Recent research from Moneyfacts revealed that loan payment protection insurance premiums are around three times more expensive than those for mortgage and income protection. Why is this? Is it another example of banks and building societies looking to make a quick buck or is there a good reason why loan protection premiums are disproportionately high?
Rather than jump to conclusions and be accused of offering a ‘knee-jerk’ reaction viewpoint, I’ve discussed statistics and rationale with research professionals, considered the Office of Fair Trading’s (OFT) responses and spoken to industry trade bodies.
Apparent discrepancies
In its February 2006 report ‘Payment Protection Insurance (PPI) in the UK’, Defaqto highlighted that ‘loan cover was three times more expensive than mortgage protection’ and ‘the most expensive loan policy cost 150 per cent more than the cheapest’. At the time, consumers would have been unable to directly compare loan protection premiums with mortgage and income products, but following September’s publication of Moneyfacts’ data, the premium discrepancies for loan cover have became all too apparent.
And before banks and building societies ask why they have been singled out – in its August 2006 market study on the market, the OFT announced that ‘80 per cent of all payment protection insurance (PPI) policies are provided by high-street banks and building societies’ and ‘the top six PPI insurers earned around 85 per cent of the gross written premiums earned in 2005’.
We’re all aware of the ‘in-house’ manufacturing and insurance arrangements of the key players, so having identified ‘they’re in control’, I’m keen to understand the rationale behind the price variations.
The sums assured on loan protection are less, so shouldn’t the risk be lower and more accurately reflected in the premiums? No, say providers. Consumers are more likely to default on a loan and lose their car, for example, than default on their mortgage and lose their house. Fair argument, but as the OFT and Financial Services Authority (FSA) says – why are you treating people who are good insurance risks as bad?
Not ringing true
I appreciate that loan policies provide life cover, whereas mortgage ones don’t, so you could argue that the life element costs more and there’s extra administration involved. But Defaqto is quick to point out that life cover costs do not equate to the premium difference and Moneyfacts advises that the sales process is indeed easier as there are fewer questions to ask. Having heard ‘stock answers’ of needing to cover distribution, training, premium collection, printing, IT and marketing costs, I’m certain they do not ring true. Why would these costs be three times higher than other payment protection policies?
Perhaps loan protection costs more because the policies run for the lifetime of the loan as opposed to the standard 12 months – representing a longer repayment exposure. Bearing in mind the OFT cites an 18 per cent claims ratio for unsecured personal loans and 10 per cent for secured loans, I suggest the level of potential exposure is remarkably low. Defaqto agrees. It calculated the cost of borrowing £5,000 over four years and added the average PPI premiums onto the lifetime of the loan (reflecting a common business practice). Feedback suggests that consumers would end up paying between £670 and £2,500 in premiums (including interest) on top of their original loan and in many cases, to recoup this extra cost, a claimant would need to be unemployed or sick for at least one and a half years out of a five-year period.
Many policies in the market restrict cover to 12 months, so this argument also falls flat. On an actuarial basis, the costs are difficult to justify, so the answer must be commission. The OFT reports that the median commission rate for single premium policies is 66 per cent.
Put simply, loan premiums are high because it is a huge money earner and the providers can get away with it. Industry trade bodies, such as the British Insurance Brokers’ Association, consider these practices to be ‘consumer detriment at its worst’ and is constantly lobbying for the de-linking of single premium policies.
Dictating the terms
But those who have the market share believe they can dictate the terms and conditions for how their policies are sold. Datamonitor suggests the PPI market is worth around £5.5bn and loan protection accounts for approximately £3-£4 billion.
All banks and building societies have sales point scoring systems and loan payment protection policies are one of the best point earners. It comes as no surprise to find that over 87 per cent of unsecured loan providers automatically include PPI in their quote and around 90 per cent of consumers take out PPI from their credit provider.
However, providers should not become complacent. The FSA will penalize firms who do not treat customers fairly (as the recent £56,000 Regency fine demonstrates), and the OFT is scrutinising pricing and commission structures. Organisations must take the initiative to resolve their product and pricing variations, before the regulators step in and enforce change.
Today’s consumers are becoming increasingly aware that they are being ‘ripped off’ and from the feedback I have gained, there is no rationale for the price variations between the policies – it’s simply greed.
