Who should read this?
Board members and senior executives of firms selling or advising on equity release products including CEOs, CROs, CCOs and those with responsibility for customer outcomes.
Reading time: 5 minutes
The FCA is undertaking a multi-firm review into equity release and has recently highlighted concerns over the way financial pressures may be increasing interest in such products since the outbreak of COVID-19.
In addition to reviewing firms’ advice and sales processes, we expect increased FCA scrutiny of sales to younger borrowers, conflicts of interest and value for money.
Firms will need to demonstrate, including through maintaining comprehensive documentation, that their customers are receiving good outcomes throughout the product lifecycle and that they have clearly explained the operation of the product and the costs (e.g. early repayment charges), risks (e.g. the speed of interest compounding), and contractual obligations (e.g. on insurance and maintenance) involved.
Our last blog on equity release predicted that, given the rising demand for equity release products, they were likely to come under increasing scrutiny from conduct regulators. In a recent update on its publications and activity, the FCA confirmed that it is undertaking a multi-firm review into the sale and advice of equity release. Whilst the detailed scope of the FCA’s review has not been disclosed, this blog sets out our view of the areas the FCA is most likely to scrutinise and the associated risk areas and actions that firms may wish to consider or revisit.
The Growth of the UK Equity Release Market
During the period H2 2017 to H2 2019, the market for new and existing customers in the UK grew by 24% percent, with 23,285 customers taking out a new equity release product in H2 2019 alone. Growth is being driven by an aging population that often has considerable housing wealth but less in the way of retirement savings, growing numbers of customers with maturing interest-only mortgages who find themselves unable to repay the outstanding capital on their loan and customers looking to use equity release for debt consolidation purposes.
COVID-19 has intensified the FCA’s concerns around equity release
In a recent interview, Christopher Woolard, Acting Chief Executive of the FCA, said there was evidence of increased interest in releasing equity from property during the crisis. Highlighting the FCA’s guidance to consumers to pause and take advice when considering equity release, Mr Woolard observed: “historically this may be a low point in the market” and emphasised: “this is the sort of error we [the FCA] don’t want to see people making”. Accordingly, we think supervisors will be sharply focused on the potential for poor outcomes for customers taking equity release during the pandemic, and the processes and controls firms have in place to ensure sales during this period are appropriate.
Product complexity and advice
Innovation in the market means that lifetime mortgages now offer a wide variety of features including early repayment facilities (including voluntary or partial repayments), downsizing protection, inheritance protection and the option to draw down income over time rather than taking a lump sum. Whilst much of this innovation has evolved to address regulators’ and customers’ concerns, it undoubtedly adds complexity, making it potentially more challenging for customers and their advisers to choose the right product for their circumstances. This is particularly so given that these are products designed for older borrowers, many of whom are more likely to be vulnerable for both financial and health reasons.
When advising customers on a lifetime mortgage, firms are required to take into consideration whether the contract is appropriate to the needs, objectives and circumstances of the individual customer, and whether there are alternative means by which the customer could raise the funds they need. This includes negotiating arrangements with existing creditors where the funds are for debt consolidation reasons. Consequently, the FCA will be looking for advisors to undertake a thorough fact find to ensure that the product is appropriate for the customer. This would include considering any indicators that the customer is potentially vulnerable and that the features and costs of the product are clearly explained and documented throughout the sales process. In the light of Mr Woolard’s comments, we expect supervisors will focus sharply on the quality of the sales and advice process during COVID 19, particularly where it appears the customer may be taking the product as a means of managing temporary financial difficulties for themselves or family members.
More generally, we anticipate a potential area of supervisory concern will be ‘dilapidations’ clauses. These require the borrower to maintain the property and provide suitable insurance. In order to meet the FCA’s expectations, advisers will need to make clear, and check customer understanding of, the contractual obligations that will fall on borrowers in these important areas and the specific risks that will arise if these obligations are not fulfilled.
