Criticism of the payment protection insurance market

The Office of Fair Trading (OFT) recently received a super-complaint from consumer group, Citizens Advice (CAB), concerning the payment protection insurance (PPI) market. In addition, FSA has recently concluded that sales practices for PPI are "very poor" in most sectors.

The super-complaint makes numerous criticisms of the current market, including:

• The sales process - the 'take it or leave it' sales pitch of these products means that customers are given little opportunity to assess the comparative merits of other policies on the market and are often mis-sold policies under which they are not eligible to claim.
• Product design - many PPI products exclude the most common situations in which people find themselves unable to service their debt. In any event cover, when given, is often insufficient when customers encounter the most severe problems.
• Price - the cost of PPI often represents a large proportion of the associated credit and lenders will often charge additional interest on the premium.
• Value for money - many PPI products give poor value for money and could ultimately lead to increased debt.

Recommendations to tackle these problems have been put forward in the report and CAB has demanded action from FSA, OFT and the Treasury Select Committee. Insurers, finance companies and retailers may face:

• Enforcement action by FSA and/or OFT in relation to current or past sales practices or products. FSA is already looking at selling practices and compliance with FSA's existing rules (i.e. ICOB) in the PPI market (as part of its themed supervisory work). FSA's campaign to improve PPI will begin in November. It has already stated that it would prefer a market solution to the problems it has identified.
• New regulation introduced by FSA and/or the Competition authorities. The Competition Commission investigations into extended warranties on domestic electrical goods and store cards (which is already looking, unfavourably, at payment protection insurance in this sector) are obvious precedents. Following a Competition Commission investigation, there are widespread powers including price control but one would normally expect remedies to focus on additional rules on enhanced price disclosure and attacking inertia sales/unbundling.

The preliminary findings of the Competition Commission in its store card market inquiry were published last week. The Commission finds that there is a lack of competition in relation to PPI pricing in this sector and remedies/new rules are therefore expected. The report highlights the bundling of coverages in one insurance (with the result that consumers are paying for some coverage which they do not need or for which they are not eligible) and the particular problems of monthly premiums which are a % of the outstanding monthly balance on the card (a formula which independent insurers have difficulty offering as they do not have access to the monthly balances figure).

A Competition Commission reference is the most likely way to evaluate competition, price and competition based remedies (although FSA now has overlapping jurisdiction). This will take time as the current inquiry is limited to the narrow store card sector.

Firms will be concerned about the lack of clarity for the market. The outcome of the FSA project and the store card investigation will be important. It seems likely that finance companies (and their insurer providers) will find the profitability of PPI sales under attack. From a compliance perspective, firms will be hoping that FSA will not, at this stage, go beyond enforcement of its conduct of business rules (ICOB) which regulate the PPI sales process. If CAB's analysis is correct, action under FSA's "treating customers fairly" principles could result in retrospective action against much of the market for poorly designed processes

The CAB report

'Protection racket – CAB evidence on the cost and effectiveness of payment protection insurance' has been compiled from evidence submitted nation wide from CAB field offices, between January 2004 and April 2005. It is worth noting much of the evidence was therefore obtained before FSA took over regulation of the sale of PPI and during the Competition Commission investigation into the store card market and associated insurance, both of which have arguably already led to significant improvements in sales processes and product features.

Below is summary of the report's main points and recommendations, with some initial CMS Cameron McKenna thoughts.

The sales process - lack of choice and mis-selling

The report notes that most PPI policies are sold with a particular credit product. The consumer is given no opportunity to 'shop around' and is offered PPI on a 'take it or leave it' basis. Consumers are therefore cajoled into making this purchase without the information necessary to make a comparative judgment on its value.

In addition, PPI products often exclude claims arising from bad backs, mental health problems, pre-existing conditions and employment patterns and do not cover borrowers above a certain age. These categories cover some of the most common circumstances in which a borrower will need payment protection.

