This appendix sets out the approach and standards which firms should use when investigating complaints relating to the sale of endowment policies for the purposes of achieving capital repayment of a mortgage. It is not intended to be comprehensive. It is primarily concerned with the assessment of whether the complainant may have suffered financial loss, and if so, how much that loss is, and therefore what amount a firm should consider offering by way of fair and appropriate compensation in circumstances where the firm's investigation of a complaint reveals:

1. (1)

   the complainant has received negligent advice on investments; and

2. (2)

   if this advice had not been negligent, either:

   1. (a)

      the complainant would be unlikely to have acquired the endowment policy but instead would have taken out the same amount of loan on a repayment basis; or

   2. (b)

      the complainant would have acquired an endowment mortgage for a shorter term.

There will also be cases where a firm will conclude after investigation that, notwithstanding its own failure to give compliant and proper advice, the complainant would nevertheless have proceeded with the endowment policy as sold, in which case no compensation will be due.

This appendix only addresses how firms should approach the assessment of loss and compensation where negligence on the part of the firm is established.

This appendix is relevant both to the obligations arising under the complaints handling rules contained in DISP 1.2 and to the FSA's approach to the supervision of firms.

This appendix is also relevant to complaints which the Ombudsman may investigate under the Compulsory Jurisdiction or Voluntary Jurisdiction of the Financial Ombudsman Service established under Part XVI of the Act (The Ombudsman Scheme).

Before proceeding to assess the extent of a complainant's financial loss, a firm will usually have completed the following stages:

1. (1)

   gathering all relevant facts and information;

2. (2)

   making a fair and objective assessment whether it has failed to comply with a relevant duty owed to the complainant; and

3. (3)

   assessing whether any failure of duty by it was in the circumstances a material failure in the sense that if it had not occurred the complainant would have been likely to have acted differently.

If it is concluded that the complainant would have acted differently, the firm should proceed to assess any direct or consequential loss.

Nothing in this appendix relieves firms of the obligation to consider the particular facts and circumstances of each complaint and to consider whether the assessment of loss and compensation should, in the light of those facts and circumstances, be carried out on a different basis. If, however, the facts and circumstances make it appropriate to do so, the FSA's expectation is that firms will apply the approach and standards set out in this appendix, and where they do not, the FSA is likely to require them to demonstrate the adequacy and completeness of their alternative approach.

If there has been a failure to give compliant and proper advice, or some other breach of the duty of care, the basic objective of redress is to put the complainant, so far as is possible, in the position he would have been in if the inappropriate advice had not been given, or the other breach had not occurred. In many cases, although it must be a matter for inquiry and assessment in each individual case, this position is likely to have resulted in the complainant taking a repayment mortgage with accompanying life cover, and this is the assumption which underpins the standard approach to redress.

Unless the contrary is demonstrated, it should be assumed that the complainant could have afforded the mortgage on a repayment basis.

The measure of any financial loss suffered by the complainant will be arrived at by:

1. (1)

   comparing the complainant's current capital position with the position he would have been in had the loan been a standard repayment mortgage as at the date the firm decides to regard the complaint as justified; and

2. (2)

   comparing the cost of the complainant's actual monthly outgoings and those he would have made had his loan been on a standard repayment basis as at the date the firm decides to regard the complaint as justified.

In some cases other factors may be included in the overall calculation, for example, if mortgage arrangement fees were waived by agreement on the occasion of the endowment policy being taken out.

If, on comparing the complainant's current endowment position with the repayment alternative, the surrender value of the endowment policy exceeds the amount of the capital which the complainant would have repaid through the repayment method, then, at the point of the assessment, the complainant has suffered no capital loss (but the complainant may suffer some compensatable consequential loss associated with changing the mortgage arrangements to the repayment basis, see DISP App 2.3). Conversely, if the capital which would have been repaid on the repayment basis exceeds the surrender value, there is a capital loss represented by the difference between the two amounts.

If the complainant's endowment mortgage outgoings exceed the equivalent cost for the repayment method, the complainant should be compensated for the higher payments in addition to any loss on the surrender value and capital repaid comparison. This means, for example, that if the endowment arrangement has been more expensive, this may result in compensatable loss even though the capital repayment against surrender comparison may be favourable to the endowment.

