regulatory update 94 and policies that were enhanced by windfall benefits

This article concerns our position on the treatment of enhancements made to a policy – as a result of windfall benefits – when assessing loss in mortgage endowment cases.

Regulatory Update 94 (RU94) advised firms that when they make offers in mortgage endowment cases, they should not take the value of any windfall benefits (including policy augmentations) into account. It also advised that, where they have already made an offer that does take these benefits into account, they should withdraw it, explaining that they have done this pending further guidance from the regulator.

However, some firms have interpreted this guidance as prohibiting the payment of redress in any case where a policy has been augmented as a result of a windfall. In our view, this is not the position. RU94 does not instruct firms to place on hold all cases that involve a windfall payment in the form of augmentation; it merely prohibits them from taking advantage of the augmentation to pay their customers less than their full entitlement.

In cases referred to us, we have encouraged firms to try to resolve the dispute by either:

deducting the value of any policy enhancement from the offer made to the customer, with the clear proviso that the firm will adjust the amount of redress if eventual regulatory guidance results in a different sum being payable; or
making an offer that uses the policy’s current surrender value, on the basis that if there is eventual guidance stating that enhancements should be disregarded, the firm will then pay any additional sum due.

The customer is, of course, under no obligation to finalise the dispute with the firm on either of these bases. However, we consider that firms should at least offer to resolve matters in this way. We do not think it reasonable that, for the sake of a relatively small adjustment, customers whose complaints have been upheld should:

fail to receive the compensation they are due;
and – critically –
continue to be locked into an inappropriate product that has been mis-sold to them.

Without the compensation they are due, these customers cannot take steps to transfer to a repayment mortgage.

The Financial Services Authority has confirmed that it does not regard our approach as conflicting with its guidance. We are now making decisions based on the above interpretation of RU94 and we are making awards on either of the above bases, if it is reasonable to do so. We therefore expect firms to progress cases in the same way. And, where appropriate, product providers should provide independent financial advisers with current policy surrender values, so they can proceed to pay redress.

Obviously, it is important that both parties to the dispute fully understand the basis on which any such settlement has been achieved, and the implications. However, the degree of care required in progressing these cases should not mean that firms make no attempt to reach a speedy settlement.

case studies – regulatory update 94 and policies enhanced by windfall benefits

14/04
When Mr and Mrs J were aged 59 and 47 years, respectively, they were sold a mortgage endowment policy with a term of 12 years. They said they had been given to understand that the policy would provide a lump sum of £6,000, in addition to the amount they needed to repay their mortgage.

When they discovered that the proceeds of the policy might not even be enough to repay the mortgage, they complained, noting that once they had retired, they would be unable to afford any additional payments to make up the anticipated shortfall.

The firm said that the policy had been arranged to mature before Mrs J retired and it claimed that the couple had been fully aware of this and had understood the risks in using an endowment policy to repay their mortgage.

We issued a provisional decision, establishing the firm’s liability for mis-selling the policy, on the grounds that the policy was unsuitable for these customers because of the element of risk.

We also decided that the firm should pay Mr and Mrs J £150 for distress and inconvenience. The firm said that as the couple’s policy had been augmented by a windfall bonus, it was unable to calculate redress until the regulator issued further guidance.

We decided that redress could be calculated. Until the firm paid Mr and Mrs J the redress due to them, they would be locked into an inappropriate product. The proportion of the policy value that was attributable to the policy augmentation was small, compared to the total compensation payable. We decided it was not reasonable for the firm to delay putting the couple in a position where they could switch to a more suitable method of repaying their mortgage.

We therefore awarded redress, calculated in accordance with Regulatory Update 89 and based on a 12-year mortgage period. We also required the firm to:

increase to £250 the amount of compensation for distress and inconvenience, recognising that the couple suffered a further delay before being able to restructure their mortgage arrangements;
provide a life insurance policy, on the same terms that would have been available to Mr and Mrs J when they took out the mortgage endowment policy; and
pay the administration fee that the couple would incur when converting their mortgage to a repayment basis.

Finally, we required that, when guidance on the treatment of windfall augumentations becomes available, the firm should calculate any increased compensation due to Mr and Mrs J, and pay it, with interest.

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14/05
Mr D and Miss M complained about the mortgage endowment policy they were sold by an independent financial adviser in 1996. They said they had wanted to take out a repayment mortgage but the adviser had dissuaded them. He had told them that taking an interest-only mortgage with a mortgage endowment policy would be no more expensive but would provide them with an additional lump sum when the policy matured.

The adviser maintained that the policy was suitable for the couple’s needs, and that the product literature he gave them was sufficiently explicit that they could have been in no doubt about the risk involved.

However, we concluded that the policy was not suitable for these customers and we awarded redress calculated in accordance with Regulatory Update 89. The policy had been enhanced by a windfall payment of 98p. Given that this is such a small sum, and in the absence of guidance on the treatment of such enhancements, we decided that the firm could deduct it from the policy’s current surrender value when it calculated the redress payable.