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Helping themselves

The big financial institutions stand accused of the inappropriate selling of payment protection insurance - and they do have a case to answer, says Mortgage Strategy.

Payment protection insurance is a core product and should be of proven value in protecting consumers' financial health. But instead, it is the subject of sustained, hostile criticism from the media and consumer bodies. Well founded allegations of predatory selling, extensive mis-selling, over-pricing, poor value cover and low quality customer service do nothing to promote a positive product image or inspire consumer confidence.

The responsibility lies with major banks whose uncomfortable reliance on extensive creditor insurance – payment protection insurance - sales to boost bottom line profits has seen them ruthlessly exploit their point-of-sale advantage with hard sell tactics. But a blanket condemnation should be tempered by an acknowledgement that PPI has underlying consumer benefit and there are independent providers in the market that do act responsibly.

To external observers the market appears rigidly sectored to reflect the originating loan which could be a mortgage, unsecured borrowing, revolving credit or second charge borrowing. Each of the four sectors operates within self-set boundaries and comfort zones with little evidence of cross boundary activities or acknowledgement of multi-source credit. It is difficult to understand such inflexibility but it works greatly to the advantage of major banks. With a distribution reach not so much protected as free from competition, they concentrate on ruthlessly exploiting their powerful position to the point where collectively they control more than 90% of the market and their insurance subsidiaries are responsible for much of the underwriting capacity.

Not surprisingly this market distortion works against independent players such as specialized product providers, mortgage and insurance intermediaries and financial advisers all of whom are effectively marginalized. At the same time, borrowers are hugely disadvantaged in terms of choice, transparency and value. With personal borrowing at record levels and with the continuous recycling of debt, banks aggressively use selling tactics which are virtually conditioned to drive up PPI sales to an estimated 24 million policies that currently generate £6bn of gross premium income a year. For consumers, multisource borrowing is routine but in such an inflexible market this is not reflected in the availability of cover, so they end up with multiple policies and. confusingly and expensively, different premiums, terms and benefits.

Exactly how many borrowers there are with multiple policies is not recorded but it is a reasonable assumption that most of those who protect major loans would be inclined to protect other loans. On this basis, around four million is the ball park figure. Banks, as loan providers, use this leverage to drive and control the market on their own terms, especially where retail premium pricing is concerned. As consumers tend to focus on the loan this makes them vulnerable to hard sell tactics, particularly when there is no other choice.

The relentless drive for profits has overridden product suitability and affordability as prime factors while commission loaded, over-priced products and volume sales have combined to produce a culture that encourages mis-selling. In this feature we will only consider mortgages and second charge borrowing. Mortgages is the only sector in the market where independents can compete on an equal footing with banks. Given that a mortgage is a consumer's single biggest financial commitment, it might be expected these two factors would produce the largest sector in terms of sales and premium volume. But in practice it is hugely underperforming.

Current MPPI penetration is 23% and the number of MPPI policies is 2.6 million. The average yearly premium cost is between £325 and £350. while the estimated total premium spend per year is £lbn. according to the Council of Mortgage Lenders and the Association of British Insurers. With limited state assistance the government is well aware of the need for borrowers to have some form of financial health cover such as MPPI. The industry paid out 694.000 claims between 2000 and 2004.

Several years ago the government called for 55% penetration by the end of 2004. with up to five million borrowers insured. Disappointingly far from reaching this target, only 23% of borrowers took out some form of cover and in 2004 new MPPI sales were 200.000 clown on the previous year. Although mortgages account for 83% of consumer borrowing. MPPI accounts for only 17% of consumer spend on PPI overall.

This is an unacceptable imbalance. Above all other loan commitments, mortgage repayments should be prioritized for protection. MPPI, in the context of the creditor insurance market generally, is reasonable value for money, hard sell free and shows little evidence of systemic mis-selling. There is every reason to believe the presence of independents provides genuine consumer choice and competition keeps premiums and commissions at acceptable levels.

