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ombudsman news

issue 9

September 2001

endowment mortgages:
missing endowment policies

background

An endowment mortgage is one where the payments to the lender only cover interest, and the intention is for the capital of the loan to be repaid by an endowment policy. Problems with endowment mortgages are not confined to cases where, because expected returns have now fallen, there are fears that the endowment policy may not produce enough to pay off the mortgage. We receive a significant number of complaints about cases where, although the intention was for the borrower to have an endowment mortgage, there is no endowment policy. The borrower therefore has no way of paying off the mortgage. In some cases the endowment policy was never taken out. In other cases, it was taken out, but then cancelled during the lifespan of the mortgage.

We recently issued briefing notes, summarising our approach to compensation in such cases. This approach is similar to that adopted in the past by both the Banking Ombudsman Scheme and the Building Societies Ombudsman Scheme. But it also incorporates the approach to past savings about which we consulted in the context of mortgage underfunding cases.

[Mortgage underfunding cases are where the borrowers make the monthly payments quoted by their lender, but the lender has quoted too low a figure. The result is that the borrowers owe more on their mortgage than they should do. They are faced with increasing their monthly payments, or having the mortgage continue for much longer (possibly even after they have retired). We consulted about our approach to these in the March 2001 edition of ombudsman news, and reported the outcome in the June 2001 edition.]

This article summarises the briefing notes about missing endowment policies and may help borrowers and lenders who wish to settle such cases. It deals with our approach to awarding compensation where:

  • a mortgage was to be paid off by an endowment policy;
  • the monthly payments to the lender only covered interest;
  • the endowment policy was never taken out or was not continued; so
  • there is now no way of paying off the mortgage.
  • We are required to decide each case on the basis of our existing powers and of what is fair in the circumstances of that individual case. We may decide that, in the interests of fairness, a particular case requires a different approach.

where the policy was never taken out

if the lender was not at all to blame

Typical cases where we would probably consider the lender was not at all to blame are where:

  • The lender made it clear at the outset that the mortgage was interest-only; it was the borrowers' responsibility to ensure they took out a policy or had some other way of paying off the mortgage; and the terms of the mortgage did not require the lender to see the policy.
  • The lender provided an endowment mortgage; it was agreed that the borrowers would arrange their own endowment policy; the lender made it clear that it was the borrowers' responsibility to arrange the policy; and the terms of the mortgage did not require the lender to see the policy.

In such cases, we would not award any compensation to the borrower.

if the lender was 100% to blame

A typical case where we would probably consider the lender 100% to blame is where: the lender agreed to arrange the policy; the borrowers had reasonable cause to believe their monthly payments to the lender included the policy premiums; and the borrowers raised the matter with the lender as soon as the discrepancy became obvious.

If we consider the lender was 100% to blame, we will require it to pay the current value of a replacement policy's "extra premiums", calculated as follows:

Premiums that will have to be paid from now onwards

Total premiums that will have to be paid from now for a replacement policy of the same type based on:

  • the original loan
  • the original maturity date
  • the current age and health of the life/lives assured.
A
Premiums that should have been payable from now onwards

The total premiums that would have been paid, from now, if the original policy had been taken out. If the amount of the original premiums is unknown, we will base this on current rates for a replacement policy of the same type based on the original:

  • loan
  • term of the policy; and
  • age and health of the life/lives assured.
B
Extra premiums

This amount is the difference between the premiums that:

  • will have to be paid on the replacement policy, from now [A], and
  • would have been paid, from now, if the original policy had been taken out [B].
A-B=C
Current value of the extra premiums

The borrowers receive compensation now in a lump sum, but the extra premiums will be paid gradually from now to the end of the term. So the current value of extra premiums [D] is the amount that would have to be invested now to make up the extra premiums [C] over the rest of the term. Currently we assume a yearly investment return of 4%.
D

If the original policy was for the amount of the loan "plus profits":

  • We are unlikely to deduct the notional past "savings" that the borrowers made as a result of not having paid premiums. These "savings" will compensate the borrowers for the reduced time during which profits can be earned.
  • Where appropriate, we will also award compensation for past distress or inconvenience.