If the total cost of the outgoings for the endowment calculation is less than that for the repayment calculation, the "savings" should be brought into account in assessing any overall loss unless it is unreasonable to do so.

It is unlikely to be reasonable to bring "savings" into account in circumstances where, at the time of the sale of the policy:

1. (1)

   the complainant was advised or informed orally or in writing that he would have lower outgoings than would be the case under a repayment mortgage, whether or not the difference was quantified; and

2. (2)

   the complainant has dissipated those "savings" on the strength of this advice or information.

The circumstances in which it may be appropriate to take some or all of the "savings" into account are those where, subject to DISP App 2.2.7 G, the complainant is of "sufficient means" so that it is reasonable for a firm to assume that the "savings" have contributed to those means.

Where it is otherwise reasonable for "savings" to be brought into account, determining whether or not a complainant is of sufficient means and, if so, to what extent the "savings" are to be brought into account, will have to be based on the facts of each individual case. It will be appropriate to require the complainant to provide adequate information to assist the firm in this task. Matters to be taken into account in this assessment may include:

1. (1)

   the length of the remaining mortgage term;

2. (2)

   the complainant's current and prospective resources;

3. (3)

   the amount of the capital shortfall in proportion to the endowment outgoings balance.

Firms may adopt streamlined processes to assist them in individual assessments of "sufficient means", but will have to satisfy themselves that the complainant's position is nevertheless protected. Firms will need to ensure that the complainant is given an opportunity to make an informed choice whether to accept the streamlined process, that the process itself is transparent, and that the firm is satisfied that the outcome would be fair to complainants.

If a firm intends to make a deduction for all or any part of the lower endowment outgoings, the firm should explain clearly to the complainant in writing both how the 'sufficient means' test has been satisfied, including details of the information taken into account in reaching the decision, and how the deduction has been arrived at. The letter should further inform the complainant that if he is unhappy with the proposal to make a deduction, either in principle or as to the amount, he should give his reasons to the firm.

If a complainant puts forward a case that it would be unreasonable for a deduction to be made, the firm should reach a fair and objective determination on the facts of all relevant matters including those set out at DISP App 2.2.8 G and DISP App 2.2.9 G.

In recognition that firms may not wish, for practical reasons, to make individual assessments of "sufficient means", firms may decide not to seek to bring into account any benefit to the complainant in assessing overall compensation.

It would not be unreasonable if a firm providing redress in these circumstances were to frame its offer of redress on the assumption that the complainant will agree to surrender the policy. However, firms should bear in mind that there may be circumstances where it is appropriate for the complainant to retain the policy, for example, where it is being retained as a savings vehicle.

If a complainant becomes aware that he has taken out the endowment policy on the basis of unsuitable advice and inadequate information, he should if necessary, after taking appropriate advice, take reasonable steps to limit his loss, and may in any subsequent claim be unable to recover for losses which are avoidable. The complainant may have to show that he has not delayed unreasonably since becoming aware of his loss. The reasonable costs and expenses the complainant may have incurred in limiting his loss are to be taken into account in assessing his compensation. These costs and expenses are likely to include the complainant taking advice on whether he should convert from an endowment to a repayment mortgage and incurring expenses in doing so, see DISP App 2.3.

The standard approach to redress can be illustrated by the following examples, which show how redress would be calculated in certain hypothetical but typical scenarios. (Because the examples are illustrative, round numbers have been used for 'established facts' in each example. The payments should be taken as being made monthly: firms should not approximate by assuming that payments are made annually. If the complainant has benefited from MIRAS, the calculations should allow for the effect of MIRAS both on the endowment mortgage and the repayment comparison.)

In fixing a repayment comparator, it would be appropriate to have regard to the repayment quotation actually provided at the time of sale. If more than one repayment quotation was obtained, the comparison should be with the quotation which approximates most closely to the terms of the endowment mortgage actually taken. If a repayment quotation was not provided, or is not now available, it should be assumed that the interest rate for the repayment comparison is the same as that of the mortgage endowment arrangements. Firms will then need to replicate interest rate changes throughout the lifetime of the comparator mortgage.

