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ombudsman news

issue 56

September/October 2006

calculating redress when a pension mortgage has been mis-sold

Although we receive relatively few complaints about the mis-selling of pension mortgages - the cases we see tend to be very complex and time-consuming.

This article outlines how we calculate redress in the complaints we uphold. Our case studies:

  • illustrate some of the different circumstances in which we have awarded redress for mis-sold pension mortgages and
  • outline the principles we have followed in setting out how that redress should be calculated.

The idea behind a pension mortgage is fairly straightforward. Because of the tax concessions associated with pensions - paying into a pension is, for some people, a potentially attractive way to build up a lump sum that can be used to pay off an interest-only property loan.

But there are risks. Just as with endowment mortgages, the amount of money you will get at the end of the policy term depends on stock market performance. There's no guarantee you'll have enough to pay off all the capital on your mortgage. And pension mortgages carry an additional risk. This is because the more of your pension fund that has to go towards paying for your property, the less there will be for you to rely on in your retirement.

We deal with complaints about the inappropriate sale of pension mortgages in much the same way in which we consider other types of complaint about inappropriate investment advice. This involves looking at whether the advice was suitable, in view of the consumer's specific circumstances and needs at the time of the sale.

If we conclude there was a mis-sale, we then need to decide on redress. The aim is always to put the consumer back, as far as possible, in the position they would have been in - had they not been inappropriately advised.

In many ways there are parallels with the way in which we calculate redress for mortgage endowment mis-sales, and we take the same approach as our starting point. But the nature of pension mortgages makes determining an appropriate amount of redress particularly complex. Only the cash element of the pension - or sometimes just part of it - would have been intended for mortgage repayment. And pensions themselves cannot usually be surrendered.

So it would only be in the most exceptional circumstances - perhaps when both the pension and the mortgage elements are manifestly unsuitable - that redress might be made by cancelling an entire policy and refunding the premiums paid, plus interest.

Inevitably there will be many variations on the main themes highlighted in these cases - and the approach to redress may need to be adjusted, according to the circumstances of the individual case.

Firms wanting general advice on our approach should contact our technical advice desk on 020 7964 1400.

case studies

calculating redress where a pension mortgage has been mis-sold

56/6
redress for pension mortgage mis-selling - a "straightforward" case

After deciding to move to a bigger house, for which he would need a larger mortgage, Mr M visited a financial adviser. At that time Mr M, a painter and decorator, was 40 years of age and married with two children. He had a repayment mortgage but no savings. And although he planned to retire when he was 65, he had not yet made any pension provision.

The firm's representative suggested that Mr M should start a personal pension plan, and use it both to save for his retirement and to meet his mortgage needs. The representative told him that when the plan reached the end of its term, just before his 65th birthday, he could take a maximum of 25% of the fund as a tax-free cash sum. He could then use this to repay the capital on an interest-only mortgage. The balance of the fund would provide Mr M with an income, once he had retired.

Mr M went ahead and took out the pension plan. But several years later, dissatisfied with the firm's response after he had raised concerns about his mortgage arrangements, Mr M came to us.

We looked into the details of the sale, and of Mr M's circumstances at the time, and concluded that the pension plan was suitable for Mr M's pension needs. However, it should not have been recommended to him as a means of re-paying his mortgage.

calculating the redress
We calculated redress on the basis that, had Mr M been given appropriate advice, he would have taken a repayment mortgage over a 25-year term, to coincide with his planned retirement at the age of 65.

There had been no changes to Mr M's pension plan since it was first set up. And he had not increased his mortgage since then. So we said redress should be calculated by taking:

A

the amount of capital that would have been repaid to date if he had taken a 25-year repayment mortgage

and deducting

B

25% of the present transfer value of his personal pension plan.

Because pensions cannot usually be surrendered, Mr M could not have used 25% of the transfer value to pay off the mortgage at the time we decided the case. He would have had to maintain that part of his borrowing until the cash sum came due, unless he had other funds with which he could pay off the capital.

But Mr M had been able to rearrange his finances and had not suffered ongoing financial hardship as a result of the firm's advice. So we took the view that no further compensation was necessary; Mr M would eventually get the benefit of continuing the whole pension. (If hardship had been an issue, we would probably have said he should be compensated with an extra sum, equal to the discounted value of future interest payments.)

25% of the policy value had been intended to repay Mr M's mortgage.

So we compared:

A

25% of the pension plan's net cost (after tax relief) to date, plus interest payments on the interest-only mortgage - to date

with

B

the capital and interest payments which Mr M would have made to date if he had taken a 25-year repayment mortgage.

In this case, as with many, the actual amount that Mr M spent was less than if he had taken a repayment mortgage. But we did not adjust the redress to take these notional "savings" into account. This was because Mr M would have arranged his day-to-day expenditure on the basis of his known outgoings, and would not have been conscious of the "savings" he was making by not having a repayment mortgage.

We are only likely to deduct such "savings" where we think it reasonable to do so, and where the "savings" were:

  • clearly identifiable as such at the time and
  • in the form of readily realisable assets.

(If, unusually, the pension (on the net 25% basis) plus mortgage interest had cost Mr M more than he would have paid for a repayment mortgage over the same period, then we would have awarded compensation to cover the difference.)

