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speech by Walter Merricks, chief ombudsman, at the FSA's summer school

Cambridge, 5 August 2007

You've all heard of the Financial Ombudsman Service. Some of you may work for financial services businesses that have had disputes referred to us. Some of you might read our regular publication ombudsman news. And some of you perhaps already know that we deal with some 100,000 complaints a year across the whole range of financial services - from stockbroking to pawnbroking, via mortgages, pensions and insurance.

the ombudsman approach

First of all, a little reminder of how we work. We operate as an alternative to the courts for consumers. We are, indeed, often seen as part of what is called the "alternative dispute-resolution" (or ADR) scene - although I would maintain that for most consumers we are the mainstream, and that the costly and complex court system is the unloved alternative.

Unlike some of the other legislation that sets up tribunals, our law sets out the basis on which we are to decide cases: "what is, in the opinion on the ombudsman, fair and reasonable in all the circumstances". This may sound as if it could result in a free-for-all, given that we have over thirty ombudsmen and more than 500 adjudicators (who make preliminary assessments). But I see it as my responsibility as chief ombudsman to ensure that our decisions are as consistent as possible.

So how do we achieve consistency? Well, we're not starting from a blank canvas. Naturally, we look to legal principles derived from court cases. But in many areas there have been no court decisions. So instead, we are able to draw on 25 years of ombudsman experience in this field to guide us.

A simple example from contents insurance. An armchair of your matching three-piece suite is accidentally damaged. Can you claim for a whole new suite, or just for a new armchair - which inevitably will not match the other two items? Not surprisingly, no one has taken a case to the House of Lords on this point. And the FSA doesn't have specific rules on the subject.

But more than 20 years ago, insurance ombudsmen decided on a simple formulaic answer - you should get the cost of the new armchair plus 50% of the cost of replacing the other items. So this is a principle we can now expect insurers to apply in these circumstances - and largely they do. You may say this is the ombudsman making regulatory rules. But, of course, if the House of Lords had made this decision, you probably wouldn't describe it that way.

There is sometimes a tendency for those in the financial services sector to assume that the FSA could - and should - be the sole source of the obligations placed on regulated firms. Some people have pointed to the consultation and cost-benefit requirements before FSA rules can be made. And they assume that any duties on regulated firms should be made that way.

But this narrow viewpoint misses the role of the courts and the impact of the general law. We have only to reflect on the past 12 months' activity in the courts in relation to unauthorised-overdraft bank-charges, to realise how great the impact the law and legal principles can have.

Over 100,000 consumers are believed to have filed court claims, on top of the 1,200 a week who referred claims to us. I should point out that we made no decisions on the legality of these charges at all. However, in the first six months of the year, the five banks who have recently published their results apparently paid out £400m - before the OFT's High Court test case suspended the payouts.

Some general reflections on this. First, consumers may have lost their inhibitions about taking court cases against large financial firms. Second, you could abolish the ombudsman service and the courts would still be there. Third, the court decisions were hardly consistent. Fourth, consumer activism can be driven by consumer champions and claims-management companies - about which I'll say more. Fifth, there were no FSA or OFT rules about bank charges. But there are legal principles about the proportionality of penalties for breach of consumer contracts that are to be found in every law student's contract-law textbook.

complaints handling by financial services firms

The ombudsman service only comes into play after a consumer has first made a complaint to a firm. Firms have clear responsibilities under the FSA rules to investigate complaints. Despite heavy emphasis by the FSA on complaints handling as part of its "treating customers fairly" ("TCF") initiative, the picture we see is that the standard of complaints handling by firms is variable to say the least. The FSA's recent "CEO letter" to banks about how they handled bank-charges complaints was pretty damning, and its report on "TCF Culture" suggests that there is still a long way to go.

My acquaintances in some of the outsourcing companies - who are drafted in to handle complaints for larger firms - tell me they are shocked at some of the strategies, designed to minimise payouts, that they have been asked to implement in bank charges and mortgage endowment work. Complainant attrition appears to be the name of the game. This involves rejecting most complaints first off (gets rid of about 60%), offer 30% if the complainant comes back (another 20% gone), offer 50% if the complainant threatens court or the ombudsman (another 15% gone), and pay in full only to the remaining 5% who actually lodge court or ombudsman claims.

Our "uphold rate" normally involves our supporting consumers in around a third of the cases we deal with - and firms in around two thirds of cases. This has been a pretty consistent pattern over the last 25 years or so of ombudsmen settling financial disputes.

But let's take a moment to look at why, broadly, we might find "against" firms when we settle disputes. Sometimes a dispute turns on a complex set of facts which we have investigated more closely than the firm - meaning we arrive at a different conclusion on the evidence. And sometimes the fact that the firm will lose is a clear "no brainer" - where the firm should have known from previous ombudsman decisions and from our widely publicised approach to disputes of that type that the complaint would be upheld.

On the other hand, why, broadly, might we find "against" consumers? Of course, some complaints will be from people who will never take no for an answer. But others are from people whose complaints - though never likely to succeed - have been so derisively dismissed by the firm that it is entirely understandable that they should seek the impartial view of the ombudsman. So you can see from this, that crude uphold rates - the statistics on who "won" and who "lost" complaints - really may not mean so very much.

Of course, we have other complaints-handling statistics too. We compile a benchmarking table showing the "top 12" financial firms - who together produce over half of the complaints we receive - ranked simply in terms of the number of complaints referred to us about each, proportionate to their market share. Every six months we share an anonymised version of this with the firms in question. This shows consistently that the best group is approximately nine times better than the worst. That firm knows that it is the best - and most of the others can guess who it is. But the depressing fact is that the other firms seem to have no ambition to narrow the gap, or to compete on improving this area of customer service. Nor does the best firm seem to want to promote its performance positively.

