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ombudsman news

issue 35

February/March 2004

calculating compensation payments for mortgage endowment mis-selling - complex situations

When firms calculate compensation in cases of mortgage endowment mis-selling, they are required to follow the guidance provided by the Financial Services Authority (FSA) and by us. Broadly speaking, this involves comparing the customer's current financial position with the position they would have been in, if they had taken out a repayment mortgage instead.

We are seeing a small but increasing number of disputes where, because the customer's circumstances are far from straightforward, the firm has been unsure exactly how to work out the correct amount of compensation. This article takes a look at some of these complex scenarios and clarifies the approach that firms should take in their calculations.

The scenarios we examine are where the customers:

  • have already switched to a repayment mortgage; or
  • switched to a repayment mortgage but kept their endowment policy going (usually as a means of making general savings); or
  • kept their endowment policy going during a "break" between mortgages.

customer has already surrendered policy and converted to a repayment mortgage

In this situation, firms should calculate compensation by:

  • comparing the mortgage endowment policy with a repayment mortgage, up to the date when the customer converted to a repayment mortgage;
  • using the endowment policy's surrender value as at the date of this conversion; and
  • adding interest, from the date the policy was converted to the date when the firm pays the compensation.

For example, in a case that came to us recently, Mr C had taken out a mortgage endowment policy with the firm in 1998. He converted this to a repayment mortgage after the firm wrote to him in July 2001, warning that the policy was unlikely to pay out enough money to cover his mortgage. In 2003, he complained to the firm about its mis-selling of the mortgage endowment policy.

The firm agreed to uphold his complaint but was unsure how to calculate the compensation. We told it to calculate Mr C's loss by following the FSA's Regulatory Update 89 (RU89), comparing the cost of the endowment mortgage with a repayment mortgage, up to the date when Mr C converted to a repayment mortgage (July 2001) and using the surrender value that applied on that date. We also said it should pay Mr C interest on this amount, from July 2001 to the date when it paid the compensation.

customer has converted to a repayment mortgage but has retained the endowment policy

Firms are sometimes unsure how to treat cases where a customer has switched to a repayment mortgage but has kept the endowment policy going and has continued to pay the premiums. In such cases, much will depend on why the customer has done this.

For example, in July 2003, Mr G complained to the firm that provided and had sold him his mortgage endowment policy. At the same time, he switched to a repayment mortgage. However, he kept his mortgage endowment policy and continued paying the premiums.

When the firm rejected Mr G's complaint, he came to us. He told us he had only continued paying his endowment policy premiums because he thought he had to do this while the firm - and the ombudsman service - was dealing with his complaint. We found that the mortgage endowment policy had been unsuitable for Mr G's circumstances at the time the firm sold it to him, so we upheld his complaint. We required the firm to:

  • calculate redress in line with RU89 up to July 2003 (the date Mr G switched to a repayment mortgage) and using the surrender value as at July 2003;
  • add interest to the loss from July 2003 to the date when the firm paid the compensation;
  • refund the premiums Mr G had paid into the endowment policy from July 2003 to the date when the firm paid compensation; and
  • add interest to the sum of premiums paid from July 2003 to the date when the firm paid the compensation.

The outcome was different in the case of Mr M. He took out a mortgage endowment policy in 1995 but converted to a repayment mortgage after the firm wrote to him in 1998, indicating a potential shortfall on his policy. He decided to keep his endowment policy and to carry on paying into it as a form of savings.

In 2002, Mr M received another letter from the firm, indicating that when the endowment policy matured it would be worth significantly less than Mr M had expected. He then complained to the firm about its mis-selling of the policy.

The firm agreed to pay compensation but it calculated Mr M's loss from the date when he first took out the mortgage endowment policy to the date when he converted to a repayment mortgage. Mr M insisted that this was wrong. He said the firm should include in its calculations the entire period during which he had been paying into the endowment policy. Unable to reach agreement with the firm, he came to us.

We explained that the firm was only accountable for the loss that had occurred while he was using the policy to repay the mortgage. It had been entirely Mr M's choice to continue paying in to the policy, as a means of saving, after he had switched to a repayment mortgage. We told the firm that its offer was fair. It calculated compensation due to Mr M up to the date when he switched to a repayment mortgage in 1998, and it paid interest on this sum, up to the date when it made the compensation payment.

customer has kept endowment policy going during a "break" between mortgages

Another situation that can affect compensation calculations is where customers have had a "mortgage break" (a period when they were "between" mortgages). These customers are in the position where, if theirs had been a repayment mortgage, they would have been able to repay it after selling their property and then would have no mortgage outgoings until they bought a new property.

Instead, having been (inappropriately) sold a mortgage endowment policy, as a flexible means of repaying current or future mortgages, they kept the policy going after selling their property, even though they didn't buy a new property right away. Their intention was to use the policy as a means of paying the mortgage when they eventually bought another property.

Where compensation is due in cases like this, the firm's calculation should take into account all the endowment premiums paid, including those when the policy was not being used for a mortgage. This is because the customer kept the policy for its initial purpose - repaying a mortgage.

Mr B's case provides an example of this situation. In 1996, he took out a mortgage endowment policy as a means of repaying a £50,000 mortgage with firm A. Four years later, he sold his property and moved abroad for a year. During this period, he kept up the payments on the endowment policy, knowing that he would need to buy a property when he returned home. In January 2001, he moved back to the UK and arranged a mortgage for a new property with a different firm - firm B. He planned to use the proceeds of his existing endowment policy, when it matured, to repay the new mortgage.

In July 2003, Mr B complained to firm A that it had mis-sold his policy. The firm upheld his complaint and offered to compensate him for his losses up to January 2000, when he had sold his first property. However, it said it did not consider it was liable for any loss that Mr B had sustained after that date. Mr B disagreed. He felt the firm should compensate him for the entire life of the policy.

We agreed with Mr B. He was continuing to use the policy for the purpose for which it had originally been sold - to repay his mortgage. There was no reason to believe that he had been aware of any potential difficulties with the mortgage endowment policy (in terms of a possible shortfall) when he returned to the UK and bought his second house. So we required the firm to compensate him, in line with RU89, for the entire life of the policy, including the period when he was abroad and was not using the policy in connection with a mortgage.

The table below summarises the compensation calculations for the three periods when Mr B's policy was, in turn, used as means of replacing an initial mortgage, retained for future use and used as a means of repaying a new mortgage.

date cost of endowment mortgage capital reduction on equivalent repayment mortgage cost of equivalent repayment mortgage
period of first mortgage (March 1996 to January 2000) £17,631.14 (interest plus endowment premiums) £2,982.02 £16,860.49
(interest and capital
repayment element)
period abroad with no mortgage (January 2000 to January 2001) £1,020 (endowment premium only) nil nil
period of second mortgage (January 2001 to date of settlement in 2003) £10,587.84
(interest plus endowment premiums)
£3,094.44 £10,942.95
(interest and capital repayment element)
total £29,238.98 £6,076.46 £27,803.44

The loss was calculated as follows:

capital comparison
total capital
reduction on equivalent
repayment mortgage
£6,076.46
minus surrender
value in 2003
£6,000 £76.46
plus
comparison of outgoings
total cost of
endowment mortgage
and premiums
£29,238.98
minus
total cost of equivalent
repayment mortgage
£27,803.44
£1,435.54

compensation payable £1,512.00
Walter Merricks, chief ombudsman

ombudsman news issue 35 [PDF format]

ombudsman news gives general information on the position at the date of publication. It is not a definitive statement of the law, our approach or our procedure.

The illustrative case studies are based broadly on real-life cases, but are not precedents. Individual cases are decided on their own facts.