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online technical resource

"churning"

This note describes our approach to complaints from consumers that an investment or pension has been "churned".

overview

"Churning" describes the situation where a financial business has persuaded a consumer to surrender or sell an existing investment and to take out another – which is either essentially the same or is unsuitable for the consumer.

This process of selling or surrendering an investment – and setting up or buying its replacement – generally costs the consumer money. A consumer may also be advised to take out an investment with a later maturity date – or one which increases the “risk profile” of their investments overall.
 
It is not necessarily inappropriate for an adviser to recommend that a consumer replace a policy –  in some cases, it can be very beneficial to the consumer.

But when the replacement policy is unlikely to benefit the consumer or they have been given unsuitable advice, it is likely that “churning” has taken place.

our approach

When we receive a complaint about possible “churning”, we compare the consumer’s previous investment with the newer one – and consider whether they serve the same (or similar) purposes for the consumer.

If it seems that the consumer was advised to surrender or sell one investment and replace it with another which provided similar benefits, we ask the business why it gave this advice.

If we are satisfied that the old investment would have done broadly the same job as its replacement, we are likely to say that churning took place – and uphold the complaint.

This might happen, for example, if both the old and new policies were endowment policies designed to repay the same mortgage at the same time.

But we may not decide that churning had happened if:

  • the new investment had a particular feature – for example, critical illness cover – that the consumer wanted and that could not be added to the old investment or obtained separately
  • there were significant concerns about the financial viability of a business the consumer had invested with
  • we think there were other good reasons for replacing the investment or
  • the consumer has not lost out financially.

Businesses sometimes say that the new investment was needed because the one it replaced was performing poorly. But unless the new investment was clearly more beneficial to the consumer – or the previous investment was almost certainly never going to recover – we are unlikely to agree with this reason.

compensation

Assessing fair compensation in cases involving churning can be a complex process.

If we uphold a complaint, we may tell the business to reinstate the original investment – and to meet the costs of doing so itself.

This is in line with our general approach where we decide a consumer has been given inappropriate or unsuitable advice. It puts the consumer in the position they would be in if the advice had not been given – and they had kept the original investment.

But it may not always be possible to reinstate the original investment. And the number of variables – for example, different premiums, terms, the sum assured, product providers, funds and uncertainties about future growth – may mean that an exact calculation of the consumer’s loss cannot be made until all the investments have matured, which might be many years later.

So we might need to estimate the loss – by taking into account:

  • the amount the consumer paid into the original investment
  • the surrender value of the original investment and
  • the amount the consumer has paid into the new investment – over and above the one it replaced.

endowment policies

In cases where the investments that were churned were endowment policies – whether or not they were sold to help repay a mortgage – we apply a formula to work out how much compensation the consumer should receive.

The formula can only give an estimate of the consumer’s expected loss. If a business tells us that it wants to carry out a full actuarial calculation, we will take those calculations into account as well.

the formula

First, we compare the amount the consumer invested in the original policy with the amount they got back (if any) when they cashed in that policy:

a =
the total premiums paid on the surrendered policy;
b = interest on each premium, calculated from the date it was paid until the date of surrender;
c = the surrender proceeds;
d = a + b - c;
e = interest on d (calculated from the date of surrender until the date of payment by the business);
f = d + e

We usually say that interest on each premium (b) should be compound and paid at 1% above the relevant Bank of England base rate (ie the rate that applied at the time that premium was paid).

And generally, we say that interest on the total amount being refunded (e) should be simple and paid at the rate of 8% per annum simple (from 1 April 1993 – but at 15% before that date). This follows our usual approach to compensating a consumer for being deprived of their money.

Next, we look to compensate the consumer for any extra costs of the new policy. We do this by comparing:
  • how much the consumer would have paid into the original policy over the remaining term of that policy with
  • the amount they will actually pay into the replacement policy over the full term of that policy.

This comparison will be on a "like for like" basis. So if the original policy had a sum assured of £20,000 and the new policy has a sum assured of £40,000, we will compare the cost of the original policy with 50% of the cost of the replacement policy.

In this calculation:

g = the total premiums paid for the same sum assured over the whole term of the new policy;
h = the total premiums that would have been paid into the original policy – from the start of the new policy to the maturity date of the original policy;
i = g - h

So the final compensation figure will be f + i.

There is an example of how we approach complaints about the churning of mortgage endowment policies in our guidance on mortgage endowment redress in more complicated cases.

single premium investments

Where we uphold a complaint about a single premium investment, it might be possible to reinstate the original single premium investment (as would happen with a regular premium investment).

For example, we may recommend that the consumer surrender the new investment and buy the same number of units held under the original policy. If there is a deficit, we tell the business to cover it.

In cases where the investment can’t be reinstated, we compare the original investment with the new one to determine how much the consumer has lost out by.

If comparison is not possible, we will look at what an appropriate rate of return would have been on the amount originally invested and compare that with the consumer’s current position.

pension policies

On 6 April 2006 (known as “pensions A-day”) the government introduced a simplified set of rules on pension schemes. This led to a substantial increase in pension business.

In 2008, the financial services regulator at the time, the Financial Services Authority (FSA), carried out a review of the quality of pension switching advice – following concerns that the risk of consumers being given unsuitable advice had risen.

The FSA’s findings were published in December 2008. We take these into account when we consider a complaint about churning.

where the original policy can be reinstated

If it is not possible to reinstate the original policy, we usually say that the “transfer value” of the new policy should be "enhanced" – to match what the transfer value of the original policy would have been if the consumer had carried on paying into it. This means the value of the consumer’s pension will be the same as it would have been without the unsuitable advice.

Where the consumer is paying a different amount into the new policy than they were into the original policy, the calculation should be carried out on a pro rata basis.

As with investments, there are a number of things that we need to consider when calculating the award when we have upheld a complaint about churning.

The situation can be particularly complicated if the consumer is close to retirement or the previous policy included a Guaranteed Annuity Rate (“GAR” – the minimum income the consumer will receive from their pension).  

where reinstatement is not possible

When a payment is being made into a policy, we will need to take into account any tax relief and/or charges that might be applied – and adjust the payment made by the business up or down where appropriate. This is to make sure that the consumer is not in a better or worse position than they should be.

Occasionally, we tell the business make a cash payment directly to the consumer rather than into the policy. Again, any possible tax relief that the consumer will get or tax they would have to pay will need to be taken into account – and the award will need to be adjusted accordingly.

help for businesses and consumer advisers

contact our technical advice desk on 020 7964 1400

This is part of our online technical resource which sets out our general approach to complaints about a wide range of financial products and issues. We would like your feedback on how helpful you found it. Please also use the feedback form below to tell us about anything you think we could clarify or explain better.

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  • The law requires us to decide each case on the basis of our existing powers and what is fair in the circumstances of that particular case.
    We take into account the law, regulators' rules and guidance, relevant codes and good industry practice at the relevant time.
    We do not have power to make rules for financial businesses.
    Our current approach may develop in the light of circumstances disclosed by further cases we receive.
    We may decide that fairness requires a different approach in a particular case.