Commentators might suggest that if neither regulatory pressure nor the current state of the market can achieve improvement in complaints handling, then this is because there is little consumer pressure to drive comparative competition - and this, in turn, may be because neither the FSA nor the ombudsman, nor firms themselves, publish data about complaints. The National Consumer Council has called on regulators and ombudsmen to do just that. In a world where schools, hospitals, rail operators, energy providers and even fertility clinics are ranked in public league-tables - I only mention the latter because I am a non-executive board member of the HFEA - we recognise that the pressure to publish will be on us too.

mortgage endowment complaints ...

Let me turn now to mortgage endowments which, sadly, have dominated our relatively short life. When our predecessor ombudsman schemes came together in 2000 to form the new Financial Ombudsman Service, we were 350 people dealing with 25,000 complaints a year. Within two years, mortgage endowment cases had soared to 14,500 a year. The following year we were hit with no less than 52,000 cases. This figure rose again to 70,000 in 2004/05 - with a similar figure in 2005/06.

Only now is the volume of these cases finally declining. Since 2000, we have resolved 500,000 disputes overall - and by the end of the year, we will have settled 300,000 complaints just about mortgage endowments. Many of these mortgage endowment cases have been driven by claims-management companies.

For the financial services industry, the emergence of these claims management companies has been an almost unmitigated disaster. They have probably been responsible for trebling or quadrupling the amount of endowment compensation that firms have had to pay out. With a simple business model, they have been able to build staggeringly profitable enterprises in a very short time.

On top of this, millions of consumers have been schooled to believe that financial firms will not deal fairly with you when it comes to a complaint - and that to succeed in squeezing compensation out of unscrupulous firms, you need to have an expert firm on your side. The "no win, no fee" slogan of the claims-management companies has been so seductive that millions of people have been led to part with a substantial slice of the compensation they could have had in full - in return for a service that in many cases may have been negligible and that probably involved consumers still having to complete exactly the same complaint forms that they would have filled in, had they complained on their own. If these consumers - mainly middle-class home-owners - could not see what was in their financial interest when it came to claiming compensation, it just shows what a long way we have to go in improving financial capability in this country. lessons to learn? So are there any lessons that the financial services industry can learn from all this? The decision that the mortgage endowment problem should not be subject to an industry-wide review - like the Pensions Review - was greeted in industry quarters with great relief. Instead, this was to be a "complaint-led" exercise, with insurers agreeing to send out so-called "re-projection" letters. With a majority of these re-projections initially showing endowments on track to repay the mortgage, financial firms sat back to see what complaints would come. No one thought that it might be beneficial to conduct a pro-active review of the endowments that weren't on track and offering compensation to anyone who had clearly been mis-sold.

What happened was that uncontrollable and unpredictable numbers of complaints started arriving - coinciding with a worsening of the stockmarket that meant most endowments were no longer on track. Firms lost the opportunity to take the initiative. Worst of all, the relationship with customers was turned into an adversarial one, once the claims-management company boom started.

However controversial the Pensions Review may have been, it did not give rise to a claims management industry. Consumers received the compensation, running into billions, to which they were entitled - with perhaps fewer hard feelings towards the financial services industry in general.

On the other hand, an estimated £4 billion has already been paid in compensation for mis-sold mortgage endowments - and yet one could argue that the outcome all round has been worse for firms, for many consumers and certainly for the ombudsman. Indeed, probably for everyone except those who have made small fortunes out of running claims-management companies - and the advertising outlets into which they poured money to spread their message.

Admittedly, it was probably their advertising that reached more consumers than our website and the FSA's information leaflets - so we cannot say that it was worse for all consumers. I doubt you would have wanted us to use your money to advertise for complaints. But then again, perhaps with hindsight you might have preferred our advertising to that which did appear?

So my plea is to learn the lesson next time. There will be plenty of people on the look-out for business opportunities now that the bank charges gravy-train has suddenly stopped. Will there be a viable mass business in helping consumers to reclaim premiums on mis-sold payment protection policies? Or on compensation for bad advice on contracting out of SERPS? If so, the lesson might be not to simply wait for the complaints - hoping there won't be too many or that it won't be too costly an exercise.

Taking control - and planning to handle complaints fairly and pay compensation where it is due - may build better long-term customer relationships. And, in the end, be less costly. A suggestion, perhaps, for a summer school topic would be for delegates to model setting up as many claims-management business opportunities as possible. So what's going to happen when the courts finally rule on the validity of bank charges? If the courts decide that they were entirely lawful, a big sigh of relief from the industry. But what if they decide not only that they are unlawful and must stop being charged, but also that they have always been unlawful? What are the contingency plans for that scenario? Will it be another "complaints-led" exercise?

Back to our own organisation. The ombudsman service is here to help the financial services industry and consumers by underpinning confidence. Consumers need to know that - in what we hope is the unlikely event they feel something has gone wrong - there is somewhere impartial they can go, to see whether they are right or wrong. Happily, research has shown that consumers' confidence in financial services is indeed enhanced by knowing about the ombudsman.

We perform our function by remaining steadfastly independent, just in the way that the courts are. But being, I hope, better than the courts in terms of process, accessibility and proximity to our stakeholders. Which is one of the reasons why I was delighted to accept this invitation to speak to you.

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