
One of these is a project to examine how to make the provision
of accessible and affordable generic advice more widespread. This
project is being lead by the FSA, and an Advisory Group of key
stakeholders has begun this work. The others areas the Group will
be looking at are: schools, young adults, work, families, borrowing
and retirement.
22. The FSA also continues to stress the need
for the financial services industry to treat their customers fairly
and explain what they are selling in terms that buyers will understand.
Complaints and Factsheet on complaints (paragraphs
63 and 64)
23. Our research indicated that 86% of endowment
policyholders recalled receiving a re-projection letter, rising
to 99% among those people who had, according to firms' own records,
received a re-projection letter in the last six months. With each
of these letters, policyholders will have received an FSA factsheet
'Your endowment mortgagetime to decide' which will have
helped them to decide whether they needed to take action and what
they might do. The leaflet also provided information to help customers
determine whether they should make a complaint and provided information
on how to do this.
24. We are again updating our literature and
policyholders will receive further information from us with the
next round of reprojection letters. This will include further
information for customers to explain what they can complain about
and how they would go about making a complaint.
25. Under the revised ABI Code, the reprojection
letters will include clearer, crisper text. The wording of the
shortfall risk warning has been made more punchy and given greater
visual impact through the use of red ink or other similar measures.
26. Our original consumer awareness research
quoted above was undertaken about 18 months ago. Since then further
reprojection letters, growing shortfalls and the awareness initiatives
by us and other bodies may have changed many consumers' intentions,
appetite for action and general awareness. We are undertaking
further research to quantify and characterise these developments
more precisely. The results will help us gauge the effectiveness
of our past actions and guide us in refining our ongoing programme
of work.
Time bars (paragraph 65)
27. Our message to customers has always been
to 'Act Now'for example to take action to ensure that they
will be able to repay their mortgage and/or to make a complaint.
Our literature has reflected this, coupled with warnings of the
consequences of delay.
28. In Phase 2 of the reprojection exercise (from
Feb 2002) all reprojection letters included an FSA factsheet containing
the warning, "If you think you have a valid complaint, take
action now - if you delay, you could lose the right to some or
all of any compensation
"
29. In Phase 3 (from Dec 2003) a revised FSA
leaflet was sent with the warning, "If the risks relating
to your endowment mortgage were not explained
.you may have
a valid complaint. But time may be running out. If you want to
complaindo it now. Otherwise, you may be too late or the
amount of compensation you can claim might be reduced
."
30. We have introduced new rules to ensure that
all customers are fully aware of the time limits that apply to
making complaints if they feel they have been mis-sold, as suggested
by the Committee.
31. From 1 June 2004, our new rules mean that
before they can be time barred, customers will receive letters
which make clear what their position is and the final date before
which a complaint must be made to prevent time barring. This notice
must be given at least six months in advance.
32. We have also introduced transitional arrangements
to protect consumers who have already received information from
their providers and could, potentially, be time barred in the
coming period. Firms will be required to provide these consumers
with two months notice that time is about to expire. We have engaged
in close dialogue with the ABI to achieve simultaneous changes
to their mortgage endowments Code.
33. These measures will not be retrospective
and will not affect consumers who are already time barred. A number
of firms have decided not to impose time bars for these customers
and others. We have discussed with the industry what more can
be done on this and other voluntary initiatives (such as the reduction
or waiving of charges normally entailed by switching a mortgage
or paying off the outstanding balance early). We will be following
up these discussions in the coming months.
Companies' handling of complaints (paragraphs
69 and 71)
34. We note the Committee's recommendation that
the FSA needs to be more rigorous in ensuring that its policies
and strategies are being effectively implemented by the financial
services industry. Our general policy is that firms' senior management
should take responsibility for compliance with regulatory requirements.
We have said on a number of occasionsfor example in our
Business Plan for 2004/05that many firms still do not give
sufficient priority to the regulatory requirement to treat customers
fairly. We regard it as a core part of senior management's responsibility
to embed this principle throughout firms' culture and to implement
it in their strategies. Checking that firms do this is an important
focus of our supervision of firms selling to retail customers.
Where we discover firms seriously failing to treat their customers
fairly, we take enforcement action.
35. The FSA continues to monitor firms' complaints
handling performance very closely and we will not hesitate to
take action where we believe that firms' complaints handling processes
are inadequate or unsatisfactory. For example, we fined Allied
Dunbar £725,000 in March this year and Friends Provident
£675,000 in December last year for mishandling mortgage endowment
complaints.
Cases prior to 1988 (paragraph 73)
36. Pre-1988 sales made by most major endowment
providers are covered by the FOS's current jurisdiction since
they agreed when joining the PIA Ombudsman scheme that pre-1988
complaints could be considered under the then voluntary jurisdiction.
When the Financial Services and Markets Act 2000 took full effect
in 2001 the existing scope of jurisdiction of the former ombudsman
schemes was fixed and rolled over into the FOS's Compulsory Jurisdiction.
But IFAs in the main did not sign up to this previously voluntary
arrangement and so their pre-1988 complaints are not now covered
by FOS.
37. Since this issue arises from the way the
original regulatory regime was put in place, it is not something
the FSA can change. Any effort to address this issue in a mandatory
way would require significant change to the legislation setting
the scope of the FOS Compulsory Jurisdiction in relation to pre-N2
complaints. We are, however, in dialogue with the industry to
explore whether there is scope for some non-mandatory action that
might help in cases prior to 1988.
Financial Services Authority
2 June 2004
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