In other cases:

  • It is likely that the borrowers will have arranged their expenditure on the basis of their known outgoings. We are only likely to deduct the notional past "savings" that the borrowers made as a result of not having paid premiums:
  • To the extent the lender can show that the borrowers still retain the "savings" as identifiable and readily-realisable assets;
    Unless the borrowers can show it would be unreasonable to do so in their particular circumstances.

  • Where appropriate, we will also award compensation for past distress or inconvenience; but only so far as it exceeds any "savings" we have disregarded.

If we do deduct any past "savings", we will not add interest to them.

Usually, we will not award compensation for any future inconvenience of having to pay the original premiums.

example calculations

The following examples are based on a case where:

  • The policy was for an amount which, plus profits, was expected to pay off the loan
  • The premiums that will have to be paid from now onwards [A] are £6,935
  • The premiums that should have been payable from now onwards [B] are £2,826
  • So the extra premiums [A - B = C] are £4,109
  • The current value of the extra premiums [D] is £3,013
  • Notional past "savings" were £2,500
  • We consider that £250-worth of inconvenience was caused to the borrowers.

Ordinarily:

  • We would require the lender to pay compensation of £3,013
  • We would not deduct any of the notional past "savings" from the compensation
  • We would not award anything for inconvenience, because the disregarded "savings" of £2,500 exceed the £250 we would otherwise have awarded.

Exceptionally, if the lender showed that £1,000 of the past "savings" formed an identifiable and readily-realisable part of the borrowers' current assets:

  • We would deduct £1,000 of the "savings" from the compensation
  • We would require the lender to pay net compensation of £2,013 (£3,013 - £1,000)
  • We would not award anything for inconvenience, because the disregarded "savings" of £1,500 exceed the £250 we would otherwise have awarded.

Exceptionally, if the lender showed that all the past "savings" formed an identifiable and readily-realisable part of the borrowers' current assets:

  • We would deduct all of the £2,500 "savings" from the compensation
  • We would require the lender to pay net compensation of £513 (£3,013 - £2,500)
  • We would award £250 additional compensation for inconvenience.
if the lender was less than 100% to blame

A typical case where we would probably consider the lender less than 100% to blame is where: the terms of the mortgage required the lender to see the policy, and it failed to do so; but the borrowers must have known that they had not taken out a policy.

In such cases, we would reduce the compensation proportionately. And it would not be fair to disregard any notional "savings" that accrued after the point when borrowers must have known there was no policy, but kept quiet about it (for example, after discovering they were not paying premiums).

where the policy was taken out, but was not continued

The policy may have stopped from a variety of causes including:

  • the insurance company stopped collecting the premiums and the direct debit or standing order for the premiums failed, unknown to the borrowers, the borrowers deliberately stopped paying the premiums
  • the borrowers surrendered the policy.

We will consider whether the lender:

  • knew, or should have known, that the policy stopped n made the consequences clear to the borrowers
  • is to blame for not having converted the mortgage to a repayment mortgage.
if the lender was not at all to blame

Typical cases where we would probably consider the lender not at all to blame for not converting the mortgage are where:

  • The lender made it clear at the outset that: the mortgage was interest-only; it was the borrowers' responsibility to ensure they took out a policy or had some other way of paying off the mortgage; and the lender did not require to see the policy.
  • The lender made it clear, when it discovered that the policy had stopped, that the mortgage was interest-only; and it was the borrowers' responsibility to ensure they took out a new policy or had some other way of paying off the mortgage.
  • The borrowers could not afford to continue the policy premiums; the lender and borrowers agreed the mortgage should be interest-only; and the lender made it clear it was the borrowers' responsibility to ensure they took out a new policy, or arranged some other way of paying off the mortgage, once their financial position improved.
  • It was not apparent to the lender that the policy had stopped.

