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These are extracts from the October 2006 report by the OFT into Payment Protection Insurance (PPI). The extracts are primarily relevant to Secured Loans Only. For a complete copy of the report visit the OFT website. 

1 EXECUTIVE SUMMARY

This market study looked at how well competition in the Payment Protection Insurance (PPI) market delivers choice and value to consumers. The purpose of this report is to set out the OFT’s findings from the market study and explain why it is minded to refer the market to the Competition Commission (CC) for a market investigation.

The OFT’s findings

1.2 PPI is a sizeable market with gross premiums estimated at £5.5bn. There are indications that consumers receive poor value in the low proportion of premium income paid out in claims (of the order of 20 per cent), and we have identified features of the market which adversely affect competition and appear to lead to poor value. The evidence suggests that how consumers purchase their PPI, their understanding of the product and the quality of information available to them hinders competition. We have estimated that the potential consumer savings from making the market more competitive could be around £1bn.

The case for a reference

1.3 The OFT is minded to refer the market for the supply of PPI in the United Kingdom. It is however minded to exclude store card PPI 2 from a reference to the Competition Commission (CC).The OFT has based its decision to consult on features of the market that might be preventing, restricting or distorting competition and thereby harming consumers. In deciding to consult on a reference, the OFT has taken account of the views expressed by insurers, distributors 3 , intermediaries 4 , trade associations and consumer organisations.

1.4 In summary, our research has indicated the following features of the PPI market which cause concern:

How consumers purchase their PPI, their understanding of the product and the quality of information available to them hinders competition:

o consumers do not shop around for the best deal on PPI. A contributing factor to this is the huge point of sale (POS) advantage enjoyed by distributors

o the complex nature of PPI makes comparison between different policies difficult

o there is a lack of upfront (advertising) information on PPI i.e. before the consumer has decided to sign up for the credit, although the FSA’s rules require firms to provide consumers with information about PPI in good time before the sale is concluded

o consumers display poor understanding of PPI, its price and the detail of their cover, with suppliers initially doing little to remedy this situation

o consumers appear only to consider the APR of the credit and not the cost of PPI or the cover it provides o consumers in some cases either assumed or were told or given the impression by the distributor that taking out the PPI would help the application for credit. While there may be competitive pressure operating at the upstream end of the market, we saw no evidence that this pressure is feeding downstream to consumers

o the POS advantage experienced by distributors means that there is little competitive pressure at the key point at which the consumer buys the insurance

o alternative products, such as income protection policies, are not direct substitutes in the sense of posing a constraint on PPI prices.

o stand alone 5 providers, who might otherwise be thought to offer a competitive pressure, have difficulty accessing consumers and face substantial start-up and marketing costs to attract custom

o present levels of cancellation or switching by consumers in this market do not exert any serious pressure on the prices of PPI. There are indications that consumers are receiving poor value from their PPI:

 o PPI has low claims ratios when compared to other insurance products, and with no evidence to suggest costs are high, it seems reasonable to assume that distributor profitability is sizeable with little evidence that this is being competed away

o commission rates paid by insurers to downstream intermediaries look high compared with other general insurance products

o the pricing of different PPI products cannot always be explained by differences in cover offered

o some unsecured personal loan providers, and possibly some credit card providers, are offsetting low margins on their credit offerings with profits generated from the sale of PPI, a less competitive market.

1.5 Under section 131 of the Enterprise Act 2002 (EA02), the OFT may make a market investigation reference to the CC where it has reasonable grounds for suspecting that any feature, or combination of features, of a market in the United Kingdom for goods or services prevents, restricts or distorts competition in connection with the supply or acquisition of any goods or services in the UK or a part of the UK. Section 131(2) 5 states that a feature of the market is to be construed as
a reference to:

(a) the structure of the market concerned or any aspect of that structure

(b) 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

(c) any conduct relating to the market concerned of customers of any person who supplies or acquires goods or services.