The planned retirement date in complaints about pension mortgages is often further than 25 years away, as in the next example.

56/7
redress for pension mortgage mis-selling - where the mortgage would have been paid off earlier if the consumer had taken a repayment mortgage

Mr D, a first-time buyer, contacted the firm for advice on a mortgage. At the time he was 30 years old and single, with no dependants. He worked as a clerical assistant and had no savings or pension plan.

The firm recommended an interest-only mortgage. It said he should also take out a personal pension plan. This would not only provide a retirement income once Mr D reached the age of 65, it would also give him a tax-free cash sum. He could use that sum to pay off the capital on his mortgage.

Mr D's mortgage was originally due to be repaid after a term of 35 years, and he would have paid interest on the full amount of the mortgage over that period.

Ten years after acting on the firm's recommendations, Mr D complained to the firm, querying the suitability of its advice. The firm admitted that a pension mortgage was unsuitable for Mr D. It offered redress but Mr D was unhappy with the amount offered and he brought the case to us.

calculating the redress
The firm had based the amount of redress it offered on:

A

the amount of capital that would have been repaid to date on a repayment mortgage for the 35-year term of the mortgage

less

B

25% of the transfer value of his personal pension plan.

We investigated the complaint and concluded that if he had been suitably advised, Mr D would have had a repayment mortgage. He would have been able to afford the repayments over a 25-year term.

So we told the firm that the correct calculation in this case should be based on:

A

the amount of capital Mr D would have repaid to date on a repayment mortgage for a 25-year term

less

B

25% of the transfer value of his personal pension plan.

Because the pension term was so much longer than the mortgage term would have been, the actual pension cost was smaller than it would otherwise have been.

However, we decided Mr D could have afforded the higher payments he would have had to pay for a 25-year mortgage. The notional "savings" were treated in the same way as in case 56/6.

56/8
redress for pension mortgage mis-selling where the pension plan was already in existence

Mr A had sought advice on increasing his mortgage as he was planning to move to a larger house. At the time, he was 40 years of age and employed as a caretaker. He was married with two children and had a repayment mortgage.

Mr A had no savings. But for the past five years he had been paying £20 a month into a personal pension plan, with the intention of retiring when he was 65.

The firm advised Mr A to change to an interest-only mortgage and to increase the amount he paid into his personal pension plan. It said that when he reached the age of 65 he could use 25% of his pension fund to repay the capital on the mortgage.

Several years later the case was referred to us, after Mr A had complained unsuccessfully to the firm about its advice. We concluded that, had Mr A been given suitable advice, he would have kept his repayment mortgage for a 25-year term. We agreed with the firm's advice that Mr A should pay more into his pension plan. However, with the repayment mortgage it should have recommended - he would have made a smaller increase in his pension contributions.

calculating the redress
Where an existing pension is "converted" into a pension mortgage, we usually decide that only the "new" part of the pension should be taken into account when redress is calculated. Similarly, where the pension contributions intended to are clearly intended to produce a higher cash sum than is needed to repay the mortgage, we disregard the "extra" contributions.

We told the firm to exclude from its calculations the proportion of the transfer value relating to the premiums Mr A had paid before taking the firm's advice. We said it should use only the proportion that related to those contributions intended to produce sufficient cash to pay off the mortgage capital (based on projections made at the time of the advice).

Just as we would usually disregard an existing pension, we would not normally include in the calculation any later contribution increases or the related proportion of the transfer value - as the next example shows.

56/9
redress for pension mortgage mis-selling - where the consumer has subsequently increased their contribution to the pension plan

A graphic designer, Mr Y, decided to buy his council flat under the "right to buy" scheme, so he contacted the firm for mortgage advice. At the time, Mr Y was a 45-year old single man with no dependants

Acting on the adviser's recommendation, Mr Y took out an interest-only mortgage with a 20-year term and a personal pension plan. The adviser had explained how, when he reached the age of 65, Mr Y could pay off the capital on his mortgage with the tax-free cash sum he would get from his pension plan.

Two years later, Mr Y started to increase his contributions to the pension plan, so that he could get a larger pension when he retired. And several years after that, when Mr Y queried the suitability of the advice he had been given, the firm offered him redress.

Mr Y was unhappy with the amount offered and also with the firm's apparent inability to explain the reasoning behind its calculations, so he came to us.

calculating the redress
The firm had calculated redress as follows:

A

The capital that would have been repaid to date on a 20-year repayment mortgage

less

B

25% of the transfer value of the personal pension plan, including the increased contributions that Mr Y started paying two years after he first set up the plan.

We agreed that the firm's advice had been unsuitable for Mr Y's circumstances and that it should pay redress. However, it should not have taken Mr Y's increased pension contributions into account when it calculated redress. These contributions were intended to provide additional retirement benefits and were not linked in any way to Mr Y's mortgage.

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ombudsman news issue 56 [PDF format]

ombudsman news gives general information on the position at the date of publication. It is not a definitive statement of the law, our approach or our procedure.

The illustrative case studies are based broadly on real-life cases, but are not precedents. Individual cases are decided on their own facts.