In such cases, we would not award any compensation.

if the lender was 100% to blame

A typical case where we would probably consider the lender 100% to blame for not converting the mortgage is where: the lender required borrowers to take out a policy; it was not apparent to the borrowers that the premiums had stopped; but it was apparent to the lender that the policy had stopped.

Usually:

  • we will tell the lender to write off the capital which would have been paid off (if the mortgage had been converted to repayment) since the date the lender should have known the policy had stopped.
  • if it was not apparent to the borrowers that the premiums had stopped, we will not deduct the notional past "savings" the borrowers made as a result of not paying the premiums.

Exceptionally, even if it was not apparent to the borrowers that the premiums had stopped, we will deduct the "savings" (without interest):

  • to the extent the lender can show that the borrowers still retain these "savings" as identifiable and readily-realisable assets;
  • unless the borrowers can show it would be unreasonable to do so in their particular circumstances.

Where appropriate, we will also award compensation for past distress or inconvenience; but only so far as it exceeds any notional past "savings" we have disregarded. We will not usually award compensation for the future inconvenience of having to make increased payments.

example calculations

The following examples are based on a case where:

  • the loan was an interest-only mortgage n the capital was to be repaid by an endowment policy
  • the endowment policy was taken out, but the lender discovered it had later lapsed
  • the lender failed to convert the mortgage to repayment
  • if the mortgage had been converted, £4,000 would have been paid off the capital
  • notional past "savings" were £3,500 n we consider that £250-worth of inconvenience was caused to the borrowers.

Ordinarily, we would:

  • require the lender to write £4,000 off the capital
  • not deduct any of the "savings" from the capital written off n not award anything for inconvenience, because the disregarded "savings" of £3,500 exceed the £250 we would otherwise have awarded.

Exceptionally, if the lender showed that £1,000 of the past "savings" formed an identifiable and readily-realisable part of the borrowers' current assets, we would:

  • deduct £1,000 of the "savings" from the capital written off
  • require the lender to write off the remaining £3,000 from the capital
  • not award anything for inconvenience, because the disregarded "savings" of £2,500 exceed the £250 we would otherwise have awarded.

Again, exceptionally, if the lender showed that all the past "savings" formed an identifiable and readily-realisable part of the borrowers' current assets, we would:

  • deduct all of the £3,500 "savings" from the capital written off
  • require the lender to write off the remaining £500 from the capital
  • also award £250 for inconvenience.

exceptional cases

Exceptionally, we will modify the approach where we consider it
For example:

  • For borrowers who are near or beyond retirement and cannot afford the future payments, even if the shortfall from the date the policy stopped is written off, it may be unreasonable to deduct retained past "savings".
  • If the borrowers ran up arrears by failing to pay all the interest-only payments, this may demonstrate that they would not have paid the premiums (if they had realised they were not being paid) or the full repayments (if the mortgage had been converted to a repayment basis). In such cases, we are likely to reduce compensation accordingly.
if the lender was less than 100% to blame

Typical cases where we would probably consider the lender less than 100% to blame are where:

  • The lender required the borrowers to take out a policy; it was apparent to the lender that the policy had stopped but the lender did not contact the borrowers; and it was apparent to the borrowers (then or later) that the premiums had stopped.
  • The lender required the borrowers to take out a policy; it was apparent to the lender that the policy had stopped but the lender did not contact the borrowers; and the borrowers had deliberately stopped paying the premiums or surrendered the policy.

In such cases, we would reduce the compensation proportionately. If the borrowers knowingly stopped paying the premiums or surrendered the policy, we would expect them to bear almost all the loss.

It would not be fair to disregard any notional past "savings" that accrued after the borrowers discovered they were not paying premiums (or knowingly stopped paying the premiums or surrendered the policy) but kept quiet.

advice for lenders

Lenders who wish to settle cases with borrowers along the lines we would adopt, but without our direct involvement, can contact our technical advice desk if they are unsure of how our approach would apply in particular circumstances.

phone 020 7964 1400
email technical.advice@financial-ombudsman.org.uk

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.