1.6 This does not mean that the OFT is obliged to make a reference in relation to every market which it believes meets the threshold set out in section 131. Rather, the OFT has a discretion whether to make a reference.
1.7 In guidance published in March 2003 6 the OFT said that it would make references to the CC only when the reference test set out in section 131 of the EA02 and, in its view, each of the following criteria have been met:

o it would not be more appropriate to deal with the competition issues identified by applying the Competition Act 1998 (CA98) or using other powers available to the OFT

o it would not be more appropriate to address the problem identified by means of undertakings in lieu of a reference
o the scale of the suspected problem, in terms of its adverse effect on competition, is such that a reference would be an appropriate response to it
o there is a reasonable chance that appropriate remedies will be available.7

1.8 Chapters 6 and 7 set out our views on the features of the PPI sector in the UK that we believe may prevent, restrict or distort competition, and on how the criteria set out in our guidance apply and we propose to undertake a reference.
1.9 Under section 169 of the EA02, where the OFT is proposing to make a decision on a reference to the CC it must first consult, so far as practicable, any person on whose interests the reference is likely to have a substantial impact. This paper sets out our proposed decision and invites comments by 30 November 2006. Comments should be sent to:

PPI Team
Markets and Projects
Office of Fair Trading
Fleetbank House
2-6 Salisbury Square
London
Second charge mortgage PPI

3.22 A second-charge mortgage is a secured loan which is guaranteed or ‘charged’ on the person’s home and constitutes the ’second-charge’ on the home.

3.23 The principal risks covered are life (L), accident and sickness (AS) and unemployment (U). The life cover generally pays off the outstanding balance on the loan in the event of a claim. The ASU cover provides a monthly benefit equal to the loan repayment outstanding. The AS benefit may be paid to the term of policy or it may be limited to a maximum number of months. Payment of the U benefit is generally limited to 12 months per claim.

3.24 PPI policies on secured loans generally involve a single premium paid up front for the term of the policy, which is commonly 60 months. The premium is generally calculated as a percentage of the loan. Results from our business survey indicate that 93 per cent of the PPI sold with secured loans is single premium.

Unsecured loan PPI, secured loan PPI, store card PPI and credit card PPI
Supply side considerations
5.11 On the supply side, the majority of PPI policies in these four markets are sold by lenders or credit intermediaries. Stand alone players are not a significant aspect of these markets.
5.12 The main obstacle to entry for PPI providers appears to be consumer access and this reflects the fact that most PPI policies are offered at the point of sale of the (primary) loan agreement.
 5.13 The consumer survey reveals that overall 88 per cent of PPI holders took out PPI at the same time as their credit product (thus presumably accepted the PPI product that was sold by the credit provider). The breakdown is as follows: 98 per cent for secured loans, 91 per cent for unsecured loans and 83 per cent for credit cards. This is reinforced by the industry that indicated in our business survey that over 90 per cent of PPI policies are sold at the POS of the credit product being insured.
5.14 Of those who didn’t take out their PPI at the same time as the credit, overall 73 per cent took out the PPI product offered by the credit provider at a later date. This is 67 per cent for secured loans, 79 per cent for store cards, 79 per cent for unsecured loans and 94 per cent for credit cards. This emphasises the point of sale advantage of the incumbent PPI provider that has established a sales relationship with the credit provider.38
5.15 Consumer access is particularly important in the case of credit card and store card PPI, for which the card issuer may be the only party in possession of information on the outstanding balance on the card, which is critical to setting the premium and calculating the claim payments. Any PPI product not sold by a card issuer would need to define cover and collect premiums on a different basis, e.g., on balances up to some predefined limit. Demand side considerations
5.16 In all four markets consumer search and demand side substitution between PPI products appears to be low. Businesses we spoke to indicated that the majority of consumers do not consider buying a PPI policy until it is mentioned at the point of the credit sale. Consumers only seem to shop around for low APRs on the credit product, rather than the cheapest combination of the credit and PPI.
5.17 This behaviour is symptomatic of the fact that the information relating to the PPI product is complex (a finding of our mystery shop survey). Moreover, a high degree of PPI product differentiation 39 , limited outside options (stand alone products) and extremely low advertising levels makes comparison between products very difficult and costly.
5.18 Product compatibility issues and costly search - PPI is rarely advertised - also significantly limit the scope for switching post sale. Unsecured loan PPI and secured loan PPI may feature additional switching costs associated with the fact that most of these policies are sold as single premium policies. Consumers do not generally currently receive pro rata compensation for early termination of a PPI policy with single premium policies. That is, consumers switching between unsecured loans or second charge mortgages cannot switch the PPI easily. System market qualities?
5.19 One lender has argued that the unsecured loan PPI market has system market properties. They argued that most lenders take a holistic approach to price setting: ‘the APR’s on loans are based on what consumer characteristics reveal about the expected risk of default and likely PPI take-up on the portfolio.
5.20 We are unconvinced that the unsecured loan PPI market is akin to a system market. Simply because a firm chooses to take a holistic approach does not mean that there is a competitive constraint acting on the price of the PPI. The same lender submitted that ‘most consumers do not consider the benefits of PPI and the risks they are insured for until they are explained during the sales process’, and this was
confirmed by our consumer survey.