From collated data, CAB assert that the mis-selling of PPI policies is closely connected to irresponsible lending practices. It also claims that the most vulnerable are at risk through pressured and ill-informed sales. Consumers are often sold policies which are inappropriate to their needs or for which they are not eligible (instances of policies being sold to customers over the age threshold are commonly referred to).

CAB recommendations

• Lenders should ensure their borrowers receive a level of cover that adequately protects them against indebtedness and performs at least as well as other products on the market, measured against objective criteria such as the number of policy benefits, the value representing these benefits and their duration and the premiums.
• FSA should develop a common insurance baseline product (to be reviewed regularly through consultation) setting out acceptable standards of content for PPI, covering all sectors of the consumer credit market and which should be incorporated into its system of rules for the conduct of insurance business. CAB notes that FSA is concerned with standards for product content through its treating customers fairly initiative, believing that blanket exclusions are incompatible with treating customers fairly and should be prohibited by a regulated baseline product. CAB has recommended its own fair baseline product.
• FSA should review the regulation of PPI sales to ensure that no borrower is sold a policy that excludes them from cover on the basis of their circumstances at the time of the sale – this would require some form of eligibility/suitability assessment for every sale.
• Lenders should be required to provide borrowers with a questionnaire containing a full list of circumstances which might make the policy unsuitable. A sale should not be concluded until completion of this questionnaire, an assessment has been made by the insurer or lender and such assessment communicated to the borrower (the report does not explain precisely what is to be assessed although it does refer to a 'suitability questionnaire' which seems to suggest that the assessment should be one of suitability rather than just eligibility).
• PPI policies mis-sold should be honoured (meaning cover should be granted) as if the borrower had not been excluded by circumstances referenced in the suitability questionnaire or where no suitability questionnaire was completed. This commitment should be incorporated into the relevant credit industry trade association codes of conduct (e.g. the Banking Code).
• OFT should develop guidance on the sale and conduct of PPI products which would be consistent with fitness to hold a consumer credit licence.
• The policy summary for PPI should clearly set out all exclusions – this goes against FSA's current thinking which is to keep all key features and policy summaries short in the hope that the customer reads them. FSA evidence suggests that more information may actually lead to less well informed consumers.

Arguments against these recommendations include the fact that FSA already has a sales process in place which requires cost, cover and principal exclusions to be explained to customers at point of sale so that customers can make their own choice. CAB seems to want to prohibit 'non-advised' sales of PPI, so that some form of suitability check would always be required. This would result in increased costs (through more thorough training and a longer sales process) and a number of customers ending up uninsured because they have no inclination to complete a lengthy sales process. The idea that all lenders should offer a product that "performs at least as well as other products on the market" (a concept flowing from advised rather than non-advised sales) in not feasible in a competitive market and would lead to all products becoming virtually identical (itself anti-competitive?).

Value for money

A study of products offered by major lenders revealed that it was difficult for borrowers to assess the value of the cover against the price paid for it. Upon examination of products offered by major lenders in conjunction with revolving credit facilities, it was noted that a borrower could spend up to £85 per year to obtain a £12 reduction in debt over a similar period. In respect of fixed sum credit agreements, a similar examination of products revealed that the PPI premium could represent between 13% and 47% of the loaned value.

The variation in both the price and extent of cover of available PPI suggests that consumers may be in a better position if they had access to comparative PPI information and were thus able to put pressure on those lenders selling products which are more expensive or offer lower standards of cover. Further, a greater awareness of alternatives such as stand alone PPI or income protection policies might aid consumers in obtaining better protection against credit default risk.

CAB recommendations

• The 'Key Facts' document for PPI policies sold with revolving credit agreements should give brief scenarios of the overall costs of the policy – as with other recommendations, this will increase the length of the policy summary and, therefore, the likelihood of it not being read by the consumer.
• FSA should establish and publicise comparative tables for PPI and alternative products insuring against credit risks. This should be in addition to an obligation to highlight, on PPI marketing material, that a better deal might be available elsewhere, directing the customer's attention to the FSA information.
• From evidence gathered it appears that the credit industry is more interested in the profitability of PPI rather than its effectiveness as a safeguard against indebtedness. Figures quoted in the Competition Commission Inquiry into the store card market suggest that savings could be passed onto borrowers and therefore the FSA should establish a PPI stakeholder product with charges capped at an economic level.

