An estimated five million home owners who took out endowment mortgages received a letter earlier this year from their endowment provider, forewarning them of the possibility that their endowment policy may not be sufficient to pay off their mortgage.
Press coverage, frequently critical of insurance companies and the much-maligned financial services industry, has fuelled public concern in presenting the selling of endowments as the latest scandal to hit the industry.
It has been reported that an estimated three million home owners, representing 60% of endowment holders, will not be able to pay off their mortgages unless they begin to save more. In the face of this adverse publicity, it is instructive to consider what the Financial Services Authority (FSA) has had to say on the subject in order to assess how serious the problem might be for insurers, endowment holders and independent financial advisers alike.
An endowment is an investment-linked life assurance policy, designed to pay a lump sum at the end of a given period (the policy term). At the end of the term the policy matures and the policyholder receives a pay-out, which is then used to repay the mortgage loan.
When a customer takes out an endowment policy, the endowment company must provide the customer with written examples of the amount they might receive if their contributions were to grow at different rates. The projection rates are based on economic factors, including inflation and interest rates and are subject to change.
In the early 1980s, inflation and interest rates were high and mortgage interest tax relief (MIRAS) was still available.
Consequently, endowment mortgages were very popular and, at that time, most endowment policies were sold using growth projection rates of 8% to 10% a year. In recent years however, both inflation and interest rates have fallen and, in July 1999, the regulators recommended projection rates be reduced to 4% or 6% per year.
The fall in inflation and projected rates of return undoubtedly mean that a substantial number of endowment policies will no longer be on track to pay out a large enough sum at the end of the term when the mortgage is repaid.
Not so well endowed
As a result, the proportion of mortgages arranged on an endowment basis has reduced markedly over recent years. In the first three months of this year the proportion of new mortgages arranged on an endowment basis had fallen to 20%. This represents a continuing decline from a peak of more than 80% endowment mortgages taken out in 1988, according to the FSA's own research. Some life assurance companies and lenders have ceased to offer the product altogether, including the Halifax, Abbey National, Nationwide and Cheltenham & Gloucester.
The FSA has conducted research into this area over the past 12 to 18 months, that is still ongoing. Its representatives made a series of visits to major firms selling the product and collated evidence on market trends, selling practices and the typical performance of endowments as opposed to repayment mortgages.
In December 1999, the FSA announced the preliminary findings of its research. Perhaps surprisingly, given press speculation, the FSA concluded that, on average, holders of mortgage endowments have enjoyed returns which mean they have fared at least as well as they would have done with a repayment mortgage. There were, therefore, no grounds for an industry-wide review of past business. This conclusion represents a marked contrast with the FSA's attitude towards pensions mis-selling.
The FSA's regulatory visits to product providers and independent financial advisers (IFAs) however, showed selling practices for endowments to be poor. Record keeping was found to be generally inadequate and raised questions as to the suitability of a significant proportion of sales.
The FSA recently warned that these findings may lead to further investigation of a number of the firms concerned in respect of their sales practices which could result in disciplinary action.
Although the FSA has not requested an industry-wide review, the Association of British Insurers (ABI) committed its member firms to a review of all mortgage endowments sold after January 1983, in accordance with the new projection rates issued in July last year.
The FSA is conducting further research to identify whether there are any particular problem categories of past business for mortgage endowments. It issued a report last week (October 3) that reiterates its view that a full-scale review of all past sales is not justified.
However, the FSA confirms that, where mis-selling has occurred and customers have lost out as a result, compensation should be paid. As in all its pronouncements, the regulator warns against cashing in the endowment or ceasing payments, without taking proper advice.
The FSA's next steps will be to issue another factsheet on endowments, that will set out how policyholders should complain.
The majority of the companies that sold endowments, certainly those that acted as IFA's, will be regulated by the Personal Investment Authority (PIA) in the conduct of investment business. When claims from dissatisfied policyholders are made, they will be judged by reference to standards set out in the PIA Rule Book and enshrined in the Financial Act 1986. The two PIA rules which are likely to be the subject of closest scrutiny, should claims arise, will be compliance with the “best advice” and “know your customer” rules.
Sold down the river
It is possible to identify certain typical circumstances where an endowment may have been mis-sold, in part based upon the FSA's own research and comments made by the PIA Ombudsman, as follows:
Complaints and claims will undoubtedly be received by the life assurance companies and lenders that supply endowments, and by IFAs where they were responsible for giving advice and selling the product.
Professional indemnity insurers can expect to receive notifications from assureds that have been active in selling endowments, either when assureds become aware of general compliance failings or possible shortfalls on reviewing their files, or when letters of complaint are received from dissatisfied policyholders.
The FSA's press release issued last week contains ominous warnings that it will “not hesitate” to take disciplinary action against companies that are found guilty of continued compliance failings. The picture will undoubtedly become clearer over the next few months.
