The last ten years have seen the level of personal debt in the UK nearly triple in size. The total of personal debt passed £1 trillion in 2004 and currently amounts to £1.2 trillion.

Faced with burgeoning debts, millions of borrowers have taken out payment protection insurance (PPI) to provide the upkeep of payments on loans, mortgages and other commitments in the event of accident, sickness or unemployment.

The market has become huge with around seven million policies being taken out each year generating some £5.5 billion in premiums for the lenders and the insurance companies underwriting the products. The majority of the products (about 60%) are sold in conjunction with unsecured personal loans with the remainder being related to credit card, store card and mortgage borrowing. Lincoln insurance advert Creative commons image Credit: swanksalot under CC-BY-SA Some insurance salespeople are more trustworthy than others...

On the face of it insuring against such risks would seem to be a prudent course of action – it is little over a decade ago that a period of high unemployment and high interest rates forced thousands of homeowners to default on mortgage payments and lose their homes during the recession of 1990–1993.

However, increasingly evidence is being gathered that questions both the way PPI policies are being sold and the value of the products themselves. In many cases the terms of the policies may mean that a financial lifeline may not be forthcoming in the way expected by policyholders in times of need.

In response to these growing concerns the Financial Services Authority – the body that regulates the UK financial services industry – undertook a review of the selling practices for payment protection insurance and its results were published in November 2005 in the report 'The sale of payment protection insurance'.

Then, in December, the Office of Fair Trading (OFT) published its initial response to the ‘super-complaint’ submitted to it by the consumer advice body, Citizens Advice, on the cost and effectiveness of PPI. This followed Citizens Advice’s own survey, 'Protection Racket', that suggested that aspects of the PPI market are damaging to the interests of consumers.

Further question marks about PPI have now come in the Competition Commission’s report on store cards published in March 2006.

So what are the issues?

There are three main areas of concern: price, insufficient cover and mis-selling:

1. The price of PPI products appears excessive

This finding was supported by the report 'UK banks: PPI – Time for change', carried out by the investment bank Credit Suisse First Boston (CSFB), and the OFT which found the claims ratio for PPI products (claims as a percentage of premium income) to be around 20%. That is, for every pound paid in as a premium, the PPI schemes were paying out just twenty pence in claims.

This figure is markedly lower than for other types of general insurance: for instance 74% for motor insurance and 55% for household insurance. For an industry facing tight margins in many conventional areas of business the high margins offered to financial companies by PPI have clearly been attractive.

The risk of purchasing an overpriced product is exacerbated by the fact that PPI is a secondary transaction involving little in the way of shopping around by consumers. The Competition Commission’s inquiry into store cards supported this view and found "that little or no competitive pressure is brought to bear on the elements, or the pricing, of insurance sold with store cards".

2. The protection offered is only partial, with many policies having unreasonable exclusions of cover for common causes of credit default

Around one in six claims under PPI policies are rejected by the insurers. The evidence from the recent surveys sheds much light on the reasons for this high rate of rejection. The FSA found that nearly half of the firms it visited that were selling PPI "were not providing the customer with balanced information on the exclusions as well as the benefits".

Indeed, firms offering products are not required to reveal exclusions verbally in face-to-face sales. In one case the FSA found that a policy with an age limit of 65 had been sold to a 68-year-old man. Not only did this mean that he would have been ineligible to claim on the policy but also, because he was retired, the majority of the benefits from the policy were not relevant to him!

More generally the exclusions in PPI policies are wider than many consumers might have anticipated – including claims by those with chronic illnesses or mental health problems. Citizens Advice also discovered some cases where customers have been unable to claim because of unreasonable requirements to provide medical evidence.

3. There is evidence that products are mis-sold and that high pressure and unfair sales tactics are employed

The FSA survey does not criticise the sales techniques in all the firms it surveyed. However, in two-thirds of the firms visited aspects of selling practices were discovered that did not stick to all the rules, therefore posing a risk to consumer protection.

In certain cases, the FSA found incentive structures in place that risked increasing the scale of non-compliant sales. In one loans company staff were paid a £20 bonus for each PPI sale and the bonus system was structured in a way that could double staff salaries. Individuals not meeting their targets got no bonuses and were earmarked as having a training need.

Another example of poor sales practice emerged from the sales script used by one loans company for PPI products. This stated that "we do not offer advice but will provide you with information on accident, sickness, unemployment and life cover" – but then later, the script tells the salesperson "if the client is unsure then you can tell them that we strongly recommend that you consider taking out PPI".

A further angle on the issue of mis-selling has come in the Competition Commission’s report on store cards. It found that PPI is being sold to customers in a package with price and purchase protection. (Price and purchase protection insure the policyholder against, respectively, the risk of the goods being subsequently offered for sale at a lower price and the risk of damage to, or loss or theft of, the goods purchased.) As a consequence customers are at risk of buying insurance they do not want or need.

In addition to these three main issues the survey evidence also found that, in certain cases, the administration of PPI claims is slow and unfair, thus exposing consumers affected to serious debt reinforcement action.

Following its initial response in December 2006 the OFT is now planning to undertake a detailed study of the PPI market. We will learn more about the OFT’s intentions later in 2006. Following the publication of its survey, the FSA sought feedback from the companies providing PPI and is expected to undertake a further review of sales practices in the near future.

The prospect, given the current apparent shortcomings, is that the sales of PPI will become more tightly regulated. Already the FSA’s Insurance Conduct of Business rules, introduced last year, have resulted in many retailers stopping the in-store sale of PPI with telephone sales being used instead to market the product.

For consumers the phrase caveat emptor (buyer beware) clearly applies. You may be paying over the odds for PPI and the insurance product may not offer you financial support when you need it.

Further reading