CAB places significant emphasis on the fact that commission is often 3 to 4 times net premium. This split of income may, however, not be unreasonable given the costs and risks incurred by the intermediary, such as the time spent by intermediary staff in the sales process (likely to be extended considerably if CAB's recommendations are adopted); training requirements to ensure staff satisfy FSA rules; the need for compliance and monitoring of the sales process against FSA requirements; advertising costs and costs associated with document production (as required by FSA rules); and the risks associated with mis-sales, complaints and a consumer friendly Ombudsman.

Making a claim

Problems with insurance policies frequently do not come to light until it is time to make a claim. The report claims many PPI products include unreasonable and costly requests for medical evidence and there is often a delay in payment.

CAB recommendations

• FSA develops clear guidelines which set out when it is reasonable to request additional evidence and when it would be unfair.
• The Association of British Insurers establish a 'quality mark' scheme to supplement FSA regulation addressing problems with claims administration and adjudications

The regulatory gap

• CAB believes that good practice cannot be left to the market place but that there is a clear co-ordination role for regulators. Since PPI straddles the jurisdiction of several regulatory regimes covering insurance, consumer credit and competition, 'no single regulator has their eye on the whole ball'.
• CAB recommendations
• FSA and OFT work closely in developing guidance on standards of conduct for all lenders promoting and selling PPI along with a joint regulatory strategy to ensure that the content of the policies offered are fair to all their customers.
• FSA investigates whether PPI policies are treating their customers fairly in respect of product design, price, the extent of risks covered and in particular the operation of exclusion clauses.
• The Treasury Select Committee investigate PPI as a pressing matter in its own right.

Super-complaints – what next?

This summary is taken from OFT guidance. Readers may find it useful to review this document, available on the OFT website at www.oft.gov.uk

What is a super-complaint?

Defined by section 11(1) of the Enterprise Act 2002 (EA), it is a complaint, submitted by a designated consumer body that, 'any feature, or combination of features, of a market in the UK for goods or services is, or appears to be, significantly harming the interests of consumers', 'any feature' may be:

• the structure of the market concerned or any aspect of that structure
• any conduct (whether or not in the market concerned) of one or more than one person who supplies or acquires goods or services in the market concerned, or
• any conduct relating to the market concerned of customers of any person who supplies or acquires goods or services

The super-complaint process is intended to be a fast-track system for designated consumer bodies to bring to the attention of the OFT market features that appear to be significantly harming consumers.

How will super-complaints be handled?

Upon receipt of the complaint, the OFT will examine the contents of the complaint in more detail to establish whether it meets the criteria set out in section 11 of EA. All the criteria must be satisfied before the complaint can receive super-complaint status. If the criteria are met, the OFT will assess the information provided and decide if it can proceed on the basis of this information or whether further evidence or clarification is needed. At the same time, the OFT will also assess whether the super-complaint is frivolous or vexatious.

Further information or clarification may be required from the super-complainant. The OFT will also carry out wider enquiries to test the evidence initially provided and to reach a view on whether further action is justified. This may involve internal research, public requests for information, or approaches to any relevant businesses or trade associations, consumer organisations, trading standards departments, government departments and/or other public bodies for information.

Within 90 days OFT will publish a response stating what action, if any, it intends to take.

Consequences of a super-complaint

Possible outcomes of a super-complaint could include:

• launching a market study into the issue to obtain more information
• making a market investigation reference to the Competition Commission if there is a competition problem, similar to recent investigations into store cards and extended warrant products
• referring the complaint to FSA
• finding the complaint requires no action or is unfounded
• dismissing the complaint as frivolous or vexatious

This is list is not exhaustive and a super-complaint could lead to more than one outcome.