Ian Moffatt is
managing director of Assurant Solutions
The UK payment protection insurance (PPI) market has received an unprecedented amount of attention over the past 14 months, since the Citizens Advice Bureau (CAB) lodged its ‘super complaint’ with the Office of Fair Trading (OFT) in September 2005.
The outcome of the OFT’s subsequent market study will be published in December, and the results of the Financial Services Authority’s (FSA) second phase review into PPI are imminent. The interim reports have raised a number of key concerns and led to speculation as to the likely consequences, particularly in relation to a subject close to the heart of many industry players – commission levels. Will the OFT refer this issue to the Competition Commission and if so, will this ultimately force rates down? Good news for consumers perhaps, but in reality, how would such a move impact the PPI market?
Disparity in commission
The UK PPI market is worth an estimated £5.5-£6 billion according to Datamonitor. While mortgages account for the largest lending amount, mortgage payment protection insurance (MPPI) is only worth about £800,000 of this total value, meaning that the vast bulk of the value in the market is made up of PPI sold alongside credit cards and personal loans – the sector of the market that charges the highest levels of commission. The recent OFT report highlighted median commission rates for regular premium policies of up to 70 per cent for retail credit although the mortgage market is not in the clear. The huge disparity in the levels of commission charged is also evident here, ranging from as low as 20 per cent to as much as 80 per cent.
So what would be the result if the OFT chose to refer the issue to the Competition Commission, and it in turn decides to force commission down to levels already being charged by some of the newer online entrants to the market, of around 25 per cent? Such a ruling would impact the current overall market by over £2 billion.
Commission represents a significant issue for the industry to address – or be forced to address – particularly as variances in rates do not appear to reflect any difference in product quality. An insurance policy tailored to meet the needs of an individual customer can be less expensive than traditional ‘one-size fits all’ accident, sickness, and unemployment (ASU) cover. London Economics surveyed payment protection products in the personal loans market on behalf of the OFT – all offering similar cover and similar benefits, and yet the price of the most expensive policy was four times that of the cheapest policy.
True cost or plain greed?
So, are these variances due to greed on the part of the distributor, or do they mask the true cost of distribution? KPMG in its PPI Sales Practices Survey in June 2006, points out that providing face-to-face advice and establishing the suitability of a product for a customer increases the cost of sale, which the customer will bear in the long run. It also highlights the range of services that distributors provide in addition to the sales process itself such as premium collection, policy administration, even branding, and cite these as costs that should be borne in mind when looking more closely at the levels of commission charged.
Yet whether the cost of these services can really defend commission levels is up for debate, and, if they do not represent a viable argument, what else could influence the high levels of commissions charged by some distributors?
Rather than masking costs of services, are they actually masking the cost of offering low APRs and zero balance transfers in order to attract and secure customers? Research by both the OFT and Defaqto found that some loans which advertise very low headline APRs become much more expensive when PPI is added to the loan. Arguably, these distributors simply would not be able to provide these price-led propositions if not supported by the insurance element of their offering that underpins the low APRs. Can this type of business model withstand the impact of a dramatic reduction in commission levels?
In a more transparent business environment that should have the customer’s interest at heart, these very high levels of commission cannot be sustained particularly if there is no apparent difference in benefit between an expensive cover and a cheaper policy. The natural outcome surely has to be that interest rates on personal loans and credit cards will increase, and the value of the PPI market will reduce as commission levels come down and products become cheaper.
It is fair to assume that lower cost products will lead to greater take-up as the value perception among consumers changes. While the actual value of the market will fall, volumes should increase and counterbalance this reduction. Still, if the protection product itself does not suit the need of the individual, how long will this value perception remain?
Rush of new activity
The PPI market has seen a rush of new offerings come to market over the past 12 months, despite all the negative publicity. These new entrants are predominantly standalone providers operating web-based business models. They seemingly have pre-empted any potential action by the OFT or Competition Commission, not only by charging vastly reduced commission rates but also in driving different levels of value into their offering. They provide consumers with new levels of choice and flexibility to allow them to tailor insurance cover to suit their individual needs and budgets. If greater transparency is forced upon the market, consumers could see greater value in buying protection products from these new online providers. Meanwhile, traditional distributors could well see their market share eroded unless they address the design of the products they offer as well as the ultimate price charged to the consumer.
No one wants to see a price-war, nor is it in anyone’s interest – especially the consumer’s – to see cheap products introduced at the expense of the quality of cover provided. A balance must be struck between product design and product price – allowing consumers the freedom of choice to select the cover they need at a price they are comfortable paying and allowing distributors to generate sustainable volumes of business.
While the size of the market is likely to reduce, PPI can continue to represent a viable income stream for distributors if we reach an appropriate balance between product design and price. More importantly, PPI can continue to play a strong part in helping consumers protect their debt in the future.
* Payment Protection Insurance Sales Practices Survey - June 2006
