Endowment Misselling

Following the FSA chief’s admission to the ‘widespread mis-selling of endowment mortgages’, Teresa Hunter examines the industry’s shortcomings

Sunday Herald 7th December 2003

Endowments came under the spotlight of parliamentary watchdogs last week when bodies ranging from the Consumers Association to the chief city policeman of the Financial Services Authority, were called to give evidence before the Treasury Select Committee.

John Tiner, chief executive of the FSA, finally conceded that there was ;very widespread mis-selling of endowment mortgages which may lead more homebuyers to consider claiming for compensation.

The Consumers Association has warned that some policyholders may be running out of time to complain, because you must move within three years of receiving a red letter warning of the likelihood of a substantial shortfall when it comes to repaying the mortgage; or within six months of a second such warning.

But complaining isn't getting easier. A number of large firms have been granted waivers allowing them to delay addressing complaints for months. Legal and General is squaring up for a legal battle with the FSA over its findings that the company mis-sold some contracts, and has appealed to an independent tribunal.

MPs on the committee were dismayed to hear that the FSA’s own consumer panel did not believe the regulator had done enough to protect policy- holders and to alert them to problems early enough. They were also aggrieved to hear that the FSA had not fully investigated the scale of the problem.

The committee has now sent the regulator off to collect some hard evidence of the numbers of people believed to have been mis-sold.

Mick McAteer, of the Consumers Association, argued: We have said all along, how can the FSA pretend to be dealing with a problem when it has no idea how big the problem is or the numbers affected?

Where compensation is payable, it must come out either of the unattributed surpluses held in the funds, known as inherited estates, or from shareholders, according to proposals for new rules on with-profits, published by the FSA on Friday. This follows concerns that where fines for regulatory failure and compensation is met out of the with-profits fund it is actually being paid by the policy- holders themselves.

With-profit investments have long been popular with savers because they offer a halfway house between safe deposits and high-risk investment funds.

However, their image has been tarnished by a succession of scandals, not least endowments, but also that of Equitable Life. The with-profits basis of many endowments is not central to the problem of mortgage shortfalls. Many unit-linked endowments have performed considerably worse.

That said, managers have considerable discretion when deciding payouts on maturity or at surrender, and whether to introduce early redemption penalties known as market value adjusters (MVA).

Policyholders have also been concerned at falling returns from these policies, particularly where they are held in the growing numbers of funds closed to new business.

Around 11 million investors are now locked in these graveyard funds, all of which pay out lower returns than funds within the same group that remain open to new business.

The new regime will lay down strict criteria for dictating surrender and maturity values, and prescribing when additional penalties such as MVAs can be levied. It will also ensure customers receive detailed information about how the fund is managed, its investment mix and its liabilities, whether opened or closed.

But it will do very little to address the “raw deal” about which many investors who are locked into these funds complain.

McAteer says:  all very well making with-profits more attractive for new investors, but our main concern is the plight of existing policy- holders. These people are effectively trapped in funds which in some cases have no prospect of any return at all going forward.

We need tough rules to fetter managers discretion when it comes to manipulating returns and milking closed funds to cross-subsidise new business. We dont just want more of the FSA transparency solutions.

In fact, that is largely all the new rules will provide to policyholders in closed funds. They must be notified within 28 days of the fund being closed, and must also submit a run-off plan demonstrating how a full and fair distribution of assets, including any surpluses and inherited estates, will be achieved.

Better information about closed funds is more significant than it may sound. In the past, policyholders have found it virtually impossible to get any information at all.

On other fronts, though, the new rules are more prescriptive than the insurance industry would welcome. The days of sticking a pin in the telephone directory to decide what numbers should be paid out will disappear, although not until March 2005.

From that date, customers must receive payouts which are closely linked to the performance of their investments, known technically as their asset share. Firms must set targets on how maturity and surrenders will be linked to asset shares, and these details must be published in the companys Principles And Practices of Financial Management (PPFM) document.

Each firm must publish a PPFM by next March, and by the following November it must also have a consumer-friendly edition, which can be sent to customers on demand.

Firms must also quantify the extent to which payouts may fall in any given year, but again not until March 2005. Despite the transitional delay, insurers are worried. Although many are already running their businesses on similar lines, they still claim tighter prescription may force them to adjust operations further in a way which could be to policyholders’ detriment.

Norwich Unions David Riddington explains: “We already publish a range which promises that we will pay out not less than 90% and not more than 110% of asset share. But in exceptional years we move outside that range. Our concern is, if we cant move outside that range it takes away our ability to manage our business in our policyholders best interests.

These worries are echoed by Standard Lifes David Hare. Either we have to set the ranges so wide they become meaningless, or we may have to switch into lower-risk investments to ensure maturities dont for example move by more than 10 or 15% a year.

This will force payouts to fall even quicker, and be bad news for homeowners with endowment shortfalls. These shortfalls will get larger rather than smaller.

Companies will be prevented from introducing MVRs for purely commercial purposes to stop customers leaving. They can only apply where they are necessary to protect those left in the fund, and must be based on actual costs to company.

07 December 2003