Unless after due inquiry there is clear evidence that the complainant with a mortgage endowment had no foreseeable need for life cover at the time the endowment arrangements were concluded, in the overall comparison between a repayment mortgage and an endowment mortgage the monthly outgoings under the repayment will include the premium for the decreasing term assurance that would have been required. This adjustment for the cost of life cover is only to be made if the firm is undertaking a comparison of monthly outgoings. It is not appropriate to deduct the cost of life cover from the capital loss calculation, as this would constitute double counting.

If a deduction is to be attributed to the provision of life cover, the appropriate approach is to assume that the complainant took out the insurance quoted in the alternative repayment quotation provided at the time of the sale. If the quotation is not available, the deduction should be at the rates that would have been quoted at the time.

As already noted, the basic objective of redress is to put the complainant, so far as is possible, in the position he would have been in if the inappropriate advice or other breach had not occurred: for their part, the complainants should take such reasonable steps as they can to limit loss once they are informed of the position they are in because of the failure of advice at the time of sale.

In practice, it is likely to be appropriate for a complainant whose complaint has been upheld to convert to a repayment mortgage, whether or not there is financial loss to date. It will normally be possible for complainants to do so without incurring unreasonable cost. Conversion will of course mean that the complainant no longer has a policy.

Firms should therefore in the case of upheld complaints inform complainants that it is likely to be appropriate and necessary for them to convert to a repayment arrangement.

Firms should make it clear that they will bear the costs of conversion if the rearrangement is made with the existing lender and to the equivalent repayment mortgage. If a complainant is not willing to rearrange with the existing lender, then the costs to be paid by the firm should normally be limited to those which would have been payable had the rearrangement been made with the existing lender and to the equivalent repayment mortgage. If it is not possible to rearrange with the existing lender, for example, if the lender has a closed book, the firm should pay all costs which are not unreasonable in completing the rearrangement with an alternative provider. Such costs might include an administration fee for changing the existing arrangement, redemption penalty, arrangement fee for the new mortgage and the reasonable cost of further advice if necessary.

If the "new" mortgage is, in fact, arranged at a lower interest rate than the existing loan, the benefit to the complainant should usually be disregarded, as it is always open to complainants to change their underlying mortgage arrangements at any time.

If the "new" mortgage is arranged at a higher interest rate than the existing loan, the increased payment should not normally be taken into account in calculating any payment to be made to the complainant.

If the complainant takes the opportunity to increase his loan on the occasion of the remortgage, the expenses which a firm pays by way of compensation should be paid by reference to the capital sum due under the "old" loan.

As stated, one aspect of the conversion process is the disposal of the endowment policy. The standard approach to assessing loss requires firms to calculate loss using the surrender value. However, once loss is established on this basis and firms move to deal with redress, they may wish to consider whether there is a role for the policy's 'market value' within the traded endowment policy (TEP) market.

A firm may arrange the sale of the endowment policy on the traded endowment market, provided the full implications of such a course of action are explained to the complainant and his express consent is obtained for the firm to arrange the sale. This includes informing the investor that he will continue to be the life assured under the policy. The complainant should be informed that such an arrangement may reduce or eliminate the amount of redress actually borne by the firm, but not so as to affect the amount of redress he receives.

In the event that a complainant is willing to pursue this option, a firm should first have assessed the complainant's loss using the approach set out in this appendix, and the minimum amount the complainant should receive under such a sale arrangement is the sum representing the position the complainant should have been in under this appendix together with the reimbursement of remortgaging costs. In order to ensure the process does not delay the provision of redress, the firm must pay this minimum sum immediately the complainant agrees to the sale arrangement. To the extent that the net amount realised by the sale of the policy on the traded endowment market exceeds the total redress due to the complainant, this greater sum is to be paid to the complainant on completion of the sale. If the amount realised by the sale of the policy on the traded endowment market is less than the total redress due to the complainant, the firm will be responsible for the amount of the shortfall.

This section of this appendix is primarily concerned with circumstances where the term of the mortgage and associated endowment policy extend beyond the individual complainant's normal retirement age in circumstances where the firm regards a complaint as justified because the arrangement is not affordable in retirement; and this could have, and should have, been foreseen at the time of the advice.

Two sets of circumstances are examined at DISP App 2.4.3 G to DISP App 2.4.13 G. Although these are considered in isolation, firms should, as part of their investigation of all of the factors involved in the complaint, consider whether either set of circumstances should be considered in conjunction with those factors examined at DISP App 2.2.

