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ombudsman news

issue 136

September 2016

awarding interest: the ombudsman's approach

Richard West, lead ombudsman for decisions, rules and jurisdiction, explains our approach to adding interest when we tell a business to pay compensation.

where does the ombudsman service get the power to award interest?

The legislation that set up the Financial Ombudsman Service - the Financial Services and Markets Act 2000 - sets out our powers to tell businesses to pay interest. These powers are reflected in the part of the FCA’s handbook that deals with ombudsman awards - DISP 3.7.

There are three different ways in which interest might come into play - which cut across all the complaints we deal with.

First, although this isn’t about adding interest to an award, calculating the award itself may include an “interest” element. One example of this is where we tell a business to refund historical credit card account interest they’ve charged a consumer, as a result of the consumer having PPI.

Another example might be where we tell a business to work out how much an investment might have grown by if the money had been invested in a different way. In those cases, we sometimes use an “interest rate” as the benchmark to work out a fair return - though we’re more likely to use an investment index, as Mr and Mrs O’s case study shows.

Second, we can tell a business to pay interest on a money award. This generally happens if a loss has “crystallised” in the past - before we make our decision about a complaint. For example, if we uphold a complaint about an investment that’s already matured, we’ll usually tell the business to pay the consumer compensation equal to the difference between what the investment was worth when it matured, and what it would have been worth on maturity assuming a fair return. On top of this money award, we’re likely to tell the business to pay 8% simple interest on the loss - for the period from the maturity date, to the date the compensation is paid to the consumer.

Third, we can tell a business to pay interest on the money award after it’s been calculated. That is, if there’s an unreasonable delay in a business settling a complaint following an ombudsman’s decision, we can decide that 8% simple interest should start to accrue.

This all sounds quite technical, and it is. There are significant differences between these powers - not least that interest as part of an award is subject to our £150,000 award limit, whereas any interest on the award, as well as on any costs, isn’t generally subject to the limit.

So it’s not surprising that we’re sometimes asked to explain what the interest is for and when it’s likely to come into play. The scenario we receive most questions about is where we tell a business to pay interest on the money award.

so why do you tell businesses to pay interest on top of money awards?

If we uphold a complaint, we usually look to put the consumer in the position they would be in if things had happened as they should - and to award fair compensation. In some cases, we decide the consumer involved has been out of pocket as a result of a business’s error.

So to compensate the consumer for being “deprived” of money - that is, not having it available to use - we can tell the business to pay interest on top of the money award, for the period their customer was out of pocket.

I’ve given an example of how this might apply in complaints about a matured investment. In the same way, if an insurance claim has been wrongly turned down, we might tell the insurer to add interest on the amount they should have paid, for the period their customer didn’t have the money they should have had. Or if we decide a bank has unfairly applied fees to a customer’s account, we may say interest should be added to those.

why do you use a rate of 8%?

When we uphold a complaint and decide to make a money award, we assess the loss the particular consumer has made in as much detail as we can. For example, how much worse off are they for having had an unsuitable investment, than if they’d had one that wasn’t unsuitable?

However, we can rarely say for sure what the cost is to someone of being “deprived” of that money. For many people, it might have influenced a whole range of decisions about spending and borrowing over a period of time.

So in deciding an appropriate interest rate on the money award, we consider the broad characteristics of the consumer. We think about how much it would cost someone with these attributes to borrow the money in question, and the range of missed opportunities they might have had - including what sort of returns they could have got if they’d invested the money. Of course, at a time when the Bank of England base rate and the returns on savings are low, we do get questions from some businesses about whether a rate of 8% is too high. And it’s right that you wouldn’t get 8% interest if you put your money in, say, a cash ISA.

However, only individual consumers and the smallest businesses, trusts and charities can use the ombudsman service. Thinking about the broad attributes you’d expect this type of consumer to have, if they’d had to borrow money to cover a loss, it’s possible they’ll have been charged well over 8%. The interest rates charged on credit cards may be 15% or even higher - not to mention the rates charged on short-term borrowing such as payday loans and unauthorised overdrafts.

Someone might also have missed out on opportunities as a result of not having had the money. It’s not only about opportunities to save or invest. There could have been things they went without having or doing - which they really needed or might have benefited from.

