TUESDAY 2 NOVEMBER 1999

MR HOWARD DAVIES, MR MICHAEL FOLGER AND MR ANDREW WHITTAKER

  40. You mentioned a stockbroker; you do not invest money with a stockbroker?
  (Mr Davies) You give money to a stockbroker who invests it on your behalf; stockbrokers typically hold quite a large amount of money in clients' accounts, and if they cannot identify that it is Sir Teddy Taylor's client account, as opposed to Mr Sedgemore's, then we do not think that that is a safe way of doing business.

  41. Turning to endowment mortgages, which seem to be of concern at the moment to the public, to the media and not least to the FSA, because they have issued a press release: "Endowment mortgages—what to do if you are worried;" so, clearly, there is a perceived problem. I know the FSA is investigating the extent that the life insurance element is not covering the pay-off of the loan at the end of term; how are those investigations going, what are you finding out? I know there is a publication next year, but what is the initial finding?
  (Mr Davies) I should say that it is not quite right to say that we are investigating whether there are shortfalls; that is actually being done by the ABI, prompted by us, I should say, but the ABI have agreed that it is now good practice for their members to look at past endowments, either after ten years or halfway through the term, to see whether the existing payments are going to deliver the sum that is required to repay the mortgage at the end of the term. And there are a number of cases where the payments are inadequate because of the changes in interest rates and inflation that have been observable recently. But that activity is being done by the firms themselves, in fact they have decided to go back even before the Financial Services Act, so they are going back to 1983, which we could not possibly require them to do, so they, as a voluntary measure, are actually doing that, and we think that is sensible. The purpose of our press release was actually to say to people that they should not, in a panicky way, think that they ought to cash in their endowment policy, because that might well be the worst thing you could do, and we were very concerned that some of the sort of noise around the endowment policy issue, over the summer, could be causing people to do foolish things, like cash in. And, even though a lot of endowments may not be terrific investments, the one thing that is worse than keeping it is getting rid of it, frequently; and so we were very concerned to alert people to that. What we are investigating ourselves is somewhat different, and that is the current selling policies of endowments, as to whether currently there is mis-selling going on, where people are being misled by using the wrong projection rates, or given ridiculous undertakings about what an endowment will deliver for you, and whether that is actually currently happening. And I cannot give you yet a read-out from that because we are in the middle of our visits to a dozen product providers and a sample of IFAs as well.

  42. So that is current selling activity as opposed to previous selling activity?
  (Mr Davies) Current, yes.

  43. Now the ABI is investigating life policies; how they are doing after ten years, 15 years? What information is there on policies that have come to the end of term and the shortfalls there?
  (Mr Folger) I might say that one of the principal issues in the endowment field, of course, is the sharp drop in inflation, which is what has caused the need for the premium review that you asked about a few minutes ago. The historical performance of endowments has actually been very strong; over the last seven years, balanced managed funds of life offices have returned in excess of 10 per cent annual, compounded. So people who took policies out ten, 15, 20 years ago, and typically these are 20-, 25-year commitments, have actually seen a strong performance, and we are not aware of major shortfalls in policies that are maturing at the present time.

  44. When pension mis-selling, which is obviously still ongoing, was looked at, one of the ways in which a decision was made that a pension had been mis-sold was that it was sold unsuitably to someone, for example, somebody in an occupational pension that was not thinking of changing a job. What criteria would be used to assess the suitability of an endowment mortgage being sold to somebody?
  (Mr Davies) I think it is important probably to be clear about what we currently regulate and what we do not. We do not currently regulate the selling of the mortgage dimension. That is something which the Government is currently considering, as to whether the FSA in future should regulate the mortgage business; we do not do that, so what we do is only the endowment policy. And, of course, one of the points made in favour of statutory regulation of mortgages is that there is an element of artificiality in divorcing the one transaction from the other, because they are typically undertaken at the same time and very closely linked. So we would look at the suitability of the insurance policy itself; and, in that, we would be expecting, if it were sold with advice, the adviser, or the company representative, to look into the financial circumstances of the individual, to check whether they have currently got a lot of insurance which might be duplicated by this and therefore the insurance element would be redundant, whether their employment prospects are, as far as they know, reasonably secure, because, of course, an endowment policy is a very bad idea if you cannot keep up the payments for a long period of time. And so those would be the kinds of things, and we would expect them to look at what other debt people had, because the outgoings of a mortgage with an endowment are higher initially than they are for a repayment mortgage. If you currently have very expensive debt then a financial adviser should advise you that, rather than taking out this parallel investment in the stock market, you should be paying off your credit card debt, or your hire purchase debt, if it is at a higher rate. So we would expect people to go through the whole financial circumstances of the individual and see whether this policy was suitable; the definitions of suitability differ from product to product, but that is the rough principle of it.