If on enquiry it is found that no proper assessment of the complainant's post-retirement means had been undertaken at the time of sale, but if the likelihood had been that the complainant would have borrowed the same amount over a shorter term (up to retirement) using an endowment policy as a repayment vehicle, then an appropriate form of redress would be for the policy to be reconstructed with a shorter term.

Redress should in most cases be provided by meeting the cost of rearranging the policy, by way of a lump sum payment into the policy in respect of the higher rate of premium due from its inception. It may be appropriate in individual cases to take account of the lower premiums that the complainant will have paid to date. The guidance in DISP App 2.2, as to the circumstances in which this will be appropriate, will be relevant here.

If the policy extends beyond retirement age and the complainant is already retired, the policy should be reconstructed to a maturity date as at the accepted retirement date, with the policy proceeds becoming immediately payable. The costs are to be borne by the firm, subject to any lower outgoings adjustment.

Firms should consider whether the reconstruction would have tax implications for complainants (see DISP App 2.5.8 G and DISP App 2.5.9 G).

The reconstruction process deals with the situation to the date the policy is reconstructed. The complainant will generally be responsible for paying the increased premiums for the remaining term.

At the time the complainant is advised of the revised premium, he should as a matter of good practice be provided with a reprojection based on the prevailing projection rates, which will allow him to address any projected shortfall.

If it is not possible for a firm to reconstruct a policy, then it should offer the investor equivalent redress, for example, by paying a cash lump sum equivalent to the amount that would have been credited to a reconstructed policy.

If a loan extending into retirement was on any basis not affordable, whether or not it is reconstructed to the retirement date, firms will need to consider whether, if proper advice had been given, the loan would have been taken out at all and, if not, consider what arrangements might now need to be made in order to reduce the amount of the complainant's borrowings.

If a complaint is regarded as justified by the firm on the basis that the endowment policy maturity date extends beyond the mortgage term expiry date and the firm is responsible for this situation, the policy should be reconstructed so that it matures at the expiry of the mortgage term.

In these circumstances the guidance given elsewhere in DISP App 2.4 will apply as appropriate.

The following examples illustrate the approach to redress as described in this section.

This section addresses issues which may be relevant to the standard redress for unsuitability cases, as well as some post-retirement cases upheld on the grounds of affordability.

Firms will need to consider the importance for many complainants of having life assurance in place to ensure a mortgage is paid off in the event of death.

If a complaint is upheld and the policy is to be surrendered as part of the settlement, the firm should remind the complainant in writing that the life cover within the endowment will be terminated and that it may therefore be appropriate to take advice about the merits or otherwise of taking out a stand-alone life policy in substitution.

If a need for life assurance at inception has been established so that a deduction representing its cost has been made from the redress payable under DISP App 2.2.4 G, the firm should advise the complainant that the firm would be responsible for paying any premium for an appropriate replacement policy which exceeds that used for calculating the deduction or alternatively will, where possible, provide the cover itself at that cost. If it is not possible for the firm to provide the cover itself at the original cost, it may choose to discharge that obligation by the payment of an appropriate lump sum. Any such amount should enable the complainant to effect the cover at the original cost, with no additional cost in respect of increased age or deterioration in health. This option may be particularly relevant if the firm against which the complaint has been made is an independent intermediary which cannot itself provide the cover, although it may be possible for such a firm to arrange for the product provider to offer cover to the complainant at the original premium on payment by the independent intermediary of an appropriate lump sum to meet any increased cost.

Firms will not be responsible for any increased costs resulting from the complainant choosing another product provider or for increased premiums charged by another provider chosen by the complainant in respect of the risk now presented, for example, higher premiums charged by the other provider due to deterioration in health, unless the original product provider no longer writes new business and is unable to offer revised life cover on a decreasing term assurance basis.

There can be exceptional circumstances where, in order to retain suitable life cover, the endowment policy has to be retained and any additional costs will be the responsibility of the firm that sold the endowment policy.

The same considerations will apply to the establishment of the need for other policy benefits including critical illness cover, disability cover and waiver of premium.

