Mystery shopping exercise
Briefing Note BN005/2005
24 May 2005
The FSA identified equity release as one of its priority areas before it became responsible for mortgage regulation on 31 October 2004. In order to assess the standards within this market, a mystery shopping exercise was undertaken:
- To find out how advisers were explaining these often complicated products to consumers;
- To get a better understanding of how advisers explain the advantages and disadvantages of releasing equity; and
- To gather information on the lifetime mortgage sales process.
The regulator undertook 42 mystery shops across 20 firms using an external mystery shopping agency. The shoppers used two scenarios designed by the FSA:
Scenario A: client on a low income (£400 per month, single/£600 per month joint) wanting to release a £4,000 lump sum for essential house repairs and generate £50 pm income to help with household bills.
Scenario B: client wanting to release a £15,000 lump sum and generate £200pm income.
In view of the number of shops undertaken the FSA recognises its work is qualitative rather than quantitative. Seventeen scenario A shops were undertaken and 25 scenario B shops.
The exercise which took place between December 2004 and March 2005 was conducted by telephone or at face-to-face meetings in the shopper's home. The result of the mystery shopping shows that a concerning number of advisers did not gather enough relevant information about their customers to make recommendations suitable to the consumers' personal and financial circumstances or enable them to make informed decisions about whether equity release is right for them. For example:
- 16 scenario A and 17 scenario B advisers (78%) failed to ask the shopper about their state of health and life expectancy;
- 15 scenario A and 16 scenario B advisers (83%) failed to ask about the shoppers preferences for their estate;
- 14 scenario A and 14 scenario B advisers (67%) failed to ask the shopper whether they had existing savings and/or investments;
- 16 scenario A and 16 scenario B advisers (76%) failed to ask what the shoppers monthly outgoings were; and
- 17 scenario A and 23 scenario B advisers (95%) failed to ask whether the shopper needed to generate a stable income from the equity released.
The percentages cited above combine figures for scenario A and scenario B shops.
Without even this basic information it is not clear how the advisers had compiled sufficient information to discuss whether releasing equity was right for the shopper's situation. The findings also indicate that a number of advisers are not giving consumers enough information about equity release products and the way they work. Lifetime mortgages are complicated products; given their make-up1 the disadvantages of a contract may not come to light for many years. The FSA is concerned that its mystery shoppers weren't provided with enough information about lifetime mortgages to make an informed decision. In particular:
- 14 scenario A and 13 scenario B shoppers (64%) reported that the adviser did not explain the downsides of equity release schemes;
- 14 scenario A and 10 scenario B shoppers (57%) reported that the adviser did not explain what would happen if they wanted to move home in the future;
- 10 scenario A and 13 scenario B shoppers (55%) reported that they were not told that they would have to pay an arrangement fee to apply for a lifetime mortgage; and
- 16 scenario A and 10 scenario B shoppers (62%) reported that they were not given information about how the loan is repaid.
The percentages cited above combine figures for scenario A and scenario B shops.
Scenario A (shopper requesting £4,000 lump sum, for essential house repairs, plus income of £50pm to help with household bills) was designed to find out whether firms would refer consumers in this situation to an advice agency (such as their local council/citizens advice bureau) for assistance. It was expected that all shoppers would be referred to an advice agency, or that the adviser would discuss these issues with the assessors. The FSA finds it concerning that only one shopper was referred to an advice agency. In the remainder of cases, the assessors went on to receive information and/or advice relating to equity release from the firm.
The regulator found that, regardless of which sales channel the assessors used, there was no conclusive evidence to show that the quality of advice differed between different types of firms. Overall the FSA has serious concerns about the standard of fact finding and the quality of information and advice being given to consumers. The FSA has committed to carrying out further mystery shopping work to ascertain any improvement in the standard of advice given to consumers as well as take specific action with firms active in this market. Senior management at firms will also be held responsible for making sure that advisers are properly trained and give suitable advice to consumers.
The mystery shopping has focussed on lifetime mortgages not home reversion schemes as such schemes are not currently regulated by the FSA2. A report is available which breaks down the results of the mystery shopping by scenario and by distribution channel (mortgage brokers, IFA and product providers). This report is available below.
Subsequent Investment Advice
In addition to a mystery shopping exercise into how advisers are explaining lifetime mortgages, the FSA wanted to look closely at the subsequent investment advice given to consumers who had released equity from their properties. The regulator suspected it was an area which could expose potentially vulnerable consumers to a higher level of risk than they were prepared to accept. The FSA was particularly concerned because releasing equity from a property to invest in equity-backed investments is a high risk strategy. The FSA wanted to be sure that consumers entering into these transactions understood the implications of the advice they had been given.
The FSA wanted:
- To determine whether advisers were taking a holistic view of the situation by making the link between the two transactions;
- Ensure advisers are providing suitable advice to customers; and
- Satisfy itself that the risks involved in borrowing to invest were made clear to consumers in a way they could understand.
Four visits and three desk based reviews were carried out between January and early May 2005 looking at around 140 individual client files across seven firms. The work concentrated on business written recently, looking at advice given during 2003 and 2004. The FSA found that advisers are failing to explain the link between the two transactions and has significant concerns about the quality of advice being given to consumers.
The FSA is particularly concerned that advisers are recommending that advisers are recommending that customers borrow money at around 7%3 and invest in products that yield around 3.5%4 after charges. The consequences of these linked transactions are not being explained to consumers.
The investment advice given fits into three key areas:
- Investing for growth: the FSA identified that, in some firms, advisers are encouraging customers to release more than they required and advising them to reinvest the surplus cash in products such as investment bonds.
- Investing for income: There are equity release products on the market that allow the consumer to draw down an income from their lifetime mortgage. Instead of recommending this route, advisers are recommending that consumers release a lump sum and reinvest it in, for example, an investment bond and take 5% withdrawals to provide a regular income stream. As well as being more expensive for the consumer, reinvesting capital in equity-backed investments unnecessarily exposes the consumer to risk.
- Inheritance tax (IHT) mitigation: Using equity release for IHT mitigation is a very finely balanced arrangement. A number of the cases the FSA reviewed were likely to leave the customer's estate worse off than if they had not taken any action to mitigate their IHT liability.
Some firms were unable to verify how many equity release customers were subsequently given investment advice and often relied on their advisers not their management information to identify this.
The FSA has committed to following up on this work, and will carry out further work to assess this high risk area of advice.
Senior management at firms will be held responsible for making sure that
- advisers are properly trained;
- any investment advice given to invest released equity is appropriate; and
- the customer understands the advice they have been given.
For anonymous case studies on subsequent investment advice, please contact the FSA press office.
Footnotes
1. The interest rolls-up on these products and is (generally) not repaid during the customer's lifetime. The exception to this is on entry to a nursing home, when the property must be sold and the loan repaid.
2. On 17 May 2005 the Queen's speech contained plans for a bill (the Land Transactions Bill) which will give FSA responsibility for the regulation of home reversion schemes. This will amend FSMA Schedule 2 to make it clear that FSA has the power to regulate these schemes.
3. An average lifetime mortgage rate (from the cases reviewed by the FSA).
4. Using the lower growth rate assumption for an investment bond (nearly all the cases the FSA reviewed were recommendations for investment bonds, where the underlying funds were considered low risk.