One of the sad ironies of the financial markets is that the people who need the most support are normally offered the least because of the poor risk they represent. There is little arguing the economics involved, although often the barriers to consumer protection are overly prohibitive and fail to truly represent the potential risk taken on by providers.
This is certainly true in the case of payment protection insurance (PPI) and given the startling rise seen in the number of insolvencies and particularly Individual Voluntary Arrangements (IVA), a real effort must now be made to close the protection gap and provide affordable and effective protection.
Potential threat
According to figures from The Insolvency Service, 12,228 people took out an IVA in the third quarter of 2006, representing an increase of almost 118 per cent on the same period in 2005. When one considers that prior to 2005 there had never been more than 4,000 IVAs registered in a single quarter, the potential threat becomes apparent and unless we take fast remedial action there will be huge consequences for thousands of individuals snared in debt and for the market and economy as a whole.
But why have people turned to IVAs in their thousands and how do they work? An IVA is a contract between a debtor and their creditors through which a percentage of the debt is repaid in monthly instalments. The repayment is about 40p in every pound of debt and once the term of the contract has been honoured the remaining debt is written off.
For an IVA to come into effect, 75 per cent of the debtors have to agree to the proposal and the normal term is five years. For debtors the attraction of an IVA is that in most instances they are allowed to retain possession of major assets such as their home. The costs associated with an IVA are also lower than those related to bankruptcy and the commercial implications are less stringent. Following IVA completion it is possible for a person to set up a firm or act as a director, while finance can be arranged more easily than for a discharged bankrupt.
Given the trillions of pounds that the British public now owes, it is little surprise that IVAs have moved away from being the preserve of sole traders for whom they were first developed in the 80s, and are now the chosen vehicle of non-commercial debtors who have hit the buffers.
Doing more for consumers
One thing the mortgage market cannot be accused of is being slow to recognise a lending opportunity and the explosion in IVA numbers has seen providers offer products specifically to this sector. There is nothing wrong with this and for those exiting an IVA, the growing options available will help create a competitive choice for them. However, we should be doing more to ensure people do not need an IVA in the first place.
This not only means that much better protection mechanisms have to be put in place for those taking out personal loans and running up credit card debts, but also for those entering into mortgage agreements. Somewhere in the region of 75 per cent of mortgages are now arranged through brokers and they have a duty to ensure they not only find the most suitable product for their client, but also that they have the ability to service it through the good and the bad times that undoubtedly lie ahead.
In turn, insurance providers have a duty to provide products which represent good value and meet the needs of borrowers rather than simply offering cover, which through a process of unjustifiable financial alchemy turns into golden profits.
According to the Council of Mortgage Lenders, around £300 million is being delivered annually to borrowers through mortgage PPI policies. Considering that Datamonitor estimated £800 million was taken in premiums during 2003, it is not difficult to see how mismatched the product is to the needs of borrowers. If the market were truly competitive and real value was being delivered, then it is difficult to believe providers would be able to walk away with £500 million in their pockets after paying claims.
Taking protection seriously
We must be as serious about protecting consumers as we are about arranging the debt they need to purchase property. There is no reason why cheaper and more flexible products cannot be launched, other than providers’ desire to make huge profits. The irony is that much of this profit would be sustainable if margins were cut, products improved and greater volumes sold. Consumers want to protect the debt they take on and the homes they live in, but not at a price they cannot afford. At the moment the industry is sitting back and waiting until the Competition Commission overhauls its processes and procedures, rather than taking it upon itself to make changes.
It remains a mystery how this can be ‘Treating Customers Fairly’ and it can only be hoped that those refusing to offer the value that borrowers really need will be forgotten by brokers looking elsewhere in the market for solutions that represent a cheaper, more flexible and more effective deal for their clients.
With insolvencies on the rise and repossessions and arrears following hot on their heels, providers should be looking to close the protection gap that exists in their market as soon as possible.
Simon Burgess is managing director of Britishinsurance.com
