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The FSA&#39s endowment approach

Thank you for your letter of 21 May. It raises a number of points, and in particular provides me with the opportunity to restate the overall approach which we have taken to endowment mortgages, and to explain the substantial body of work that has been, and is being, undertaken here.

The overall FSA strategy as defined publicly in October 2000 has been:

To ensure that consumers are well informed, are encouraged to complain where they are unhappy with the advice they were given, and that they are treated consistently and fairly when they do so; and To follow through on identifying potential &#39pockets of loss&#39 in a focused way, in order to see redress delivered effectively to consumers who have lost out as a result of poor advice.

As a result of our actions, in early 2000 every mortgage endowment holder received from his or her provider an FSA factsheet. This explained the economic reasons for lower growth rates in endowment policies, leading to potential shortfalls. It also outlined the circumstances in which consumers could lodge a complaint. Through the ABI we ensured that all policy holders were then sent a clear, standard format &#39re-projection&#39 letter. That letter clarified whether there was a potential shortfall on their policy, and what the options were if this was the case. It explained that a process had been put in place to ensure that policyholders would be sent a reprojection letter at least every two years in future. We believe that these letters put policyholders in a good position to decide on a response which is appropriate to their circumstances.

We have been monitoring firms&#39 conduct of the re-projection exercise very carefully. Our research, conducted in Spring last year, indicated that only three out of ten policyholders had by that time taken action to remedy their potential shortfall (see our press release on 2 July 2001: “Endowment Mortgages: seven out of 10 households have taken no action”). Around half of those who had taken no action said they had good reasons (such as that they had repaid the loan by other means and were continuing to fund the endowment, but as a savings vehicle). This left a third of policyholders who were undecided or who were content to let the position ride. Some of them should undoubtedly be taking further action.

The current, second round of re-projection letters is likely to stimulate further responses. Firms are required to issue reprojection letters with the FSA factsheet &#39Your endowment mortgage – time to decide&#39. This factsheet is designed to ensure that all consumers understand the options open to them to make up any shortfall, and that those who have reason to believe they were missold are fully informed of their right to complain. It was consumer tested on the target audience, endowment policyholders, who were very positive about the content and felt it gave them the information they required, both about complaints and about how to make up a potential shortfall. The feedback also showed that they wanted the letter from their provider to make clear that this information came from the FSA as the independent regulator rather than the firm. A sentence in bold was therefore inserted in the first paragraph of the reprojection letters which reads: &#39The enclosed factsheet about your options is from the independent watchdog set up by the government, the Financial Services Authority (FSA). Please read these documents carefully.&#39 The factsheet spells out the circumstances in which consumers may have a valid complaint and says &#39If 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 that may be due to you. Wait for the outcome of your complaint before taking further action.&#39 It also makes clear that consumers who want to make a complaint can get the FSA factsheet &#39Endowment Mortgage Complaints&#39 free from our helpline or by downloading it from the website.

We also included a new section in the factsheet: &#39What to do next if you want to make a complaint but are not sure if you have a reasonable case&#39. Feedback from our research had shown that this was an area of concern, as was the decision on the further steps they should take. This section refers people to our complaints factsheet and to the Financial Ombudsman Service case studies, which enable consumers to compare their own case with those that the ombudsman has already assessed as reasonable complaints. We have also explained how people can track down the firm or adviser who sold them the policy if they did not buy it directly from their endowment provider.

We do not believe it would be appropriate or proportionate to also include the more detailed factsheet &#39Endowment Mortgage Complaints&#39 with the reprojection letters. This factsheet is relevant only to those who wish to make a complaint, not to those who wish to know how to make up a potential shortfall but are not considering making a complaint.

Alongside this work directed at getting information into the hands of consumers, we published guidance to firms last year to ensure a consistent approach to their handling of mortgage endowment complaints. Our latest figures show that just over 100,000 such complaints have been received by firms since the reprojection exercise started in April 2000 (representing around 1% of all policies). Over one third of these complaints have been upheld by the firm, leading to average redress paid of #3,000. We continue to monitor closely the effectiveness of product providers&#39 complaints handling processes, and are working closely with the Financial Ombudsman Service. We assess evidence of flaws in those processes and regulatory breaches and, where appropriate, we investigate and take disciplinary action to help safeguard consumers.

