We set out our findings from our review of outsourcing and third-party service providers. We identified governance over outsourcing as a priority area for supervision in the life insurers’ portfolio strategy.
Who this review is of interest to
- life insurers who outsource key business functions
- outsourced service providers (OSPs)
To ensure they meet the requirements in our existing rules and guidance, we encourage life insurers to consider whether the findings and examples set out in this paper are relevant to them, and to review their systems and controls where appropriate.
Why we conducted this review
There is an increasing demand for later life lending, and we have seen a significant growth in the lifetime mortgage market in recent years.
Our focus for this market is on making sure consumers are fully informed and receive suitable advice that has taken account of their individual circumstances.
Deciding to take out equity release is one of the most important and long-term decisions consumers make in later life. The consequences of their decision are likely to have a significant impact on their financial wellbeing for the rest of their lives. This makes it particularly important that firms and their advisers get their advice right.
So advisers should work with consumers, particularly those who may be vulnerable and not fully understand the recommended products, to ensure they realise the implications of these decisions. Firms also need to be able to evidence how they came to the conclusion that the product was suitable.
Where customers were suitably advised, we have seen some good outcomes where consumers ended up with an equity release product that met their long-term needs. In these cases, consumers benefited from the stability of a long-term fixed interest rate, unlocked wealth from their main or only asset, and not had to make monthly interest payments. When sold correctly, equity release products have allowed consumers to:
- repay their existing mortgage
- carry out home improvements, essential household repairs and adaptations
- consolidate burdensome debts
- reduce their working hours or fund earlier retirement
However, when consumers are given unsuitable advice, they can suffer major harm which affects them for the rest of their lives. In some cases, ending these contracts or repaying the amount owed early can be unaffordable. Some examples of poor outcomes are:
- Younger consumers not being told of their other borrowing options, such as traditional mortgages. These may be cheaper and more flexible, given the difficulty in predicting consumers’ future circumstances and needs for 30+ years.
- Short-term benefits, such as consolidating debts and freeing up cash, being wiped out by the long-term cost of equity release. In most cases interest rolls-up (rather than being paid monthly), meaning interest compounds over many years, so the debt can end up being several times the amount borrowed. This can be particularly damaging where consumers actually have surplus income that they could have used to repay the debts, rather than consolidating them.
- Customers paying substantial early repayment charges of tens of thousands of pounds only a few years after taking their loan, because their circumstances have changed.
- Consumers limiting their ability to release further cash or downsize in the future without repaying their equity release in full.
Consumers should make sure they fully understand both the short and long-term impact of equity release on their financial future. Some lifetime mortgages may seem similar to ‘traditional’ mortgages, but the risks involved are different. Consumers should take time at every stage of the process to make sure they fully understand the implications of their decision. But, most importantly, we expect firms and their advisers to help and guide consumers to make these decisions in their best interests.
For these reasons, we took a closer look at the sales and advice process for lifetime mortgages, reviewing a sample of case files from several firms.
Control over outsourcing is a key part of operational resilience. Putting in place a stronger regulatory framework to promote operational resilience of firms and financial market infrastructures (FMIs) is also a key priority for the FCA, the Bank of England and the Prudential Regulation Authority (PRA). We recently published joint policy proposals on operational resilience. Our Consultation Paper also contains a chapter on outsourcing. And the PRA published a Consultation Paper and draft Supervisory Statement on outsourcing and third-party risk management at the same time.
What we did
Our findings were mixed. We saw cases where lifetime mortgages were working well, unlocking equity for consumers who would not have been able to afford traditional mortgages or other sources of borrowing. However, we also saw cases where it was not clear that the advice was in the best interests of the consumer.
We found 3 significant areas of concern about the suitability of advice provided, which we consider increases the risk of harm to consumers in this market:
- Insufficient personalisation of advice
- Insufficient challenging of customer assumptions
- Lack of evidence to support the suitability of advice
What we found
Where necessary we are addressing our findings with the firms in our sample.
As part of our ongoing supervision of mortgage intermediaries we will be undertaking further work to review the suitability of advice in the lifetime mortgage market.
Poor quality advice in this market is unacceptable and is likely to create significant harm for customers who may be vulnerable. Where we find breaches of our rules we will, in line with our general approach to supervision, take the necessary supervisory action.
Since the completion of our review, the coronavirus (Covid-19) pandemic has placed new pressures on people’s finances and there is anecdotal evidence of more interest in equity release. The ongoing situation does not change our conclusion or findings. Indeed, it reinforces the importance of advice reflecting the needs and circumstances of the individual.
All firms should ensure that their advice processes, including how they record the suitability of advice, are sufficient. While MCOB sets out our expectations in detail, as a result of this work we particularly noted the following to bring to firms’ attention:
- Firms need to ensure that they take reasonable steps to obtain sufficient information from customers to provide advice.
- When giving advice to enter into an equity release transaction (for the first or subsequent time, including making amendments to existing equity release products), firms should ensure the advice given is suitable.