If, as a result of policies being surrendered or reconstructed, or if any form of underpinning or guarantee is given, there is a potential tax liability for the complainant, it will be appropriate for firms to undertake in writing to the complainant to reimburse any tax payable, or which becomes payable. Firms should make this payment on production of appropriate evidence of the liability and payment having been made.

Firms proposing to offer arrangements involving some form of minimum underpinning or 'guarantee' should discuss their proposals with the FSA and HM Revenue and Customs1 at the earliest possible opportunity (see DISP App 2.5.8 G). The FSA will need to be satisfied that these proposals provide complainants with redress which is at least commensurate with the standard approaches contained in this appendix.

One of the reasons for introducing the guidance in this appendix is to seek a reduction in the number of complaints which are referred to the Financial Ombudsman Service. If a firm writes to the complainant proposing terms for settlement which are in accordance with this appendix, the letter may include a statement that the calculation of loss and redress accords with the FSAguidance, but should not imply that this extends to the assessment of whether or not the complaint should be upheld. Firms should point out that if the complainant remains dissatisfied, he may refer the complaint to the Financial Ombudsman Service.

A statement under DISP App 2.5.11 G should not give the impression that the proposed terms of settlement have been expressly endorsed by either the FSA or the Financial Ombudsman Service.

Windfall benefits should be determined in accordance with the principle in Needler Financial Services and Taber ('Needler'). The basic legal principle in Needler is that a windfall benefit is not to be taken into account in determining the amount of an investor's recoverable loss. The following paragraphs explain our views as to how firms may act in accordance with that principle.

A windfall benefit arises where:

1. (1)

   there has been a demutualisation, distribution or reattribution of the inherited estate, or other extraordinary corporate event in a long-term insurer; and

2. (2)

   the event gave rise to 'relevant benefits', as defined in DISP App 2.5.15 G (below).

'Relevant benefits' are those benefits that fall outside what is required in order that policyholders' reasonable expectations at that point of sale can be fulfilled. (The phrase 'policyholders' reasonable expectations' has technically been superseded. However, the concept now resides within the obligations imposed upon firms by FSA Principle 6 ('...a firm must pay due regard to the interests of its customers and treat them fairly....') Additionally, most of these benefits would have been paid prior to commencement, when policyholders' reasonable expectations would have been a consideration for a long-term insurer.)

The issue of free shares or cash on a demutualisation, and additional bonuses and policy enhancements given by way of incentive to approve a reattribution or distribution of an inherited estate should, unless there is evidence to the contrary, be treated as relevant benefits for the purposes of DISP App 2.5.15 G. Whether additional bonuses and policy enhancements on a demutualisation are relevant benefits should be determined by applying the test in DISP App 2.5.15 G to each benefit.

Firms should review the terms on which proposals were put to policyholders and the reasons given for a corporate event when determining whether a benefit should be treated as a relevant benefit.

Firms should not normally bring windfall benefits which are relevant benefits (as defined in DISP App 2.5.14 G) to account when assessing financial loss and redress. Where a windfall benefit is in the form of a policy augmentation the benefit should be deducted from the overall value of the policy when making this assessment.

A relevant benefit derived from a corporate event may only be brought to account if the firm is able to demonstrate, with written records created at the time of the advice, that:

1. (1)

   The firm foresaw the prospect of the event and the benefit;

2. (2)

   The firm's advice included a statement recommending the particular policy because of the possibility of the benefit in question; and

3. (3)

   The statement was a material factor in the context of the advice and the decision to invest.

If a firm considers that it can meet this requirement, the firm should by letter explain clearly to the complainant the reasons why it proposes that the benefit should not be treated as a windfall and should be taken into account. The firm should provide the complainant with copies of the relevant documents.

The letter should also explain how the proposed value of the benefit has been calculated and should inform the complainant that if he does not accept the proposal to take the benefit into account he may tell the firm, with reasons. The letter should also say that, if he remains dissatisfied with the firm's response, he may refer the matter to the Financial Ombudsman Service.

If, exceptionally under the guidance at DISP App 2.5.13 G to DISP App 2.5.21 G, cash or shares derived from a corporate event are to be taken into account when assessing loss and redress, cash should be valued at the amount actually received and shares should be valued at their issue price. In both cases there should be no addition for interest.