Despite this, penetration levels have been and remain low, and some of the contributory factors are indifference or inertia on the borrower's part, self insurance, media negativity and intermediary caution. It is significant that intermediaries who have achieved a powerful position in the mortgage market by placing 70% of new loans are only responsible for, at most, 25% of all MPPI sales, even with access to better products than lenders offer in terms of pricing and cover.

If it is accepted that MPPI can and should underpin borrowers' financial health - and after all this is what the government was implying - there is little doubt overall market penetration is woefully underperforming and intermediaries' contribution is much less than it could and should be. Perhaps the sales process is not cost effective, too time consuming or there is concern about the product's negative image. If it is more convenient to pass in favour of lenders' inhouse products, even though these could be inferior, it remains to be seen how that stands regarding general insurance regulations and best advice.

There is evidence of genuine concern among intermediaries that they operate in a best advice minefield and have potentially much wider exposure to mis-selling issues than banks and white label outlets that enjoy information only status and a less intrusive regulatory regime. There seems to be substance to claims that when it comes to selling MPPI, it is not a level playing field. This, no doubt, is a significant factor in brokers' reluctance to increase their activity.

Seen objectively, it makes sense for borrowers to protect their mortgage and other loan payment commitments with some form of financial safety net as state assistance in the shape of mortgage interest income support is very limited. More than one in three borrowers who contact the free debt advice sector with financial problems have mortgages, which suggests the potential for further increases in delinquency statistics.

In the context of overall consumer debt of £1 trillion, second charge loans are relatively insignificant. But this is among the fastest growing sectors of the personal loan market, with borrowers at the higher end of the risk spectrum. It is also the only area of consumer lending dominated by a handful of national finance brokers who compete fiercely for business through expensive advertising. The cost of buying business means there is a reliance on the sale of expensive PPI to boost profits. This is reflected in astonishingly high penetration levels.

Current PPI penetration is 85% and the number of PPI policies is 360,000. The average yearly premium cost is more than £250 and the estimated total premium spend per year is £100m. With such substantial commissions generated, obtaining a loan is virtually conditional on taking PPI, the cost of which is inflated to cover commission content of up to 80% and more. It is not unrealistic to suggest loan providers take up to £60m a year in commissions. This sector is also the birthplace of the infamous and expensive single premium PPI - the cost of which is added to the loan upfront and amortised in monthly repayments, attracting interest charges of course.

There is a popular view that borrowers never buy this product, they are always mis-sold it. It is a truly contentious product with a predatory image. It is continually attacked by the media and influential consumer bodies as obscenely over-priced and poor value. The pressure is on the Financial Services Authority to regulate it out of the market since, other than as a revenue earner for lenders, there is little point to it anyway. Not surprisingly the industry is reluctant to be open about sales volume and there is little or no hard information in the public domain, but consumer watchdogs suggest there are up to 250,000 currently in force. These include many borrowers who are financially vulnerable so it's no surprise this sector attracts so much adverse comment regarding hard sell tactics and unsuitability.

This is of particular concern given that, unlike the tightly regulated primary mortgage market, second charge lending, which is Consumer Credit Act regulated, is lightly policed by the Office of Fair Trading. There is a lot of regulatory rhetoric about loan and insurance related consumer abuse, and single premium PPI in particular, but it remains to be seen whether this will result in anything but cosmetic action. On the regulatory front, there is little doubt the creditor insurance industry is biased in favour of loan providers - and not only because of their point-of-sale advantage. They also have no open competition, no information-only status, no compulsion to disclose commission levels and an easy regulatory regime compared with brokers.

In response to this criticism, banks either shrug their collective shoulders and deny there are any systemic problems or, if pressed, defend their position on four counts that can be summarized in the following way. Without point-of-sale positioning, penetration would fall dramatically exposing countless borrowers to potential payment default, debt overhang and financial difficulties, and as for over-pricing, premiums are market driven. There is no market alternative cover available to borrowers, and without PPI revenue loan rates would have to rise to maintain profits.

