Outlook: Climb aboard the compensation gravy train

Balancing act
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The Independent Online

The savings industry was yesterday put on show for its second public thrashing in a week. As if things were not already bad enough for Britain's battered life assurers, along comes the Treasury Select Committee to argue for endowment mis-selling compensation potentially running to tens of billions of pounds. Admittedly, the Committee's report was a mercifully shorter and less judgmental affair than Lord Penrose's tome on Equitable Life a couple of days previously, but much of the language was essentially the same, and the underlying criticisms of the industry and its regulators were similar in tone.

The savings industry was yesterday put on show for its second public thrashing in a week. As if things were not already bad enough for Britain's battered life assurers, along comes the Treasury Select Committee to argue for endowment mis-selling compensation potentially running to tens of billions of pounds. Admittedly, the Committee's report was a mercifully shorter and less judgmental affair than Lord Penrose's tome on Equitable Life a couple of days previously, but much of the language was essentially the same, and the underlying criticisms of the industry and its regulators were similar in tone.

The Committee fulminates that this is an industry which is still dominated by a commission-driven culture that focuses on short-term sales with insufficient appreciation of its long-term duty of care to customers. Moreover, life assurers failed to give policyholders adequate information in a timely fashion about likely shortfalls, complaints in many cases had not been handled fairly, and the assets were mis-managed in a way which failed to generate the levels of return policyholders had been led to expect.

The Committee omitted to mention collective overpayment of bonuses over a period of many years, meaning that the reasonable expectations of the current generation of policyholders cannot be met - which Lord Penrose found to be the key part of the mischief at Equitable - but it might well have done.

All the same, there are some key differences that separate the two scandals, and in a number of respects, the Committee's unashamedly popularist response to the problem of mortgage endowments misses the point. For a start, there are some obvious and powerful mitigating circumstances.

No one anticipated the shortfalls that are now materialising, but nor would anyone have anticipated the extraordinary rise in house prices that has taken place since the early 1990s, or the long-term fall in interest rates, which has dramatically reduced the servicing costs of a mortgage. In nearly all cases, these compensating trends hugely outweigh the endowment shortfalls.

This doesn't excuse the mass sale of what was always a completely inappropriate product for the purpose of repaying a mortgage loan. Anyone who plans to offset a fixed capital sum with an investment product whose final value can never be guaranteed needs their head examining, yet mortgage endowments were sold in their millions on the promise that not only would they deliver the required capital repayment, but there would in all likelihood be a tidy little sum on top to pay for that long planned kitchen extension or luxury holiday.

Even so, the offsetting rise in house prices and reduction in mortgage servicing costs does somehow make endowment mis-selling seem less of a scandal than the Treasury Select Committee makes out. In their demand for compensation all round, the MPs almost wholly fail to address the issue of who pays. The Government? Don't be silly. Shareholders? They, too, are largely ring fenced from liability. For all the space the Committee devotes to this crucial question, it might as well be the tooth fairy. Regrettably, the answer is other policyholders.

Endowment compensation is merely robbing Peter to pay Paul, for even in proprietary companies, nearly all such payments come straight out of the life fund, thereby reducing the bonuses available to everyone else. So far the industry has been relatively successful in holding back the growing wave of claims. To date, "only" £650m has been paid out, but if the MPs are right that 80 per cent of policies are likely to show a shortfall and a half of all policyholders think they were mis-sold their policies, that wave will soon become a veritable Tsunami. Do the maths. The collective shortfall across all mortgage endowments is reckoned to be approaching £40bn.

The MPs want urgent action to make the compensation procedure better understood and more accessible to policyholders, yet the truth is that it is already far too easy to claim. All you have to do is fill out a form and, if all you can say is that the salesman had bad breath, that may well be good enough. This is because two years ago the Financial Services Authority shifted the burden of proof of endowment mis-selling from the policyholder to the endowment provider.

A claimant no longer has to demonstrate that the policy was mis-sold. Rather, the life assurer has to demonstrate that it was not. Most of them have lamentably poor records, particularly in cases where they were selling through tied agents such as banks and building societies, so they are wide open to claims. The moral case for not claiming compensation because you fully understood the risks when you took out the policy long since disappeared out of the door. When everybody else is claiming, you'd be crazy not to. There's a lot wrong with the savings industry, which has a mountain to climb in regaining public trust, but the situation is hardly helped by the cloud cuckoo land of compensation that the Treasury Committee is apparently so keen to encourage.

Balancing act

It only seems like yesterday that the Chancellor was standing up to deliver his pre-Budget report. Can the Budget proper already be upon us? As it happens, it was indeed little more than three months ago that Gordon Brown announced his pre-Budget report, and yes, in case you hadn't noticed, the Budget is next week. None the less, quite a lot has changed in the intervening period, so the Chancellor's statement may not be quite as dreary as the City thinks.

For one thing, Mr Brown will be able to crow about his economic forecasts which, much derided at the time of the pre-Budget report as hopelessly optimistic, now look as if they may even be an underestimate. The world economy has turned on a sixpence in the short three months that have elapsed since they were made, during which a world of sluggish or nil growth seems to have returned to near boom conditions.

Even so, the Chancellor still has a credibility gap to close on the public finances. The economy is growing as forecast, but tax revenues are not, and with the Chancellor perilously close to breach of his own golden rule even under his own numbers, few would bet on him staying on the straight and narrow without a sizeable hike in taxes. The political calculation Mr Brown must make is whether he's already too close to a General Election to risk raising taxes further, or whether by delaying further he might be forced into raising them just ahead of the election next year, which would be electorally far more damaging.

My bet is that cautious operator that he is, Mr Brown will raise them a bit this time around in the hope he can be neutral, or even give a little back, in the pre-election Budget. None the less, he won't want to do anything headline grabbing, so there will be nothing on income tax, national insurance or VAT. I'd also be amazed if he tampered with stamp duty. Housing is too politically contentious to tackle this side of an election.

Rather, the pain will be heaped on to the so called stealth taxes, where the Chancellor can achieve quite a lot of extra revenue for no noticeable immediate effect on people's pockets. By their nature, these taxes tend to hit business hardest and first. For instance, the tax exemption on small business profits of up to £10,000 will almost certainly go, this on the grounds that it has become used mainly for tax avoidance purposes. There are plenty of other, similar tax raising wheezes the Chancellor can launch without it costing him votes.

Yet the biggest challenge the Chancellor has got is less trying to convince voters that their taxes aren't going up as demonstrating that Labour's extra public spending is delivering results. So far there is little sign of it in the official statistics. To the contrary, spending is going up for no noticeable improvement in output. The Chancellor is convinced that this is because the statistics don't properly measure public sector output, and he's commissioned a review to prove his case. Even if he's right, it won't convince many. For them, only hard evidence in terms of real, visible improvement in public services is good enough. That's hard to achieve in services such as health and transport, where consumer expectations are rising all the time.

jeremy.warner@independent.co.uk

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