Conclusion on unsecured loan PPI, secured loan PPI, store card PPI and credit card PPI

5.21 With very little demand or supply-side substitution, we believe that separate markets for unsecured loan PPI, second charge mortgage PPI, credit card PPI and store card PPI exist.

6 SUMMARY OF ISSUES AND THE CASE FOR A REFERENCE

6.1 PPI can provide worthwhile cover against unforeseen events that cause repayment difficulties. It can offer valuable peace of mind whether or not a claim is made.
6.2 However we are concerned that there are features of the market that adversely affect competition and lead to poor value for consumers.
6.3 In this chapter we have set out the issues that have emerged from the market study which give us cause for concern, a number of which are evidence of features of the market which we believe prevent, restrict or distort competition. There is also other evidence indicating a lack of competition. These are under three headings: How consumers buy PPI; Competitive pressure on prices and; Value for consumers.
6.4 Where the threshold for a reference is met, the OFT’s guidance on the exercise of its discretion 42 says that in assessing whether the adverse effects of features of a market on competition are significant, we will consider whether they are likely to have a significant detrimental effect on consumers through higher prices, lower quality, less choice or less innovation. We have considered this question throughout the analysis of the features of the markets that follows.
6.5 The issues in the following chapters exist across all of the sectors we have identified i.e. credit card, unsecured loan, first charge mortgage and secured loan PPI, albeit they may be less marked in some of the five individual retail PPI market sectors.

How consumers buy PPI

6.6 Where consumers are well informed, and able to choose without facing undue sales pressure, they are in a position to make efficient choices. Their purchases will provide useful information to sellers about consumer preferences, which can then provide signals to potential entrants and possibly stimulate innovation. In the absence of such information, or under such sales pressure, markets may fail to work effectively, and price competition and quality of service may be reduced, even where there are many firms operating in the market.

Poor upfront information

6.7 Our research found a lack of upfront (advertising/marketing) information i.e. before the consumer has decided to sign up for the credit (and the PPI), which makes shopping around for PPI all the more difficult. We noticed during the course of the study that whilst there was a mass of upfront marketing information readily available for consumers to read on the credit product, it was very different for the PPI element. Our research highlighted that while it was easy to obtain information about
credit products from a lender’s branch, information specifically relating to PPI was usually given very little attention in ‘pick up ‘ leaflets and was quite often difficult to find. Lenders have argued that increasing the level of marketing of PPI within branches (face to face is the most popular sales channel for PPI) could simply confuse consumers.
6.8 Over the internet the picture is similar. Most credit websites we visited did have a section on PPI, but in some cases it was difficult to locate and more often than not we had to find the policy summary for details about the policy, and this was often located at the bottom of the page and could easily be missed.
6.9 Whilst it is possible to find information on cover, information about exclusions tends to be more hidden and on occasions the text could effectively discourage consumers from searching out information about exclusions.

Poor upfront information on PPI prices

6.10 We did come across some good practice of lenders of unsecured loans giving consumers upfront information about the cost of PPI, setting out examples of the cost (monthly and/or total) of the credit AND the cost of the PPI in marketing literature. However, this was not the situation across the board and marketing literature, which consumers could use as a starting point for weighing up whether they would get a good deal, often contained no information about the cost of PPI. As the examples at paragraph 6.16 highlight, adding PPI to the deal may significantly alter the total cost of a loan.

Poor understanding of PPI 6.11 PPI is a complex product which is relatively difficult for consumers to understand or assess. While consumers from our consumer survey, on the whole, appeared to be satisfied with the information that they received on PPI, it was telling that, when probed, many knew little about what they were paying for. For example 53 per cent of those paying for PPI monthly 43 did not know what they were paying; 34 per cent thought that there were no exclusions on the policy (and we saw no policies without exclusions) and 38 per cent did not know whether the policy contained any exclusions. Of the 27 per cent of consumers who said there were exclusions on their policy only 48 per cent could name these (13 per cent of all PPI holders).
6.12 Pre-existing conditions are a common exclusion which consumers need to be aware of, yet insurers report that these are the main reasons for turning down claims suggesting that the consumer did not know or understand what these exclusions meant. Defaqto 44 highlight the irrelevance consumers sometimes attach to pre-existing medical conditions as they may be unaware of what such `conditions’ are. This could come up as an issue only once they try to claim and then discover that the policy they have purchased perhaps was not appropriate for them in the first place.

