Good idea, poor deal

The reputation of loan payment protection insurance (PPI) lies in tatters and some tough decisions are needed if it is to ever regain its credibility.

As is often the case, the product itself is not inherently bad. Instead, it is the way it is sold and the perceived high cost and poor value on offer from some suppliers that have led to its fall from grace.

The negative publicity has infected the entire sector of the market, in particular dragging down sales of mortgage payment protection insurance (MPPI) despite the FSA giving it a general thumbs up.

Clive Briault, the FSA's managing director for retail markets, said after last year's mystery shopping exercise that payment protection insurance "can provide worthwhile cover for consumers" and he added: "We were therefore pleased to see that sales of regular premium PPI sold with prime mortgages are generally compliant."

It was the area of single premium PPI business that attracted his criticism about lack of compliance and his warning that those firms where problems exist "must take urgent action to address them".

In the headlines that followed the FSA's investigation, the positive message about MPPI was totally lost. A recent survey by Paymentshield of more than 1,500 consumers and 250 brokers found, of the 47% of homeowners aware of the regulator's criticisms of PPI, nine out of ten believed that criticism applied to all PPI products including MPPI.

The FSA's failure to differentiate between the good and the bad has important ramifications, and not just for an industry hit by falling sales. At a time of rising unemployment, the unfairly hostile attitude towards MPPI could ultimately lead to many people being unable to meet their mortgage repayments.

At present the FSA and the Office of Fair Trading (OFT) are looking closely at the market, raising the hope that something worthwhile can be salvaged from the wreckage.

The PPI market is huge. There are about 20 million policies in force, generating
premiums in excess of £5bn a year for a market dominated by banks, building societies and credit card companies.

Healthy demand
This should indicate healthy demand from borrowers who want to guard against the possibility they will not be able to make loan repayments if they lose their income. Instead PPI has become renowned as a fantastic money spinner for the lenders rather than as a sensible protection tool for consumers.

There have been a host of damning reports and statistics. Investment bank Morgan Stanley reported that up to a fifth of banks' retail profits are generated by PPI sales.

The OFT itself found firms offering PPI pay out only 15% of the amount they make in premiums compared to 74% for motor cover and 55% for household.

Financial research company Defaqto said recently that consumers are wasting £350m a year in premiums on PPI policies that don't pay out, mainly due to the policy being sold to someone who would not be able to claim or due to exclusions in the small print.

It is obvious that steps need to be taken quickly to help restore the public's confidence.

The FSA is looking hard at sales practices to ensure that advisers selling the policies make sure they are suitable for borrowers, and to dissuade companies from offering incentives programmes that may lead to high-pressure selling or targeting consumers who are ineligible to make claims after paying their premiums.

But it should go further than this. Banning single-premium PPI - which came in for particular criticism last year - would be a good step.

To begin with, single-premium PPI tends to earn large commission. But also, in many cases, borrowers are persuaded to add the up-front cost of a single-premium PPI policy to the loan. The problem is that borrowers then pay interest on the cost of the insurance as well as on the loan itself.

This is obviously good for the lenders, but totally unfair on the borrower; especially given the fact in many cases they repay the loan early or transfer to another provider and are not refunded the full cost of the premium.

The same happens with MPPI but, if anything, the effect is magnified by the size of the loan and the type of customer. Single-premium MPPI is mainly sold in the sub-prime mortgage market and the higher client risk is reflected in the premiums.

Borrowers in this sector of the market are often just thankful the lender is offering a loan - they can't easily go elsewhere and will willingly sign up for whatever cover they need in order to secure the mortgage. Typically the cost of five years of cover is added to the mortgage at the start of the loan, leading to higher interest payments.

Within the five years the borrower often builds up a good payment record and will seek out a mainstream loan at a better rate. But remortgaging usually means the loss of the premium or, at best, a refund at short-term cancellation rates. Again this is good for the lender, bad for the consumer.

Buildings insurance
Lenders argue that selling single-premium PPI is a legitimate way to make sure the customer will be able to afford the repayments if the unexpected happens. The reality is that it is making borrowers pay through the nose.

Along similar lines, we have been approached about the possibility of offering a long-term buildings insurance policy that can be added onto a loan. We have refused on the basis that this too is an obvious ploy to win more commission and interest, again to the detriment of the consumer.

The PPI market has been brought to its knees by the bad publicity, but there are now encouraging signs with recent product launches demonstrating the market can be competitive and act in the consumer interest.

The FSA and the OFT should use their investigations as a chance, not only to rid the market of its worst excesses, but to educate and inform the public so that they learn to recognise and refuse these poor deals. IT

' David Quick is managing director of Central Electronic Trading Agency (CETA)