As ever with spin, there is an element of truth in these arguments, but closer examination shows them to be disingenuous at best and downright specious at worst. Banks are keen to protect their bad debt positions and if borrowers pay an exorbitant price by way of PPI to achieve this, so much the better. The fact this could also be achieved at a fraction of the cost is irrelevant and if they were really concerned about the FSA's current favorite mantras - 'treating consumers fairly' and 'consumer focused strategy' - they could lower premiums, increase benefits or recommend to their customers to look for an open market alternative. Only now is independent standalone PPI beginning to appear. Ignoring the fact many PPI covers have been mis-sold and probably offer no protection at all. in the open market with the right product at the right price, take-up levels would be higher than the banks suggest. The mortgage market is not subsidized and competition ensures rates are kept at an acceptable level. Without the PPI subsidy there would by necessity be greater emphasis on responsible lending and affordability risk assessment. Consumers would find it harder to get easy loans but equally they would find it harder to over borrow.

Competition purely on loans is fierce, driven by high profile marketing centered on low headline rates on which, so the banks claim, profit margins are non existent or wafer thin hence the need for PPI sales which are the equivalent to an extra 2% to 3% on the loan rate. Whether or not this is the case, it poses the question of whether they are selling insurance or giving away loans and it would be interesting to know how many applicants qualify for these teaser headline rates. Regulation requires 66% but how this is monitored is conveniently vague. It's not rocket science to work out that linking the loan directly with creditor insurance has resulted in an asymmetrical and uneven market that is significantly biased against consumer interests and requires corrective.

The chairman of the Financial Services Consumer Panel (the FSA's own consumer facing watchdog), in her recent annual report, criticised the FSA for being too industry focused and reluctant to implement consumer friendly legislation. The OFT's regulatory powers will be strengthened under the new Consumer Credit Act to be introduced later this year but whether this will result in a more active policing of this market remains to be seen. If regulators have the political will for root and branch reform they could consider options such as an insurance disclaimer whereby every CCA agreement would contain a prominent clause confirming that the loan was not conditional, whether expressed or implied, on the borrower taking out associated insurance products.

Or they could consider time and distance regulation whereby banks can make loans and sell insurance but not link them, and not at the same time. In practice there would be, say, a 30 to 45 day delay between granting the loan and offering cover. There are also calls for regulators to look hard at the role bank-owned insurers play in the PPI market to determine whether they have independent objectives or are primarily conduits for high premiums and commission charges or used to reinforce bank dominance and marginalise competition. Such a hidden agenda would work against consumer interests. This has genuinely important consumer implications, given the close ties between major supermarkets and banks who provide them with white labelled loan and insurance products, particularly as this area is predicted to grow dramatically. Payment protection insurance is a £6bn per year industry promoted as providing essential protection cover.

But with £4bn of this stripped out in commissions, many external observers query whether it is more a vehicle for generating revenue at consumers' expense rather than providing genuine financial protection. The more obvious negatives in the industry include fragmentation, a bias toward banks, 90% ofthe market being controlled by banks, marginalised independent competition, brokers underperforming, image problems - such as being over-priced and poor value hostility from media and consumer watchdogs and growing regulatory concern...

MPPI can consider itself an unfortunate casualty of this generic condemnation of PPI, guilty by association as it were, because there is genuine choice, relative value for money and transparency. It's not perfect but it's much better than any other sector and the government is still pushing for penetration levels above 50% - whether as an implicit product endorsement or because there is a limited state safety net is an open question.

From a consumer perspective, the payment protection insurance industry needs more genuine internal competition rather than less, which will happen if the presence of independents continues to be marginalized. Perhaps their position and that of consumers will improve when they radically rethink and re-energize both their product concept and their consumer facing strategy to take advantage of the widespread dissatisfaction with the banks' predatory attitude, and bring them back onside.

This cover story is based on a report published by OmniCheck.