Use of a headline APR

6.13 The OFT consumer survey found that when choosing a provider and a product, APR rate [for the credit product] is usually the only stated discriminator, effectively ignoring any differences in the cost of the PPI or in the cover provided.
6.14 The results of our `mystery shop’ exercise suggest that it is not uncommon for some distributors to make use of a headline APR to draw people into a credit deal. Consumers appear to look at the APR (the cost
of credit) and not at either the cost of PPI or the cover it provides. Results from our consumer survey indicate that 22 per cent chose the product because of the APR and 16 per cent because of the 0 per cent interest or finance deal. The APR for the credit is not necessarily a good indicator of the best deal, once the PPI gets factored in.
6.15 Research by Defaqto Limited also found that some loans which have very low headline APRs become much more expensive when PPI is added to the loan. Our own research found evidence of this too.
6.16 For example, one distributor advertised an APR of 6.1 per cent for a five year unsecured loan of £5,000. Our researcher was offered an actual rate of 7.4 per cent which changed to an approximate equivalent 22 per cent when PPI was added (as a single premium), a difference of 14.6 per cent. Even where the headline rate was the same as the actual rate offered, the addition of PPI can still make a big difference to what the consumer eventually pays. For example, one distributor offered a low APR of 5.7 per cent for a similar loan of £5,000. The approximate equivalent APR including PPI was 13.7 per cent, a difference of 8 per cent.
6.17 The issue grows in significance when take up rate of PPI is high. Anecdotal evidence and responses to our business survey indicate that take-up rates for PPI on secured loans are high (perhaps as high as 70 per cent). When a consumer can neither determine the total cost of the loan with PPI added nor the quality of cover, the potential for consumers to get value for money is significantly reduced. Poor information on product detail
6.18 We found that providers of PPI are not particularly effective at putting across key information about their products. We contacted 24 unsecured loan providers by telephone and not one mentioned the exclusions associated with their relevant PPI policies without a prompt from the caller. Not one of the unsecured loan providers mentioned to our researcher that the policy was based on a single premium without a prompt. Just one third (30 per cent) of unsecured loan providers detailed the criteria required to qualify for PPI at the quotation stage.
6.19 In some cases, particularly with secured loans, we found very little information given out unless we were prepared to go through an application stage. Even at this stage we are unsure whether a consumer would be provided with sufficiently clear information required for them to make an informed choice or whether they would be left to find their way through policy documents and terms and conditions themselves to determine whether PPI was for them, particularly given the FSA’s thematic work which showed that too much reliance was placed on written disclosure.
6.20 Our view is that providing information at the application stage will in any case typically be too late, as at that time the consumer has been ‘captured’ having been credit checked and possibly approved for a loan, and hence may be reluctant to refuse the offering of PPI because of a perceived obligation to carry the process through. It isn’t difficult to reach the conclusion that the timing of information provision, and the
way in which it is presented, is likely to play an important role in consumers’ choices.
6.21 Nevertheless, it should be noted that, as mentioned above, the FSA’s rules require consumers to be given key information about the PPI policy in good time before the contract is concluded. If these were complied with, this ought to improve the information available to consumers to help them consider alternative products.
Lack of shopping around
6.22 Whilst 40 per cent of respondents to our consumer survey claimed to have shopped around for their credit product, just 12 per cent shopped around for the PPI. Furthermore, of those who didn’t shop around for their credit product, just three per cent shopped around for PPI.
6.23 Whilst 26 per cent of mortgage PPI holders claimed to have shopped around for PPI and 13 per cent for secured loans, just 5 per cent of credit card holders, 3 per cent of store cards holders and 5 per cent those with unsecured loans had shopped around for their PPI. Given that unsecured loans earn a large/majority share of the PPI market, that only five per cent of consumers shop around for this product is of particular concern.
6.24 Many within the industry indicated that consumers are not prepared to
look beyond the PPI product that is offered by the credit provider. Research by Harris International for the Finance and Leasing Authority (FLA)(2005) showed that web searches on PPI are low. We were frequently told by stakeholders that PPI is a product which is sold not bought i.e. consumers rarely set out to buy this product on its own. Instead cover is promoted in some way by the distributor of the associated credit. PPI is a secondary and even a tertiary product. This lack of shopping around might explain why, when consumers do take out PPI, the vast majority take it out with the lender who sells the credit. The consumers who indicated that they did shop around tended to be MPPI buyers. The general lack of shopping around limits the scope for competition to work to the benefit of the consumer.
6.25 Discussions with the industry suggest that consumers decide whether they can afford the PPI they are offered (in relation to their overall monthly payments) rather than whether it represents good value in comparison to other products or against bearing the risk themselves. Point of sale advantage
6.26 The POS advantage is a key feature of the PPI sector. On average our business survey showed that overall 91 per cent of PPI policies are sold at the POS of the credit product being insured. Distributors who we spoke to indicated that it is common for 100 per cent of unsecured loan PPI policies to be sold at POS. Credit card PPI is least likely to be sold POS (on average only 64 per cent of sales), but even there PPI tends to be sold via a follow-up exercise such as when the card is activated, which it could be argued is also POS. We only came across one stand alone provider who sold stand alone credit card PPI cover and they indicated that the number of policies sold were small.
6.27 MPPI is the only sector where the POS advantage appears weaker but even there at least one stakeholder indicated that the majority of MPPI is sold at POS. One possible answer could be that there is a stronger presence from stand alone providers. Another is that PPI products are vying with other products (e.g. life insurance, home insurance) for a slice of the consumer’s limited purse - often pushing it a long way
down the list of consumer’s priorities. More generally, the absence of advertising reflects the POS advantage; if consumers are not actively shopping around for a good deal there is no need to advertise. 6.28 The POS advantage strengthens with the sale of single premium PPI. On the whole consumers tend to pay for the single premium PPI by adding the cost of the PPI to the loan. Whilst the consumer could look elsewhere for credit to pay for the PPI, this would involve taking out a separate credit agreement - an unlikely scenario. Our consumer survey showed that 98 per cent of those who took out a secured loan PPI (which is predominantly single premium) purchased the policy at point of sale. For unsecured loans, which again tend to be predominantly single premium, the figure is 91 per cent.