  45. Current regulatory arrangements insist that someone selling an endowment points out that it is not guaranteed to cover the loan at the end; has that always been the case?
  (Mr Davies) From my understanding, and Michael will correct me, that has been the case since 1988.
  (Mr Folger) Broadly speaking, I think the precise wording of that commitment has changed through time.

  46. So prior to 1988, that was not required?
  (Mr Folger) No.
  (Mr Davies) Before the Financial Services Act came into force, that would not have been required.

  47. So there would be problems in demonstrating the selling prior to 1988, on that point?
  (Mr Davies) Absolutely; and, indeed, we would not be able to get at those transactions, even under the powers we have, that we have borrowed from the old Financial Services Act, that would be hidden from us.

  48. And just turning to mortgages themselves, and the speculation about when they might go into the FSA, how, in your opinion, should mortgages be regulated?
  (Mr Davies) With great care and caution. Although, as Sir Michael pointed out, the new Bill gives us considerable responsibilities to make our own rules, and, indeed, if we believe that regulation should be extended there is then a process whereby we would produce a cost/benefit analysis, etc., Ministers made clear, at the beginning of this process, that they wanted to make the decision about whether mortgages should or should not be included and that the role of the FSA was to give them advice on the costs of doing so and, if possible, on the benefits of doing so. We published, a couple of weeks ago, our cost/benefits analysis, where we suggested that, on our best estimates, whereas the current voluntary code has a one-off cost of £166 million put in place and running costs of £95 million a year, we believe that statutory regulation would cost that much plus an additional £36 million of upfront costs and an additional £32 million of running costs, it would add about a third of the running costs of the existing voluntary regime, or something like three-tenths of a basis point on the average mortgage. As for the benefits, we thought that there should be some improvement in suitability, in that I think it would be likely that a statutory regime would cause lenders to be much more careful than they currently are, particularly about the people who sell mortgages on their behalf, as to whether they had, in fact, gone through a process of assessing the suitability of the product and assessing the financial circumstances of the individual to whom it was sold, because they would be aware that they were at risk in future of some kind of review by the regulators. So we assumed that there would be some increase in suitability. I think that the view of my Board would be, on balance, that they would now favour statutory regulation, on the basis that beyond what the existing code is doing the costs, though not trivial, are not huge, and that it is likely to produce a more even standard of the application of the good practices which the industry has itself developed. So that is where my Board would currently be on this.

  49. There has been some speculation again about a possible role for the Office of Fair Trading, to take on this particular role; what is your opinion of that?
  (Mr Davies) I think that, for most of the firms who are the large providers of mortgages, we already have a relationship with those firms. So, for example, if we were looking at the mortgage business of the Bradford & Bingley then our teams who normally visit the Bradford & Bingley and look at their life insurance business, their personal pensions business, their endowment business, would simply add some mortgage files to that visit and look to see if the good standards and the terms of the code of practice, etc., were being followed in the mortgage area as well. That would be a pretty cost-effective way of doing it, because we have monitoring teams who do that business anyway, and, actually, frequently, when they are looking at endowments they sort of get the same file anyway but they then have to disregard the mortgage part of it and look only at the endowment part of it. So, from a pure practicality point of view, we have the arms and legs to do this job which the OFT currently does not have.

  50. Mr Davies, did you clear the FSA fact sheet on endowment mortgages before it went out?
  (Mr Davies) Clear it; we discussed it with various—

  51. Did you approve it?
  (Mr Davies) Did I approve it; yes.

  52. Could you explain why in advice point 5 you recommend that if you were young and single with no dependents you may not need the life insurance that is built into an endowment policy?
  (Mr Davies) I think we would regard that as fair comment. You may not need it, and, indeed, as we go on to say, if you do need this type of insurance you can get it in other ways, not just through an endowment policy, and we point out that there is also term insurance not linked to a savings scheme. So what we were trying to do, in that note, was to disentangle the life element, which is one decision, from the element of investment in the equity market, which is another decision.