It’s also important to note that 8% is paid at a simple rate of interest - not the compound rate people are charged on borrowing. Being charged interest on interest in this way can make a significant difference over a period of time. And the interest is potentially subject to income tax.

So in most cases, for most consumers, we think a rate of 8% simple interest is appropriate to reflect the cost of being deprived of money in the past. This also reflects the current statutory interest rate on judgment debts.

but don’t the courts sometimes use a lower rate?

It’s true that a court could use a different rate of interest. There’s a lot of discretion involved - about whether to award interest, how much and over what period. And a lot depends on the type of claim being made, the “class” of claimant and the division of the court considering the case.

The courts might use a lower interest rate if that would better reflect the hypothetical borrowing costs for a claimant with that claimant’s particular attributes. For example, if the claimant is a larger business, it’s likely they would have been able to borrow money at a rate lower than 8% to cover a missing payment.

As I mentioned earlier, we only look into complaints from individual consumers and the very smallest businesses - who will take a much harder financial hit if they need to borrow money. However, if fairness requires it, we’re also able to use a different rate of interest.

when might you award a lower rate of interest?

In some cases we might decide, in the individual circumstances, that a rate of 8% is too high. A good example is highlighted in our principal ombudsman’s decision of a few years ago, which is published on our website.

The consumers involved had several million pounds of savings and no debts. They’d been out of pocket. But we didn’t think it was likely they’d missed out on anything relating to their lifestyle through not having the money they were owed - or that they’d borrowed unnecessarily.

On the other hand, they’d missed out on the chance to get a return on their money, as they had with their other savings. So the ombudsman awarded an interest rate to reflect a typical return on a deposit account at the time.

what about interest on PPI compensation?

The 8% interest rate has come up in discussions around changes to the PPI complaint-handing rules, in light of the judgment in Plevin v Paragon Personal Finance. Some respondents to the FCA’s consultation pointed out that in some court cases involving PPI, the court awarded interest at a rate of less than 8%. However, the FCA doesn’t believe the parties involved closely resembled typical PPI customers - given they were generally reasonably affluent or involved in business enterprises or investments.

The FCA also said that, despite some businesses’ concerns, they’ve seen no evidence of people delaying making a complaint about mis-sold PPI to maximise the interest on their compensation.

what if a business delays paying compensation awarded by an ombudsman?

In cases where the loss is calculated up to the date of the final decision - rather than a date in the past - there won’t be any interest to pay on the money award. But if the award isn’t paid in a reasonable period of time, we’re likely to tell the business to add interest from the date of decision to the date of payment.

We generally think a reasonable amount of time is 28 days from the date we tell the business the consumer has accepted the ombudsman’s decision. So if they haven’t paid by then, interest should start to accrue.

This compensates the consumer for being deprived of the money we’ve awarded if the business doesn’t pay in good time - while giving the business a reasonable opportunity and encouragement to pay.

what if I’ve got questions about the ombudsman’s approach to interest - or how I go about applying it in a particular set of circumstances?

If you have general questions about our powers to award interest - or you want to talk things through with us - you can get in touch with our technical helpline on 020 7964 1400. We can also answer questions face to face at our free events for smaller businesses.

case study

Mrs L complained that she didn’t need the life, accidental death and critical illness cover she was sold when she bought a car on hire purchase. The business couldn’t explain why they’d recommended the cover - and, in Mrs L’s individual circumstances, there was no evidence she needed it.

So we told the business to pay compensation equivalent to the premiums she’d paid - adding 8% simple interest per year on each premium from the date Mrs L paid it to the date of settlement, to reflect the fact she’d been deprived of that money.

case study

When Mr and Mrs O surrendered their equity bond at a loss, they complained it had been too high risk for them. We decided the advice they’d received hadn’t been appropriate in their circumstances.

It wasn’t clear how Mr and Mrs O would have otherwise invested their money. So we suggested the business compare the actual performance of the equity bond with an appropriate benchmark - in this case, the average rate for fixed-rate bonds - from the date the investment began to the date it was surrendered.

We explained that, if fixed-rate bonds had performed better, the business should pay the difference. And they should add 8% interest on the difference from the date Mr and Mrs O had surrendered the investment to the date of payment - to reflect the fact they’d been unfairly deprived of that money.

Caroline Wayman

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.