Complexity of product makes comparisons difficult

6.29 Even if consumers wanted to shop around for PPI our research shows that shopping around is not easy. The complex nature of PPI makes comparison between different policies difficult for consumers. There is a wide variety of products and prices, and PPI policies tend to include a relatively large number of terms and conditions compared with other financial products. There are wide variations in exclusions, product structure, the way benefits are paid and use of general terminology. Our own research found cover ranging from:

o Accident and sickness only or
o Unemployment only, to
o Life, sickness, accident, unemployment some with added hospitalisation cover and carer cover.

6.30 Policies had different `waiting periods’ before benefit can be claimed or paid (30, 60 or 90 days) with some benefits being accrued daily and some accrued monthly.
6.31 Such product differentiation makes it difficult for consumers to compare products on offer, even where these are aimed at similar needs. As a result consumers may pay more than is necessary and inevitably purchase, on occasion, inappropriate policies.
6.32 Product complexities were also highlighted in research by Defaqto Limited 45 which set out the different terms used throughout the industry to describe the same thing, e.g. excess period/waiting period both describe a period of time after the claim date during which the consumer is not eligible to receive benefit payments. Defaqto found that products that appear to have the same waiting period before any benefit
is paid can in fact be very different, and choosing the wrong type of policy could disadvantage consumers.
6.33 We understand that some in the industry have made efforts to adopt industry standard terms and to keep exclusions and waiting periods to a minimum. However this would need to be an industry wide initiative to be successful in helping consumers to choose confidently between different products.

PPI automatically included in the quote

6.34 Our research found that nearly all unsecured loan providers [87 per cent] who we contacted automatically included PPI in the quote for the loan. For mortgage PPI the figure was lower at 40 per cent.
6.35 The FSA’s rules require the consumer to be given the price of PPI separately from the price of the credit in good time before the contract is concluded. Again if these were complied with, this ought to improve the information available to consumers to help them make informed decisions.

Potential to mislead

6.36 A particularly worrying finding was that nearly a third (30 per cent) of consumers in our survey who went on to buy PPI either assumed, were told or were given the impression by the distributor that taking out the PPI would help the application for credit. The FSA’s rules require firms to treat consumers fairly and to communicate information in a way that is clear, fair and not misleading. It is difficult to see how giving such impressions would be consistent with these rules. Whilst the number who were told by the supplier was small it is disturbing that something about the way the market is operating leads consumers to make these kinds of assumptions.

Competitive pressure on prices

6.37 We found evidence of some competitive pressure operating at the upstream end of the market with those distributors who operated a tendering process having several bidders for each contract, distributors possessing a degree of buyer power and insurers seeing a squeeze on net underwriting profits for several years. It appears that the costs of switching PPI provider in the upstream end of the market are low and many distributors indicated that they had switched insurers over the last few years. However, we saw no evidence that this pressure was feeding downstream into retail prices.

