@risk. Equity release big business risky business! July 2004

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1 Welcome Renewing your professional indemnity insurance will be at the forefront of your mind. We value your custom and hope you will choose to renew with us. We hope also that as a current customer you share our interest in minimising your exposure to claims. In this month we highlight some of the key issues to be aware of relating to the increasingly popular equity release schemes and their potential dangers for solicitors. Andrew Nickels, Zurich Professional Equity release big business risky business! Stop press It s renewal time and we re open for business! Return your renewal application and get your quotation from us now. For further information call our team of Account Executives on (Mon Fri, 9am 6pm). What s it all about? For older homeowners with little or no mortgage, equity release schemes are a means of unlocking some or all of the equity tied up in their property, without having to move house or having to demonstrate that the finance generated can be repaid out of income. It s an increasingly popular means of supplementing income, Great news for solicitors then? Yes if you have a keen understanding of the rules of professional conduct and possess the specialist skills necessary to understand these complex products and to explain their nature and legal implications to elderly clients, including being able to advise in specialised fields such as estate planning, welfare benefits, tax and long-term care funding. No if you regard equity release schemes as just another mortgage to be dealt with by those in the property department who may possess little or no understanding of the real needs of elderly clients or the nature and implications of equity release. High risk for solicitors Described as higher risk products by the FSA and the last resort by consumer group Which, equity release is also high risk for solicitors. The profession has the claims experience to prove it the fallout from the 1980s-type schemes when many clients alleged that their solicitors failed to advise them of the nature and effect of home income schemes which left some without a home when the market crashed. In recent claims, we are seeing the same mistakes being made all over again. To avoid falling into the same trap you will need to fully understand the nature and effect of the specific product you have agreed to advise on, to fully explain its nature and effect to your client and take into account other factors relevant to their circumstances. You will need to ensure your clients are making informed decisions about entering into what can be expensive and inflexible schemes. And the fundamentals of any funding large expenditure, or reducing liability to inheritance tax. And it s big business the fastest growing sector of the mortgage market, with over 1 billion being lent in 2003, with predictions by Datamonitor that the value of the market could soar to 50 billion over the next ten years. engagement should not be ignored identifying the client, confirming their authority for you to act, considering conflicts of interest, addressing issues of mental capacity, undue influence and duress, considering carefully the terms of your engagement and complying with the Client Care Code. It s early days yet, but already some of our Insureds have failed on one or more counts. Advising on equity release is not money for old rope, it s specialist stuff! What kinds of equity release schemes are there? Two main types: 1. Reversion schemes The client sells all or part of their home to a reversioner (who may be an individual, a group of individuals or a conventional financial institution) in exchange for capital, an extra income or both. The client is able to remain in residence for life as a tenant paying a nominal rent, but will not receive anything like full market value from the reversioner. They typically pay between 40% and 60% of what the property is worth. When the property is sold (usually on the client s death, or if they move into long-term care) the reversioner will receive the proceeds of sale relating to the percentage of the property owned by them. The reversioner therefore shares in any increase in the value of the property proportionate to its interest. The client s estate will benefit from the value of any remaining share of the property. Page 1 of 6

2 Are equity release schemes regulated? There is currently no statutory system of regulation, however, from 31 October 2004, the FSA will regulate the advice and sale of mortgages, and home reversion schemes in certain circumstances. In the interim, there is a voluntary self-regulation system covering some equity release products through the Safe Home Income Plans group (SHIP) Code of Practice and through the Council of Mortgage Lenders (CML) Mortgage Code. 2. Lifetime mortgages These involve borrowing against the value of a property to provide a lump sum, an income (usually by way of life annuity) or both. The loan is repaid when the borrower dies, vacates the property or moves into long-term care. The borrower retains ownership of the property and benefits from any increase in its value. 