Payment protection insurance is under scrutiny as never before; and now the complaints have reached the ear of the OFT, write David Heard and Vanessa Evanson-Goddard
For over 10 years, various consumer protection bodies, including the Citizens Advice Bureau, have been concerned about sales of payment protection insurance (PPI). In addition, for more than five years, both the Insurance Ombudsman and the Financial Ombudsman Service have been receiving and investigating complaints about the mis-selling of PPI.
Indeed, in February 2000 an extensive report was released by the consumer credit division of the Office of Fair Trading (OFT) into the bundling of PPI with loans and discounted annual premium rates (APR) being quoted as a result. Most recently, the Competition Commission's inquiry into store card credit services has highlighted issues relating to PPI.
As a result of recent developments, however, it now looks as if we can expect regulatory action in this area. Whether such regulatory action will amount to a full mis-selling review, in the same vein as the pensions and endowment reviews, remains an open issue.
In September of this year, the Citizens Advice Bureau lodged a formal "super-complaint" with the OFT in connection with PPI and called for a government investigation into the market, which it described as a £5bn "protection racket".
The Financial Services Authority, having assumed regulatory responsibility for the selling of general insurance products such as PPI in January this year, also initiated a review of PPI selling practices.
The allegations
PPI, otherwise appearing in the market as income protection (IP) cover, mortgage payment protection insurance (MPPI), or accident sickness and unemployment (ASU) cover, has been sold in connection with debt obligations for many years. It differs from classic IP insurance or critical illness cover in that it is tied to a particular debt obligation and ought to be clearly distinguished from other insurances (such as purchase protection and price protection) offered on a credit sale.
The various allegations of mis-selling that have recently been published include suggestions that:
- there are an array of "hidden charges" and "sneaky exclusions"
- consumers are being "unfairly pressurised" and many are precluded from claiming from outset
- 70p in every £1 spent on PPI goes straight on to the lender's bottom line
- PPI premiums can be as much as 25% of the finance and are often added to the principal of the loan;
- less than 5% of policyholders ever claim, and
- lenders make as much as 20% of all their profits from PPI.
Furthermore, a wide range of clear examples of PPI mis-selling have been quoted in the press.
The defence
Notwithstanding these allegations, the industry's position is not indefensible. In particular, industry representatives would argue that PPI cover is optional, not compulsory, and that this is generally made clear. Furthermore, in many instances PPI cover does provide valuable benefits.
PPI costs and terms, particularly exclusions, are disclosed and the industry ought not to be held responsible for consumers' failure to read disclosures - the principles of caveat emptor have traditionally formed the bedrock of insurance contract law as much as they are an integral part of general contract law.
The industry can also cite numerous examples of policyholder fraud in the area of PPI - we have all heard stories of employees taking advantage of sick leave to improve their squash game. Such fraud, of course, increases the administrative burden of policing claims and adds to underwriting costs.
The Citizens Advice Bureau's super-complaint was lodged with the OFT in September 2005. The OFT has 90 days to respond but no response has so far been published. In addition, the final report from the Competition Commission on store card credit services is expected early in 2006.
The FSA has already instigated a review of PPI mis-selling. It has undertaken visits to 45 firms offering PPI in connection with debt obligations and found the industry to be generally compliant, but noted some instances of clear mis-selling.
Further investigation included more firm visits and inquiries by way of mystery shopping carried out by the FSA, which found that poor selling practices were rife in this sector.
What next?
It remains to be seen what will emerge from these recent developments. Nevertheless, one may well speculate as to likely outcomes.
First, it seems likely that the OFT will come out with recommendations, with regard to PPI, similar to its response in recent years to extended warranty selling. One can envisage OFT requirements in respect of the unbundling of PPI sales from offers of credit services. One might also speculate as to whether or not pricing regulation (which generally falls outside the remit of the FSA) may be imposed by the OFT.
It may well be that a PPI inquiry will result in the UK's first foray into prescriptive premium regulation in the same way that certain kinds of general insurance premiums are prescriptively regulated in the US. Generally, however, UK regulators have attempted to avoid that degree of prescription.
Secondly, the FSA currently appears to favour an industry response to the issue rather than a regulatory one. Given the recent introduction of FSA general insurance regulation (consequential upon the January 2005 implementation of the EU Insurance Mediation Directive) it is unlikely that any PPI mis-selling review will have the same degree of retrospectivity seen in the circumstances of pensions and endowment mis-selling reviews. What does seem likely is that the PPI sector will be subjected to enhanced regulatory supervision and that considerable focus will be added to regulation of PPI sales practices and the training and competence of those involved in such sales.
The FSA has hinted strongly at prospective tightening of the relevant rules (currently found in the FSA's Insurance Conduct of Business) but that any rule changes will be subject to the usual cost/benefit analysis.
Perhaps the most alarming idea raised by the FSA to date is the mention of the Treating Customers Fairly initiative and its potential scope and impact in the PPI field. It should also be noted that the FSA is embarking upon a general review of its insurance mediation regulation as it has been implemented and applied during the course of the current year.
Difficult prospect
Those involved in the PPI industry can expect tougher times in the future. It would appear that the days of easy PPI sales, if they ever existed, are history and that extensive conduct of business compliance will be required in respect of PPI selling. We can expect further emphasis on disclosure pre-contract, training and competence standards for sales personnel and more focus on suitability in particular.
Current industry practice is also likely to change. The viability of the currently quite common practice of adding PPI premiums for the term of a loan to the principal of the advance at outset is especially questionable. The offering of PPI at the final stages of loan negotiations (which increases the prospect of a "pressurised" sale) is also likely to cease. The current broad descriptions of some covers may also be modified to more closely reflect the limitations and exclusions applicable to those covers.
Now is the time for insurers and intermediaries to focus on compliance issues. Although it will be more difficult to effect PPI sales in an increasingly regulated world, where there remains a consumer benefit PPI sales can still be justified, subject to strict compliance monthly monitoring. It must, however, be acknowledged that sales revenues and underwriting profit in this sector are likely to be thinner in the future.
Vanessa Evanson-Goddard, associate at Reed Smith UK Financial Services Group.
David Heard is partner and head of Reed Smith UK Financial Services Group.