When valuing windfall augmentation benefits for the purposes of calculating loss and redress the objective is to exclude all changes arising from the windfall event. The amount of redress payable will then be equal to the amount that would have been payable if the windfall event had never occurred.

A product provider should ensure that the method it adopts for valuing augmentation benefits is consistent with the statements made in the documentation published about the windfall event. Relevant documentation for the purpose of valuing such benefits will include (but is not limited to):2

1. (1)

   Any description of increases in benefits in any circular to policyholders (and any other public information relating to the event);

2. (2)

   Any principles of financial management established for the management of the fund after the event;

3. (3)

   statements in any report produced by 2an actuary appointed under SUP 4 (Actuaries)2 for the event;

4. (4)

   statements in any independent actuary report produced for the event; and

5. (5)

   subsequent statements relating to bonus practice, calculation surrender values, or both.

The method of valuation adopted should treat the complainant fairly overall.

Where an accurate calculation of the value of an augmentation benefit either cannot be made, or would result in disproportionate expense or delay, product providers may adopt a simplified approach or a proxy method for calculating its value.

A simplified approach should treat the complainants fairly overall.

An actuary, appointed by a product provider under SUP 4 (Actuaries)2 should certify that the method adopted by the product provider for calculating the value of an augmentation benefit is in accordance with the guidance in DISP App 2.6.1 G to DISP 2.6.6 G.

The principles set out above (in DISP App 2.6.1 G to DISP App 2.6.7 G) should be applied directly to mortgage endowment complaints where the capital loss is calculated by comparing the surrender value of the endowment policy with the capital which would have been repaid using a repayment mortgage.

In most cases where there is a loss, the endowment policy will be surrendered and put towards the cost of setting up a suitable repayment mortgage. Where this is the case, that part of the surrender value relating to the windfall augmentation should be paid as a cash lump sum to the investor or to the investor's order as part of the redress package. Only that part of the surrender value which does not relate to the windfall augmentation should be put towards the cost of setting up a suitable repayment mortgage.

There may be some circumstances in which the policy will not be surrendered (see DISP App 2.2.15 G). In these cases, there is no requirement to pay the value of the windfall augmentation as a cash lump sum since the value of the augmentation will become payable when the policy matures. However, any fund value used in the calculation of redress payable should exclude the value of the windfall augmentation.

Firms are entitled to mitigate losses by making use of the Traded Endowment Policy (TEP) market (see DISP App 2.3.8 G to DISP App 2.3.10 G). This allows firms to sell policies on the TEP market to meet the costs of redress, rather than using the surrender value. Where this method is adopted, firms should pay to the investor, as part of the redress package, a cash lump sum representing that proportion of the policy realised which would have related to the windfall augmentation.

As this windfall amount should be excluded from the fund value used in the calculation of loss and redress it would also be appropriate for this extra payment to be ignored when assessing whether, "the net amount realised by the sale of the policy on the traded endowment market exceeds the total redress due to the complainant..." (DISP App 2.3.10 G).

There may be circumstances in which a policy needs to be reconstructed (see DISP 2.4). In carrying out the required reconstruction, the windfall augmentation should be ignored in both the existing and the revised policy. However, the policyholder's revised policy should be credited with any windfall augmentation which would have applied if the policy had been set up with the revised terms from the original date of advice. This enhancement can be taken into account in assessing a suitable level for future premiums, in line with DISP App 2.4.8 G.

DISP App 2.5.10 G provides firms with the opinion of underpinning benefits. Firms should satisfy the FSA that their proposals provide complainants with a level of redress that is at least commensurate with the standard approaches and, to ensure consistency, windfall augmentations should be excluded when considering whether an underpin will apply. The FSA will take this into account when considering proposals put forward by firms.

Product providers with windfall benefits in the form of policy augmentations should tell:

1. (1)

   their own relevant customers (mortgage endowment complainants); and

2. (2)

   other firms1 with such customers (and any other interested parties);

   1

that they have excluded windfall augmentation benefits from values used or to be used for loss and redress. Firms1should provide this information to the Financial Services Compensation Scheme when providing them with a value to be used for loss or redress. Should their own relevant customers, other firms1 with such customers (and any other interested parties) and the Financial Services Compensation Scheme request it, the firm should provide the value of these benefits and a description of the method used to exclude them.