2.1 Roll-up loan schemes the most common a mortgage for life which provides a cash lump sum or an income. There are no payments of interest or capital until the client dies or the property is otherwise sold. Interest is compounded and rolled-up by being added to the outstanding loan. As interest is charged on interest as well as the on the original amount borrowed, the amount owed can mount up quickly. Research carried out by Which estimated that if borrowing 30,000, even with the cheapest loan available, after just ten years the amount owed would have nearly doubled to just under 60,000. There is a very real danger that all the equity in a property could be eaten up. Other forms of lifetime mortgages include: 2.2 Traditional home income plans mortgages for life with the loan being used to buy a life annuity to provide a fixed (sometimes increasing) income. Interest on the loan is paid at a fixed rate out of the annuity income. A combination of low annuity rates and tax changes mean that these are no longer popular. 2.3 No-interest home income plans mortgages for life which release funds used to purchase a life annuity. No interest is charged and the plan provides a fixed (sometimes increasing) income which is set at a lower rate than a traditional plan to reflect the fact that no interest has been charged. The loan is repaid on death. 2.4 Fixed rate appreciation mortgages mortgages for life at a fixed rate of interest, with the loan being used to purchase a life annuity. The provider supplements the plan by charging a lower rate of interest in exchange for a fixed share of growth in the value of the property. 2.5 Shared appreciation mortgages This is a mortgage for life which provides a lump sum or an income (usually through a life annuity). Interest will be at a low fixed rate paid out of the income, or there will be no interest at all. In return the lender takes an agreed percentage of any future increase in value of the property. The amount originally borrowed and the agreed percentage are paid to the lender on the borrower s death or when the property is otherwise sold. The cost of the loan will not be known until it is actually paid back. In a period of rising property prices the lender may receive a large return on a small initial loan. As borrowers give up a proportion of future appreciation, they may find themselves with insufficient funds if they wish to move. 2.6 Protected appreciation mortgages A lifetime mortgage is taken out at a fixed interest rate, to provide a lump sum or an income (usually annuity based). Life expectancy is assessed and interest over the whole life of the loan is calculated accordingly and added as a lump sum to the outstanding loan. A protection is built in providing that the total loan and interest will not exceed 80% of the property value. The loan and interest are repaid on the borrower s death. Key issues for solicitors Should you be advising at all? Given the variety and complexity of the schemes available and their ancillary implications, only you will know whether you possess the requisite specialist expertise! Financial advice suitability of the plan Solicitors are not financial advisers. Unless you are authorised to do so (and there are only about 180 of you out there), avoid giving financial advice! Clients are likely to contact you after they have selected a plan on the recommendation of a financial adviser. It is the financial adviser s role, not yours, to provide advice on the various schemes available and which particular product is most suitable for the client. The financial adviser will provide the client with a Financial Planning Report (or Reasons Why Report ). It is important that you obtain a copy of this at the outset. But does the financial adviser concerned have the appropriate experience and expertise to advise on the various plans available? (You may be required to warrant his advice! See Beware the solicitor s certificate below.) Does he advise on a range of products, or on one product only? Is the adviser truly independent or does he advise exclusively on the products of a particular lender to which he is tied? And is the financial adviser insured? Page 2 of 6

3 The terms of your engagement With financial advisers involved in the transaction, ensure there is clarity about who will be responsible for advising on what. Define your retainer with your client. If you are not advising on ancillary implications make this clear to the client in writing. And remember that certain tasks and duties may be regarded as so integral to the engagement that any attempt to exclude liability for them may fall foul of the Unfair Contract Terms Act (For limiting liability, June 2004.) Should you meet the client? It s your duty to ensure that the client is provided with sufficient information in a format which enables them to make an informed decision. How else can you judge whether your invariably elderly client understands what is a complex financial product, other than by face-to-face dialogue? And how can issues of capacity, duress and undue influence be addressed if you never meet the client? Record your discussions with the client in writing and send follow-up letters confirming your advice. Your file must tell the whole story! Other solicitors Be careful about what your fellow solicitors may ask you to do. December 2003 we highlighted the dangers of accepting instructions to act as another solicitor s agent for the signing of equity release scheme documentation.! Beware the solicitors certificate! Assuming duties to lenders for the advice of financial advisers Lenders who are members of SHIP require borrowers to have the benefit of independent legal advice and for this to be confirmed in a certificate signed by the solicitor. The SHIP certificate requires solicitors to warrant that the borrower: has agreed to proceed with the plan as being suitable to his/her requirements based on the advice provided by the plan provider s representative/ independent financial adviser. So, you will be asked to provide the lender with a warranty which