Sales to ‘younger’ borrowers
In a speech published in late 2018, Mr Woolard (who was then Executive Director of Strategy and Competition at the FCA) highlighted an upwards trend in lifetime mortgages being sold to ‘younger’ customers (defined as customers in the 56 to 60 age group). Whilst the number of sales to this age group is relatively small (approximately 7% of all lifetime mortgage sales), Mr Woolard noted that, due to the effect of compound interest, the risks associated with the product were higher when sold to such consumers, and would thus be an area of FCA focus. He urged firms to use their “common sense” when lending to ensure they are matching “the right products to the right customers”.
The FCA will expect firms to be able provide documentary evidence of how they satisfied themselves that sale of the mortgage to a ‘younger’ borrower was appropriate and suitable given the customer’s specific circumstances and of extent to which they explored potential alternatives with the customer.
Conflicts of interest
Conflicts of interest have become a rising concern for the FCA across all sectors. They can potentially arise in the lifetime mortgage sector as a result of vertical integration (for example, where a group has an advisory business that recommends equity release products sold by another of its businesses) or as a result of intermediation (where commission is paid to third party distributors). Conflicts of interest may also arise between consumer and lender.
The FCA expects firms to have a robust process in place to identify, manage and oversee any conflicts of interest. In particular, where one entity is recommending products sold by another entity within the group, the FCA will expect to see comprehensive evidence of how the business satisfied itself that these sales were appropriate and did not result in poor outcomes for consumers.
Whilst the FCA’s “Mortgages Market Study (MMS) Interim Report: Findings on Lifetime Mortgages” (published May 2018) found little evidence that commercial arrangements in the lifetime mortgage sector adversely affected consumer outcomes, we nevertheless expect the FCA to continue to scrutinise commission arrangements and inducements. The FCA will, of course, be seriously concerned if commissions, inducements or wider group relationships and interests, rather than product appropriateness, appear to be driving advisors’ recommendations.
Firms will also need to manage carefully any conflicts of interest between consumer outcomes and prudential and liquidity considerations that may arise in the course of repayment, particularly during COVID-19. For example, if there are challenges in selling the house at the point of repayment (either because of ‘lockdowns’ or falling house prices), there may be inherent tensions between achieving a sale in order to repay the loan, the desire to achieve a good price, and the implications of interest continuing to rack up until the loan is repaid. In such circumstances, firms will need to communicate clearly and unambiguously the procedures they follow through the course of the repayment process, and address any poor outcomes that may arise as a result, including full consideration of potential customer vulnerability.
Value for money and early repayment charges
Interest rates on equity release products have decreased significantly over the past few years. In January 2020, the average rate was 4.48%, down from almost 6% in July 2016. Consequently, as highlighted by the FCA’s MMS Interim Report, it is possible that some existing lifetime borrowers could be losing out financially by being on significantly higher rates than those currently available. These customers could potentially benefit from switching but may be unable to do so as a result of high early repayment charges.
Consistent with the FCA’s concerns about the extent to which fees and charges act(ed) as a barrier to exit and switching in the life insurance and platform sectors, as well as its broader concerns around value for money, we think it likely that the FCA will scrutinise the potential for existing lifetime mortgage customers to receive poor value for money as a result of being unable to switch products. In particular, the FCA is likely to view early repayment charges that exceed the cost to lenders of early redemption as a disproportionate barrier to switching.
Conclusion: how can firms respond?
As the FCA’s scrutiny of lifetime mortgages grows, particularly during the COVID 19 pandemic, firms will increasingly need to demonstrate that their customers are receiving good outcomes throughout the lifecycle of the product. Effective oversight including the use of MI, Quality Assurance and Outcome Testing from across the three lines of defence is crucial, The FCA will expect firms to be focused on addressing their customers’ needs, rather than their own, and on ensuring that customers understand both the complex nature of a lifetime mortgage and the charges involved.
We set out below some actions firms can consider to address key conduct risks throughout the product life cycle and ensure they are delivering good outcomes:
 Lifetime mortgages make up 99% of all equity release product sales in the UK. Consequently, this blog focuses predominately on the sale of these products