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ombudsman news

issue 58

December 2006/January 2007

mortgage endowment complaints about post-'A Day' sales

We recently published on this website a briefing note on post-"A Day" mortgage endowment complaints. A post-"A Day" sale is one that took place after 29 April 1988 - when the provision of investment advice became regulated under the Financial Services Act 1986.

There is nothing new in the approach set out in the briefing note; the principles were established many years ago. But we hope the note will prove useful in drawing together some of the available information on the way in which we handle these complaints.

Here, we provide a short extract from the briefing note, together with some recent case studies.

'In general terms, since "A Day", firms should:

  • obtain sufficient personal and financial information relevant to the service to be performed for the customer to "know the customer" and
  • (based on that information) give recommendations that are suitable to the customer's circumstances.

We consider the regulatory requirements that applied to the firm at the time of the sale when deciding whether a recommendation was suitable for the particular customer.

There may have been something about the customer's circumstances, or about the policy itself, which meant that the firm should not have recommended the policy to that customer - irrespective of the customer's understanding of the risks involved. Examples could include situations where it was clear that the customer required a level of flexibility that was inconsistent with a long-term commitment or where affordability over the full term was likely to be an issue.

But in the vast majority of cases the underlying issue, when considering whether or not a policy is "suitable", is whether the policy exposed the customer to a risk (or level of risk) that they were unwilling, or unable, to take with the repayment of their mortgage.

One of the main differences with post-"A Day" (as opposed to pre-"A Day") cases is that there is likely to be more documentary evidence available from the time of the sale. With post-"A Day" complaints there may be a "fact find", illustration, brochure or "key features" document and (after 1995) a "reason why" letter. Where these are available, we consider them carefully, along with the customer's circumstances, to help us decide whether the policy was suitable.

The following case studies illustrate some of the wide range of complaints we deal with involving post-"A Day" mortgage endowment sales.

case studies

mortgage endowments: complaints about post-"A Day" sales

58/6

In 1997, on the firm's recommendation, Mr and Mrs V took out a £30,000 interest-only mortgage and an endowment policy. The policy - invested in the firm's managed fund - had a 25-year term.

The "fact find" which Mr and Mrs V signed records that, at the time:

  • Mr V was 20 and employed as a factory worker, earning £13,000 a year
  • Mrs V was 19 and employed as a cleaner, earning £6,000 a year and
  • they had a young child and were expecting another baby in five months' time.

There was a question on the "fact find" about "attitude to risk in regards to using an investment vehicle to repay your mortgage". Customers answered this by selecting a number on a scale from 1 (signifying "cautious") to 10 (signifying "speculative"). The couple had answered with a "3".

The firm told us it believed Mr and Mrs V had knowingly accepted the risk associated with the policy. It said the couple's answer to the question about attitude to risk suggested they had a "balanced" attitude, consistent with the policy it had recommended.

The firm said it had given the couple:

  • (at the time of the sale) an illustration which stated: "These figures are only examples and are not guaranteed - they are not minimum or maximum amounts. What you will get back depends on how your investments grow"
  • (after the sale) a "key features" document and
  • a "reason why" letter, which summarised why it had sold the endowment policy.

Mr and Mrs V told us:

  • they remembered the "attitude to risk" question - they had ticked '3' because the adviser said "3 was average and normal" and
  • they didn't understand the illustrations but had trusted the adviser, who said their mortgage would be repaid in full and they would receive "at least £10,000 on top".

complaint upheld
Mr and Mrs V took out the policy in 1997, so the regulatory requirements and standards introduced by the Financial Services Act 1986 applied to the sale. We considered whether the policy sold to Mr and Mrs V had been suitable for them.

Mr and Mrs V's jobs at the time of the sale do not suggest there was scope for significant salary increases. They were struggling financially and found it difficult to save. It seemed likely to us, from their circumstances, that they would expect it to be difficult to cope with a shortfall on their mortgage. It was unlikely they would knowingly have risked having to do this.

Mr and Mrs V's explanation of why they had answered the question about attitude to risk with a "3" appeared to us to be plausible. And we didn't think the record necessarily reflected their actual attitude to risk.

We thought the illustration and 'key features' document were likely to have been of secondary importance in the sales process to the information provided by the firm's representative. Mr and Mrs V's occupations did not suggest they would have been familiar with documents of this type, and we thought the couple would have relied heavily on the representative's advice.

The "reason why" letter referred to the fact that the policy would be reviewed to ensure it remained on track to repay the mortgage. However, we were not persuaded that this would have alerted Mr and Mrs V to the extent of the risk presented by the policy, bearing in mind that the representative had already advised them that the policy was suitable for them.

After considering the detail of Mr and Mrs V's testimony, we were satisfied that they had not appreciated the risk posed by the managed fund policy. We did not consider the policy to have been a suitable recommendation and we upheld the complaint.

58/7

In 1993, acting on the firm's recommendation, Dr D took out a £63,360 interest-only mortgage and a with-profits endowment policy.

The mortgage application form that he signed stated that he:

  • was working as a hospital doctor earning £40,000 a year
  • was aged 30 and divorced with no dependants
  • held approximately £20,000 on deposit in bank and building society accounts
  • was looking to move house and
  • already had a £30,000 interest-only mortgage supported by a with-profits endowment policy.