endorses the judgement of a third-party adviser as to the suitability of a complex product for your client. This begs the question as to why lenders don t require such a certificate from financial advisers themselves. Do financial advisers not have professional indemnity insurance? Solicitors should only be required to provide warranties in relation to their own advice to clients. Why should you be asked to assume responsibility for advice given by other professionals when you are not qualified to do so? And to lenders who, in most cases, will not be your clients? The high risks of doing so are self-evident! Just how far has the profession come from the 1990s when conveyancers for example, were routinely required by lenders to warrant the valuers valuation report? Key issues for clients Consulting the family Equity release schemes reduce the value of the client s estate and the potential inheritances of the younger generation. Advise clients to consult their family. This may reduce the chances of later disputes (including potential claims by disappointed beneficiaries against solicitors it s only a matter of time!) and might even avoid the need for an equity release scheme to be entered into at all. Family members may be willing to provide alternative financial assistance. Alternative sources of finance The Consumers Association advise that equity release plans should only be recommended when all other alternative means of financing have been exhausted. Alternative sources of finance might be: moving to a cheaper property selling or letting part of the property. If the client needs funds to repair or adapt their home, alternative finance may be available through: local authorities home improvement agencies the Home Improvement Trust the Department for Work and Pensions charities. Ordinary loans and mortgages might also be available. Some lenders have schemes designed specifically for older applicants such as interest-only loans. Advise clients to be wary of non-conventional financial institutions. Page 3 of 6

4 Ancillary implications Remember that the specific scheme may affect your client s entitlement to meanstested welfare benefits and services, and their liability to tax. Watch out for speculation Any hint from clients that they intend to use released capital speculatively, rather than to produce a steady income, should be questioned. In the 1980s borrowers used their loans to speculate on the stock market when the value of stocks fell and interest rates soared many were left with debts that exceeded the value of their homes. Your advice on the documentation No negative equity guarantee It is imperative to check for this in the documentation to ensure that even if the amount borrowed (plus any rolled-up interest, etc.) exceeds the selling price of the property the client will never have to repay any more than the amount their home is actually sold for. But beware of schemes that incorporate words restricting this guarantee, for example, a proviso included that the property must be kept in good and substantial repair. Interest rate How will this operate? Will the rate be fixed, variable or capped? A variable rate is likely to impact on any income payment received by the client. Further advances Most lifetime mortgage providers prohibit further advances for between three and five years. And when a further advance is available additional costs may be incurred. The lending criteria at the time of the further advance may differ from that which existed at the time of the original loan, and this could include a higher interest rate. It may be more appropriate to arrange a lifetime mortgage with a drawdown facility, rather than an initial mortgage that will have to be increased in the near future. Some schemes offer a lump sum in instalments over a number of years. These are not further advances. With home reversion schemes the reversioner might be an individual or a group of individual investors rather than a conventional financial institution. Check the standing of the reversioner to enable the client to make a judgement about the reversioner s ability to meet their ongoing obligations. Repairs and maintenance and insurance Most lenders will expect the property to be in a reasonable state of repair. If a survey identifies repairs as being necessary these will have to be completed over a time scale agreed with the lender, who may require an undertaking from the borrower that the repairs will be carried out within the agreed time frame, or they may make a retention out of part of the loan. Unless the plan provides otherwise the client will be responsible for ongoing repairs and maintenance. Most lenders will include a condition that it may inspect the property on giving reasonable notice. The client is also likely to be responsible for insuring the property with insurers approved by the lender. Will the client be able to move house in the future or make early repayment? This will depend on the type of scheme entered into. Many plans allow the plan to be transferred as long as the new property meets the provider s criteria and provides adequate security. The client will be responsible for all the costs relating to the move. A client with a lifetime mortgage moving to a less expensive property may have to pay an early redemption charge on top of repaying some of the loan. An early redemption charge may also apply if the client wishes to pay off the loan or part of it. With shared appreciation mortgages usually the full amount borrowed will have to be repaid as well as a sum representing any shared appreciation in the value of the property. With reversion schemes