FOOL'S EYE VIEW
The Perils Of Payment Protection Insurance

By Cliff D'Arcy
March 11, 2003

Have you ever taken out a mortgage, personal loan, credit or store card? If you have, I'm willing to bet that the salesman, brochure or website "strongly recommended" that you also buy payment protection insurance (PPI). I'm also confident that you get annoying unsolicited calls trying to sell you this cover, as well as promotional brochures and leaflets in your monthly or annual statements.

However, as with all products that are given the "hard sell", with PPI, you should be very wary of what you're buying, otherwise you're going to get pillaged....

PPI is an optional insurance policy. It's almost always sold to us alongside credit agreements, although there are a few stand-alone (direct) policies available from insurers and brokers. PPI is often called accident, sickness and unemployment cover (ASU), as it protects us from these risks. Borrowers receive monthly benefits if they have an accident, fall ill or lose their jobs. Life cover to pay off the debt is also included in personal loan and credit card PPI (but not normally in mortgage PPI).

Some commonly used names for PPI are: LASU (life & ASU cover), mortgage payment protection insurance (MPPI), personal loan protection (PLP) and credit card repayment protection (CCRP).

Now, here's my confession. Before becoming a Foolish writer, I worked for several PPI insurers over an eleven-year period. My career included claims and legal roles before I settled into a marketing position. So, I know the industry very well, which is the reason why I decided to write this article. From my inside experience, I'm aware of so many problems with PPI that it's hard to know where to begin!

Nevertheless, here's an explanation of why I have never bought a PPI policy - and never will.

PPI is massively over-priced
Thanks to the UK public's insatiable appetite for credit, PPI premiums have soared over the last ten years, perhaps approaching £4 billion in 2002 alone.

However, only around 20% of total premiums collected is paid back to us in claims (and even less for the most expensive products). So, about 80% of the price we pay is pure profit for the lenders and insurers. This is a grossly excessive level: we pay around five times the net cost for PPI (what it costs the lenders and insurers to meet claims and admin expenses).

This over-pricing means that commissions we pay are absolutely vast. The PPI industry works hard to keep this secret from us: PPI is one of their most lucrative and profitable products. Last year alone, I would estimate that lenders and insurers shared profits from PPI of nearly £3 billion pounds!

Somewhat predictably, many of the most expensive policies are sold by the High Street banks and building societies, whose products can be up to ten times as expensive as the best-value policies. Conversely, there are a few praiseworthy online lenders that sell PPI policies at realistic prices, often at a fraction of what many mainstream lenders charge.

The PPI industry is anti-competitive
There is, to all intents and purposes, no competition whatsoever in this industry.

A lender will choose one insurer (or a panel) to underwrite its PPI portfolio. Thus, we borrowers are offered only one product (or a menu of cover options) alongside our credit products. This means that we have restrictive choice at the point of sale. Lenders will claim this sales method is convenient for borrowers, but these tie-ins discourage us from shopping around and thus stifle competition.

You can buy stand-alone policies from brokers or direct from insurers, many of which offer far better value for money than point-of-sale products. However, prohibited from access to borrowers at the point of sale, these policies represent the tiniest fraction of the overall market.

By preventing us from exploring our options, the lenders and insurers are preying on our ignorance and inertia. This behaviour prevents, restricts and distorts competition, making it almost impossible for us to value these policies effectively. Lenders know that we struggle to place an accurate value on PPI policies so, in effect, they are free to charge as much as they think we will pay.

Every major mortgage lender and unsecured credit provider operates in this way. Also, there is a "complex monopoly" of insurers in this business, with the majority of PPI policies being underwritten by five key insurers. Interestingly, several PPI insurers are also being investigated for colluding with retailers and manufacturers in the extended warranty market!

In many ways, the PPI market is very similar to the extended warranty industry (and to travel insurance sold by travel agents) and is therefore, in my view, anti-competitive.

PPI policies are poorly designed and selling practices are alarming
By and large, PPI policies are riddled with small print and exclusions. Being filled with jargon, they are almost incomprehensible to the typical consumer. Despite eleven years in this market, I sometimes can't make head nor tail of some badly written PPI literature!

There is no government CAT Standard governing the price of PPI and cover on offer. There is a voluntary benchmark for mortgage PPI, but it does little to strengthen consumer protection. Also, there is no specific statutory legislation governing the sale of PPI, and the voluntary codes from the Association of British Insurers and the General Insurance Standards Council are, in practical terms, worthless. This means that, when it comes to PPI, our consumer protection is inadequate.

PPI is normally "assumptively sold", with premiums often being added to loans without our awareness or prior permission. We will normally be quoted repayments with PPI already included, effectively establishing an "opt out" or "negative option" strategy.

Furthermore, the staff selling these policies are often poorly trained, have little knowledge of the cover on offer, and rarely bother to check to ensure that products meet our needs. Thus, we consumers usually receive incomplete information and little or no advice at the point of sale. Also, promotional literature for PPI can be misleading and often omits some of the vital information we require in order to decide whether the protection being offered meets our needs.

This is a big problem because we're being sold off-the-shelf "one size fits all" products. Usually, with other products such as life, travel and medical insurance, the policy is personalised to match our requirements (what insurers call "individual underwriting"). This lack of customisation with PPI probably goes some way to explaining the soaring level of complaints about it to the Financial Ombudsman Service.

The PPI swindle is vast: I estimate that there are over 25 million policies in force in the UK - that's one for every British household. This is why I believe PPI to be another massive financial services scandal, perhaps on the scale of the mis-selling of personal pensions and mortgage endowments.

Recently, the Office of Fair Trading (OFT) instructed the Competition Commission to conduct a wide-ranging inquiry into the sale of extended warranties, an £800m-a-year market. As the PPI market is around five times as big, I believe that the OFT could get an enormous "bang for its buck" by launching a similar inquiry into PPI.

Who knows, perhaps the OFT will soon be frying bigger fish!