The firm's records showed that it had prepared an illustration the day before Dr D met the firm's adviser. The firm was not able to produce any other point-of-sale documentation.

The firm said:

  • it had advised Dr D on his general finances in 1990 and, as a result, he had taken a Personal Equity Plan (PEP) and a unit trust
  • with-profit funds are considered a low area of investment risk and were "within the attitude to investment risk" demonstrated by Dr D's existing
    equity investments
  • the illustration it provided had clearly shown that a shortfall was possible and
  • Dr D had understood and accepted the risk that the endowment might not produce enough to pay off his mortgage.

Dr D told us:

  • the adviser had said the endowment policy would cover his mortgage, provide surplus cash and work out cheaper than a repayment mortgage
  • he had not received the firm's illustration - possibly because the firm sometimes sent documents to his work address and they didn't always reach him and
  • his attitude to risk is extremely cautious; he would have taken a repayment mortgage if he had known the endowment policy carried any element of risk.

complaint rejected
Dr D took out the policy in 1993, so the regulatory requirements and standards introduced by the Financial Services Act 1986 applied to the sale. We considered whether the endowment policy was suitable for him.

At the time of the sale, Dr D had savings in a building society account. Every month he paid £70 into a personal equity plan (PEP) invested in a UK fund and £80 into a unit trust invested in a family of funds.

We acknowledged that Dr D's attitude to risk might differ when it came to his mortgage rather than his savings. However, it seemed possible to us that Dr D had some knowledge of financial matters and might have been prepared to take some risk. He could expect a rising income from his occupation and the endowment policy was due to mature ten years before he reached retirement age.

We thought it plausible that, in his circumstances, Dr D might have decided to accept a risk in return for the prospect of receiving a surplus over and above the amount needed to repay his mortgage.

The illustrations the firm had provided were clear. And since they had been prepared in advance of the meeting with Dr D, it seemed likely to us that they had formed part of the sales process. Of course, we couldn't be sure Dr D had seen the illustrations. However, we thought it likely that if he had done so, he would have understood them.

After considering the detail of Dr D's representations, we decided it was more likely than not that he had understood and accepted the risk of an endowment policy. We rejected the complaint.

58/8

In 1998, on the firm's recommendation, Mr and Mrs T took out a £40,000 interest-only mortgage and endowment policy. The policy was invested in a with-profits fund and had a 25-year term.

At the time of the sale, the adviser noted down his recommendations in a "Customer Needs Analysis" form which Mr and Mrs T had both signed. This form records that:

  • Mr T was 38, working as a taxi driver, earning £10,000 a year and expecting to retire when he was 65
  • Mrs T was 35, working as manager of a car rental shop earning £11,000 a year and expecting to retire when she was 60
  • the couple had no savings or investments apart from the £3,000 they were using as a deposit for the house
  • they did not expect to be in a position to save or invest in the future and
  • they were buying their first home together and required a mortgage for £40,000.

The adviser's notes from the point-of-sale documents show that he recommended a with-profits endowment mortgage because it has a "secure build-up of funds which matches clients low tolerance to risk concerning the repayment of their mortgage" and because the couple "anticipated moving home in the future".

The adviser also noted that Mr and Mrs T were aware that "... although the idea of an endowment is to repay the mortgage sum at the end of its term, there is the potential to accumulate an additional lump sum, however this is not guaranteed."

The firm told us:

  • the adviser obtained sufficient information from Mr and Mrs T to make a suitable recommendation and he carefully documented their attitude to risk
  • Mr and Mrs T had a low tolerance to risk, which matched the fund recommended.

Mr and Mrs T told us:

  • the adviser assured them the policy was risk-free and would pay out a cash surplus at the end of the term, but a repayment mortgage would cost more
    and be less flexible
  • they relied on what the adviser told them - but if they had known about the risk they would not have taken an endowment mortgage
  • they told the adviser they didn't expect to be able to save in the future and
  • if the adviser had discussed a shortfall, they would have expected him also to document how he expected them to fund it.

complaint upheld
Mr and Mrs T took out the policy in 1998, so the regulatory requirements and standards introduced by the Financial Services Act 1986 applied to the sale. We considered whether the policy was suitable for the couple.

The adviser's notes stated that Mr and Mrs T had a "low tolerance to risk concerning the repayment of their mortgage". We thought about this statement carefully. It seemed to us that it could mean more than one thing. A consumer - unused to the terminology of the investment industry - might think that having a "low tolerance to risk" meant they would not want to take a risk, not that they would be happy to accept a low risk.

And it was not clear from the adviser's notes whether the couple appreciated that it was the repayment of the mortgage that was "not guaranteed", or just the additional lump sum.

We thought it likely that there had been at least some sort of discussion about Mr and Mrs T's attitude to risk. But the notes and "fact find" from the time of sale were not decisive in this case.

After considering the couple's circumstances and their detailed submissions, we decided that, on balance, the firm's recommendation had been unsuitable. It exposed the couple to a level of risk they were not prepared to take with the repayment of their mortgage. We upheld the complaint.

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ombudsman news issue 58 [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.