repayment is unlikely to arise, as the reversioner will own the property or part of it. However, as the reversioner will receive payment earlier than expected if the client wishes to give up occupation, some reversioners may provide an extra lump sum or place a sum into trust to provide the borrower with an income. Most reversion schemes provide for the client wanting to move as long as the new property is not more expensive. Absence from or vacating property Lenders may call in the loan if the borrower leaves the property for a period of time. Many older people make the most of their retirement by travelling or living abroad for part of the year. Check to make sure they won t be left with no home to return to. Going into care Check to see what conditions apply if your client leaves their home for long-term care. Under most schemes this will trigger repayment. Some schemes may provide the client with additional benefits in these circumstances. If a client has a reversion scheme, the full value of any interest they retain in the property could be made available to fund the cost of care. Other occupiers If someone other than the borrower aged 17 or over is to be in occupation at completion, that non-owning occupier will be required to sign an occupier s agreement after seeking independent legal advice. The borrower client should be made aware that on their death or their ceasing to occupy the property the non-owning occupier may be required to move out. Consent of the lender This is likely to be needed if the borrower marries or cohabits or if a friend or relative moves into the property, after the plan has been entered into. Consent will also be required to: let the property or part of it alter the property or change its use enter into a subsequent mortgage. Page 4 of 6

5 Equity release file checklist Please note that this checklist is to be used by those who are already competent to advise on equity release. Client name: Introducer: Property: File No. Provider: Amount Client Establish who is the client Initial attendance note on file Confirmed N/A Explain documentation Offer letter Key features document Confirmed N/A If instructions given by an intermediary, obtain client s written confirmation of instructions Does the client have capacity to: Enter into equity release contract? Make a gift? Create an enduring power of attorney? Reasons why report Agreement Legal charge Transfer Lease Declaration of trust Is medical evidence as to capacity required? Solicitor s certificate Is there a conflict of interest? Is there evidence of duress or undue influence? Client care Send Rule 15 information to client Send general terms and conditions of business Send letter setting out terms of retainer (and duplicate for client to sign and return) Send letter (brochure) giving advice on equity release Provider/Intermediary Tied Independent Background and experience Has advice been given on different options or one? Have key features and reasons why report been produced? What is the regulatory status of the provider adviser? What are the safeguards/protection for the client? Explain implications of plan No negative equity guarantee Loan interest rate Repayment of loan Further loans Property insurance Payment of outgoings Repairs and maintenance Home improvements and alterations Moving to another property Absence from or vacating property Long-term care Occupiers at completion Occupiers after completion Early redemption/termination of plan Costs Commission Will the client and provider receive independent legal advice? Does the provider/advisor provide an after-sales service? Explain ancillary implications Welfare benefits and services Advice Tax Alternative solutions Address lifestyle issues/personal circumstances Financial healthcheck Inheritance Life expectancy in relation to the plan Effect of inflation on plan Funding repairs and adaptations to property Loans and mortgages Family assistance Sell part of property Downsize Rent part of property Miscellaneous matters Review/make will: Client/family Enduring power of attorney Living will Advice given on attendance. Date: Advice on miscellaneous alternatives Advice confirmed in writing. Date: Fee earner: Date: Page 5 of 6

6 Useful websites The Financial Services authority The Council of Mortgage Lenders Safe Home Income Plans Age Concern Help the Aged Training Equity release courses Oxford 20 Solihull 6 October 2004 Guildford 20 October 2004 Cambridge 3 November 2004 Watford 15 November 2004 PPS Training and Consulting Telephone: Fax: Our thanks to Jonathan Wilkey of Gwyn James Solicitors for providing research material and permitting the reproduction of his equity release checklist. Mr Wilkey specialises in issues concerning the elderly and disabled. His forthcoming title A Practitioners Guide to Equity Release is due to be published in the Autumn. Contact Zurich Professional ZL (111668A07) (6/04) AMCH Risk Management Andrew Nickels Tel riskman@zurichprofessional.co.uk General Enquiries and Sales Tel Sales fax solicitors@zurichprofessional.co.uk Claims Helpline Claims Fax Zurich Professional 90 Fenchurch Street London EC3M 4JX The material contained is issued by Zurich Professional Limited and does not establish, report or create the standard of care for solicitors, nor does it represent a complete analysis of the topics presented or constitute legal advice. It is intended to highlight issues which may be of interest to our customers. Readers should conduct their own appropriate research on how to act in any particular case. A member of the General Insurance Standards Council. Copyright Zurich Professional Limited 2004 Page 6 of 6