Our thanks to the member who contributed this detailed analysis.
Time bars and endowments extending into retirement
Millions of people who were mis-sold endowment mortgages should be
eligible for compensation under rules made by the Financial Services
Authority. The aim of compensation is to put people in the position
they would have been in had they been properly advised. This generally
means converting to the repayment mortgage that should originally have
been recommended by their financial advisor. If this costs money, then
the firm responsible for mis-selling has to pay.
The body responsible for implementing the FSA rules on compensation
is the Financial Ombudsman Service. It is the Ombudsman who makes decisions
in specific cases when people are unhappy with the way that firms have
responded to their complaint.
One obstacle that stands between the complainant and a satisfactory
outcome is the fact that complaints must be made within a specified
time limit. The rules on limitation are complicated, but the starting
point is that a complaint can be ruled out of time unless it is made
within six years of the event complained of. This would clearly be unfair
in cases where a person only discovers that there is a problem after
this period has expired. Most people with endowments thought that the
mortgage would be repaid at the end of the agreed term. It was only
when they received warning letters that they realised that the mortgage
was in fact based on a risky stock market investment.
To deal with these cases, there is a second rule which says that the
limitation 'clock' only starts ticking when someone discovers that there
is a problem, and from this point they must make a complaint within
three years.
The FSA has been concerned that those who were mis-sold endowments
have been slow to complain. At the same time, there has been much debate
about how people might come to discover that their mortgage arrangements
were not as secure as they had thought. This argument has centred on
the so-called "red letters" -
warnings sent out by endowment firms to customers saying that their
endowments were very unlikely to grow at a rate that would repay the
mortgage when the policy matured.
In response to this, the FSA changed the terms of the three-year rule
earlier this year, in an attempt to ensure that people were not caught
unaware by the rules on time barring of endowment mortgage complaints.
The six year time bar on endowment complaints
In all these discussions, problems associated with the six year time
bar have been completely overlooked. Yet it is now apparent that because
of the way it is being interpreted, the six year time bar is having
a devastating effect on a particularly vulnerable group who were sold
policies at the height of the endowment boom in the early 1990s, when
five out of every six new mortgages were based on endowments.
In the hyped atmosphere of the time, endowments sold to people in
their mid-40s were often arranged with a standard 25 year term. This
meant that borrowers would have to continue paying premiums long after
they had retired, when they would be living on much smaller incomes.
Queries about this were often answered by pointing to high rates of
inflation and investment returns, both running at an average of around
10% over the previous decade. High investment returns would mean that
the mortgage could be paid off early. High inflation meant that even
if this didn't happen, the real value of the outstanding debt would
be greatly reduced. Borrowers were reassured that they need not worry
about the mortgage term.
As we now know, what actually happened was a stock market crash and
the emergence of a low inflation economy. This leaves a group of older
homeowners with an under-performing endowment, and an outstanding mortgage
debt that has not been eroded significantly by inflation.
Although the prospect might look bleak for this group, there is hope.
From today's perspective, most of these endowments were mis-sold. FSA
rules specifically state that mortgages should not be arranged with
a term that continues into retirement unless this is absolutely unavoidable.
If this happened, and appropriate warnings were not given, then there
are grounds for a complaint of mis-selling. Quite apart from this, many
of these endowments were mis-sold because most people were unaware that
what they saw as the security of home ownership was in fact being risked
as a bet on the stock market.
Time barring and the ombudsman
If a complaint of mis-selling is upheld, FSA guidelines clearly state
how matters should be put right. The mortgage should be rearranged on
a repayment basis, but with a reduced term so that borrowers no longer
have to continue making payments after they have retired. Some complaints
have indeed been resolved in this way. But in others, endowment providers
have argued that people who took endowment mortgages must have known
that the 25 year term would run past their retirement date. In their
view, this means that the complaint can be blocked by applying the six
year time bar. Complaints made more than six years after the mortgage
was arranged should be ruled out of time.
Astonishingly, the FOS has accepted this argument and have admitted
that complaints about mortgages that continue into retirement are routinely
time-barred. Even in cases where complaints have been upheld on other
grounds, such as attitude to risk, Ombudsmen rule that compensation
should not be based on a repayment mortgage that would be paid off at
the date of retirement.
The effects of such ruling can be catastrophic. A typical case might
involve a 45 year old man, who took a 25 year endowment in 1990 to cover
a mortgage of £60,000. If a complaint of mis-selling is settled
now and the time bar argument is not invoked, a settlement that follows
FSA guidelines would leave him with a repayment mortgage at a cost of
around £475 per month. Reduction of the term to 20 years would
mean that the mortgage would be completely repaid when he retires. On
the other hand, if the time bar is applied the term remains at 25 years.
This reduces the monthly outgoings to around £415, but payments
must be maintained at this level for another five years after he has
retired. With falling annuity values and present uncertainty about pension
provision, few pensioners can contemplate paying mortgage costs of almost
£5,000 a year out of retirement income. Yet this is what will
happen when the time bar is applied.
These figures show that the interpretation of the rules on time bars
is critical. And in this case it looks as though the FOS has got it
wrong. The FSA rules say that the clock starts ticking on the six year
time bar when the person complaining "became aware (or ought reasonably
to have become aware) that he had cause for complaint". This doesn't
mean simply that he knew the mortgage term was 25 years. He has accepted
this term because he was advised to do so, and since he followed that
advice it must be assumed that he thought it was sound. Typically, it
is only in the light of recent publicity that people have come to realise
that they were badly advised. The FOS is therefore wrong to concede
to firms on this point, and many complainants are being left very much
poorer as a result.
Questions for the ombudsman on time barring complaints
So far, the FOS shows no sign of giving way on this point. But there
are three tough questions that the industry regulators have so far failed
to answer:
- Are the FOS correct in conceding that it is only necessary to show
that the complainant was aware of the mortgage term to satisfy the
requirement that he should have been "aware that he had cause
for complaint" about this?
- In cases where a firm has been negligent in failing to take account
of the client's attitude to risk, is it legitimate for the FOS to
accept the six year time bar so that inappropriateness of the policy
going beyond retirement age is not a relevant factor in assessing
compensation?
- In cases where mis-sold endowment mortgages extend into the complainant's
retirement, is the FSA satisfied that the outcomes that result from
FOS interpretation of the six year time bar meet its objectives for
dealing fairly with endowment mortgage complaints?