  53. I understand that, but I am just worried generally about the adequacy of some of the material that the FSA puts out, because it seems to me, in relation to advice point 5, you might have been better pointing out to young people that as they age and if they become ill they may rapidly become uninsurable, or they may, in fact, face very rapidly increasing premia. Is that something you should have drawn to their attention?
  (Mr Davies) The points you make in general about life insurance, of course, are fair points, but the question is, on the endowment policy, whether you really want to invest in the equity market. If we were advising people on life insurance then we would certainly make those points. All we were trying to do here was to put a little hook in what we were saying about endowment policies, to make it clear to people that the life insurance element is a different kind of calculation and not one that you need to make at the same time as you decide on endowments, you can perfectly well get a cheaper life insurance policy and not have the exposure to the equity market that an endowment policy gives you. So if you were giving people a fully comprehensive set of explanations as to how they should consider their financial circumstances, undoubtedly the points you incorporate are fair ones but it did not seem to us that they fitted neatly into something which was primarily about endowment policies.

  54. But you do not think there was a case for being slightly more comprehensive?
  (Mr Davies) I am inclined to think, myself, that the balance in that particular paragraph is a reasonable balance, in the sense that we were pointing people to the fact that if they need life insurance they can get it in a different way and that they should think about that, too. So, I have to say, I am rather unrepentant on this point.

  Mr Ruffley: Right; let the record show you are unrepentant about advice point 5.

  55. Just one brief question, if I may. What do you think is the proper role of an adviser? Say, for example, I were to come to you, as an adviser, and say, "I want an endowment policy," and you took the view that I was perhaps unlikely to be able to keep up the payments because I had an insecure job, as an MP; what is the job of the IFA then, and if he does wrongly and perhaps sells the endowment policy, or arranges for the sale, do you think that is something he should be responsible for? What do you think is the role of an adviser, if he has doubts about the validity?
  (Mr Davies) The suitability requirement is the requirement to give advice on suitability, not to require the investor to take that advice. And, therefore, if an IFA could show that she had given advice to the Member of Parliament that his majority was so small that he should not be thinking about this but he nonetheless went ahead, there would be no issue, from my point of view.

  56. How could we put that; that means you have to give a warning statement, is that right, will you give me a warning statement to say, "I am selling you this policy but I would strongly advise that you don't do it," otherwise how else could it be proved, if I were to come up and complain to the FSA and ask for the firm to be closed?
  (Mr Davies) I am talking here all about the old PIA regime, which I have inherited. You go through a process of a fact-find with the individual and then you give them something called a "reason why" letter, which is why you think that they should do what you are advising them to do; and if they then decide to do something else, something quite different, which you do not regard as suitable, then, of course, the fact that you have given them their "reason why" letter, which is on the file, is an adequate defence against any charge that you have given unsuitable advice. So you would not then have to go through a whole warning process on top of that.

  57. I see; and if I took the view that it was wholly unsuitable for him to do this, I should still go ahead and sell, so long as I give him a letter saying, "You shouldn't do it"?
  (Mr Davies) I think that, at that point, it becomes a business decision for you, not a regulatory decision; you have fulfilled your regulatory requirement to give what you believe to be suitable advice within the terms of the regulatory environment. Now I can then imagine that some individuals might then say, "Look, Sir Teddy, I really think this is such a bad idea for you that I'm not prepared to sell it to you, because I just think it's bad business and I shouldn't, because you'll still come back and complain to me. Go down the street and buy it from somebody else." There will be some people who say that, and that happens in all walks of business life, there might be others who say, "Well, you know, that's your lookout, and, if you want to buy it, I don't think it's a good idea but don't come and complain to me." You then enter the realm of the normal business decision about whether you think, as a supplier, you should be supplying an unsuitable product to a customer, and people will have different views on that.

  58. A final question, just to help the public. If I were not given the proper advice, if I were not given a warning letter and if I were in something wholly unsuitable, what rights do I have, as an individual, and what can you do about the firm who acted so unprofessionally?
  (Mr Davies) The normal route we would always advise people is that they should complain to the firm itself, first; and I have to say that most problems of this kind are resolved in that way, because most firms, if they have clearly sold unsuitably, will, in fact, pay compensation or redress without regulatory intervention, because they will regard it as being in their business interests to do so. If you do not get satisfaction from the firm then you can go to the ombudsman and say you do not like this, or, indeed, you can bring it straight to the regulator, and that is what we would encourage people to do; but we would always encourage people initially to complain to the firm, because, in percentage terms, most of these problems are resolved between the consumer and the firm. Now, in saying that, I am not saying that the regulators are absent, because I think that firms do deal with these problems partly because they know that there is a regulator standing behind who could—

  59. What could the regulator do?
  (Mr Davies) The regulator could oblige them to pay redress, if it was a clear case of mis-selling.