As part of this work, John Tiner wrote to all the Chief Executives of the main endowment providers, and the largest IFAs, in April this year, drawing general attention to issues of concern that had arisen from our supervision of mortgage endowment complaint handling in firms. Firms were asked to respond to our letter and to review and if necessary to revise their complaints handling procedures in the light of the concerns expressed.

We therefore continue to follow a stratified approach, as suggested in your letter; we focus on areas where there are high concentrations of consumer risk. We have identified, and required firms to resolve, a number of areas of significant consumer detriment, caused by pockets of mis-selling and mispricing of products. As a result, to date 20 firms have agreed proactively to compensate policyholders who were missold their policies. This involves around 218,000 policies, leading to total compensation of around #315 million due to be paid.

We will continue to fulfil our commitment to investigate areas of potential consumer detriment such as high charges and excessive growth rates. We have focussed on specific firms and required them to pro-actively compensate consumers. We have taken public enforcement action against two firms so far and are continuing investigations into a number of firms where there is evidence of potential misselling. Where such misselling is established we will take steps to ensure that consumers receive appropriate redress. Disciplinary action against the firms may also result.

It is important to emphasise the economic background to these cases. Just because consumers now face a potential shortfall does not mean they were missold the policy at outset. A number of those who received a red or amber letter may well continue to consider that the product is suitable to their needs, because they can afford to increase the premiums, or because they are no longer using it to repay their mortgage. We do not accept that identifying companies who are the worst performers, in respect of investment performance, the extent of shortfalls and the number of complaints in relation to their mortgage endowments, would help consumers decide whether they were missold their policy. Such information could provide an exaggerated incentive to complain, with no greater prospect of that complaint being upheld. At the same time, disclosure of individual firms&#39 records by the regulator raises difficult confidentiality and human rights issues.

You raised in your letter the question of policies sold before the regulatory regime came fully into force, i.e. pre-April 1988. The vast majority of pre-A day mortgage endowment complaints already fall within the Compulsory Jurisdiction of the Financial Ombudsman Service (FOS). Cases that do not fall within the Ombudsman&#39s jurisdiction are essentially those where the firms in question had not joined the PIA Ombudsman Bureau&#39s Voluntary Jurisdiction and have not subsequently signed up to the FOS&#39 Voluntary Jurisdiction arrangement. Under the Financial Services and Markets Act 2001, the FSA has no power to compel firms to subscribe to the Voluntary Jurisdiction of the Financial Ombudsman Service.

Finally, you refer to potential misuse of policyholders&#39 funds in meeting the costs of redress. The cost of compensating consumers largely depends on the type of policy issued, and the circumstances of each life office. The policyholders of mutual life offices will share all the costs incurred by their office, just as they share all the profits. In the case of proprietary life offices, the shareholders may meet all or some of the costs, depending on the nature of the policies issued. In the case of unit linked policies, the costs would be met entirely by the shareholders, whilst for with-profits policies the costs would be met by the fund and shared among policyholders and shareholders, in the same proportion as they share profits. This does not prevent a life office from using surplus funds from past business, held in the with-profit fund, to meet some or all of the redress costs, and need not therefore affect bonuses for current with profit policyholders. We do not believe that the current rule, allowing proprietary life offices discretion on how they fund fines, is fair to policyholders. We have therefore proposed a change to the current rules.

In a Consultation Paper published this month we proposed the following amendment to the Interim Prudential sourcebook for Insurers:

“If we impose a financial penalty (that is a fine) on a long-term insurer, the insurer must not pay the penalty from any of its long-term insurance funds. This includes any with-profits funds. This would only apply to long-term insurers who are not mutuals.”

The closing date for consultation on this rule change is 19 July, and we hope that you will let us have your views on our proposals.

In summary, we believe that our overall approach to mortgage endowments is fair and proportionate: it ensures that consumers have the information they need to make informed decisions. Where they have cause to complain our policy is designed to ensure that the industry responds fairly. Where significant pockets of consumer detriment have been caused by misselling, we require the firm involved proactively to compensate its policyholders.

A full-scale proactive review along the lines of the pensions review would involve an estimated administrative cost of around #5 billion. In our view this would be disproportionate. The population of mortgage endowment cases with a redressable loss is much lower than for pensions: in phase 2 of the pensions review, 80% of the cases reviewed received redress. Moreover average redress paid to mortgage endowment policyholders is around 20% of the figure for pensions misselling cases of over #15,000, even though the administrative costs per case are similar.

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