- Firms should ensure that they collect and retain the necessary evidence to support that assessment of the suitability of advice and how it was determined.
Business continuity planning
You should think of equity release as a long-term transaction (it can be expensive if you change your mind). Consider whether it will be right for you both now and in the future, as well as how much it will ultimately cost.
You may find it helpful to discuss your plans with a friend or family members and remember they can accompany you to appointments.
If anything is unclear check with the adviser or independent sources, such as the Money and Pensions Service.
If you are unhappy with the advice you have been given or the way your transaction has been handled, you should contact the adviser or their firm first to follow their complaints procedure. If you’re not happy with the response you get from them, then you may be able to ask the Financial Ombudsman Service to get involved.
Governance, systems and controls
Information provided to outsourcing governance committees tended to focus on operational performance, with less emphasis on customer outcomes.
Where outsourcing management information (MI) identified shortcomings, it was in some cases unclear what risk they posed to customers or whether timely and effective remediation action had been taken.
In response to our queries, most firms were able to provide customer-centric MI and reasonable explanations of what actions they had taken and why. However, in some cases firms did not provide this information as part of the outsourcing MI to their outsourcing governance committees. Some firms were unable to demonstrate that their outsourcing governance committees had sufficient focus on customer fairness in addition to operational issues.
There is a risk that ensuring customer fair treatment may be seen within some firms as a separate compliance-related issue, rather than being an integral part of oversight and control over outsourcing.
Clearly defined group policies
A firm had group-wide policies in place. The Group Sourcing and Supply Chain Management Policy created defined business standards and parameters for the Group to follow, making clear to the business the requirements in dealing with third-party providers. The Group outsourcing guidance is explicitly linked to FCA, PRA and other applicable requirements and creates expectations for the business on the requirements to be undertaken to mitigate against the risk of customer harm.
To support the second-line policies, first-line business procedures were in force reflecting key Group guidance, systems and controls on outsourcing. These procedures helped give employees clear instructions on required practice on outsourcing, against which the firm could monitor compliance.
The framework provided by Group policies helped establish effective systems and controls and governance at business unit level.
Clear governance structure
A firm has four sub-committees, which are joint forums between the firm and the OSP. The sub-committees report directly into the applicable governance committee and subsequently to the ExCo Steering Committee, which includes all OSP services across the group. If necessary, issues can then be escalated to the boards of the applicable entities. Responsibilities for each committee are well-defined in their terms of reference. Sub-Committee minutes indicate clear escalation of issues and action taken.
The clear governance structure ensures that issues, once identified, are dealt with promptly and effectively.
Failure to follow up on action to address issues identified
At one firm, MI was not clear and did not evidence where issues involving outsourced services had been escalated and appropriately actioned, despite some having potential for customer harm.
The MI did not give assurance that issues were followed up, even where there was potential for customers to have been underpaid or for regulatory breaches to have occurred. For example, MI identified that error reports in calculating amounts due to customers had not been actioned and remediation action had not been taken. In one case, investigation into an incident which occurred in 2017 was still ongoing.
The firm’s failure to take timely action in respect of identified issues creates a risk of continuing customer harm.
Conclusion and next steps
We will recognise the LSB’s Standards of Lending Practice for business customers for 3 years. After this time, we can extend our recognition if we think the content of these Standards is still relevant and appropriate. Our recognition of these Standards is as it stands at the current date. If we think that they no longer represent proper standards of market conduct, we will withdraw recognition before the end of the 3-year period. The LSB’s separate Information for Practitioners for business customers is not included in our recognition.
Existing rules will continue to apply
Firms following the code will still need to comply with any restrictions that apply on financial promotions in the Financial Services and Markets Act 2000 or rules in CONC 3 (Financial promotions and communications with customers), which may apply to some unregulated activities. The Standards of Lending Practice for business customers expressly acknowledge that where legislation or statutory rules replicate or conflict with the Standards, the legislation or statutory rules supersede them.
By conducting themselves in line with the applicable Standards of Lending Practice for business customers, individuals and firms will tend to indicate they are meeting their obligation to meet proper standards of market conduct for unregulated activities.
We do not intend to supervise firms or individuals directly against the Standards of Lending Practice for business customers in unregulated markets. Our role is to make sure that firms meet their governance, and systems and control obligations, including under the SM&CR. We expect firms and individuals to consider both the spirit and letter of the Standards of Lending Practice for business customers to make sure they fully meet any obligations to observe ‘proper standards of market conduct’ for unregulated activities. Compliance with the Standards may be one way to show evidence they are complying with our overall governance requirements.
We will not take action based solely on a breach of provisions in market codes, recognised or not. However, codes may however be used as evidence and relied upon in determining what proper standards are, or were believed to be, at the relevant time. Recognition of a market code does not change our enforcement approach. It is not a new basis for enforcement, and does not strengthen our ability to take enforcement action.