Alternative products do not appear to provide competitive pressure

6.38 Products such as income protection policies are not considered to be direct substitutes in the sense of posing a constraint on PPI prices. As we indicated earlier, they differ in their terms and conditions (tending to be longer term in nature and varying in the benefits paid e.g. do not cover unemployment). In any event, given the complexity of the PPI products and the lack of comparable information on PPI which we discussed earlier, it seems unlikely that consumers would look wider than PPI when considering the risk. Hybrid products such as the Post Office’s Lifestyle Protection product may offer a competitive alternative in the long run but it is too early to assess its impact.

Point of sale advantage

6.39 The POS advantage referred to earlier means that there is little competitive pressure on PPI at the key point at which the consumer buys the insurance.
Difficulties for stand alone providers
6.40 Stand alone providers, who might otherwise be thought to offer a competitive pressure, have indicated that given the POS advantage, they have difficulty accessing consumers and face substantial start-up and marketing costs in order to try to attract sufficient volume of consumers to trade successfully over the long term. Their main sales channel is the internet. However, as the Harris International work for the FLA showed, web searches for PPI are low. Our recent business survey did not ask distributors or lenders about the proportion of PPI sales via the internet, however, we did ask a similar question during our consultation for the 2005 super-complaint. Although few respondents were able to provide much data on this, most told us that only a small number of PPI policies were sold online and that these were mostly
direct/stand alone products.
6.41 Stand alone PPI providers tend to focus on mortgages where policies are more likely sold through intermediaries and consumers seem to be more willing to shop around. However, even MPPI stand alone providers have a limited presence. Council of Mortgage Lenders (CML) data 46 shows direct sales dropping from six per cent in 2002 to only one per cent in 2005, while our consumer survey showed 63 per cent of MPPI purchasers buying from a different provider than their mortgage provider.
6.42 For credit card PPI, where premium is normally based on account balance, not having access to that balance could be a significant barrier to entry for stand alone providers. Whilst one stand alone provider has found an innovative way around this based on an allotted level of monthly cover, they have themselves indicated that this is a small part of their business. Nevertheless, it may indicate potential for innovation
and improvement and, in the long term, offer the possibility of a competitive pressure. Our consumer survey found that 94 per cent of credit card PPI purchasers bought this directly from their credit card provider.
6.43 The POS advantage also means that insurers have themselves been unable to provide an alternative competitive pressure by selling direct to consumers. At least one major insurer has tried to sell directly to the consumer, but was unable to achieve reasonable penetration and pulled out of direct sales.
6.44 Intermediaries have a stronger presence in the MPPI sector and could, in theory, shop around for their clients, accessing the whole market. It is not clear that that happens in practice and anecdotal evidence suggests that many act in a similar way to distributors i.e. they do not offer consumers a choice of PPI products. On the whole they sell linked (to the credit) products (often just one) rather than picking from, say, a panel of suppliers. This appears to be a more practical way for them to operate but it also means that they are not acting as an alternative sales channel to distributors and the POS advantage is, albeit slightly weaker, nevertheless still operating.
Neither initial purchase decision, nor cancellation act as a pressure on prices - lack of switching
6.45 It could be said that in the absence of pressures from competitors, the careful weighing up of value for money by consumers before buying, or the risk of consumers cancelling the PPI could act as some pressure on prices. However, where PPI is purchased at POS it is doubtful that any careful weighing up takes place (or indeed could take place given the limited information available). Nor do most consumers appear to change their minds after the event. Our survey shows that most consumers were content with their PPI purchase even if their understanding of it
was poor. Few consumers cancel (14 per cent). Consumers may have been deterred by less than proportionate refunds of premium on single premium policies. Just over one quarter (27 per cent) did not know whether they could cancel and one in ten (nine per cent) did not think that they could cancel the policy. The main reason given for cancelling a policy was because it was too expensive (43 per cent) or because the holder’s situation had changed (39 per cent).
6.46 Of the small number who did cancel only sixteen per cent switched to another policy (the majority of which were MPPI consumers) however we saw no evidence that those who switched did so in order to get a better deal. As we said earlier, a lack of comparable information on other PPI products could act as a barrier to switching and the pricing of single premium policies (the consumer may not receive a pro rata
refund) may effectively prohibit switching given the potentially high redemption costs.
6.47 It seems unlikely that present levels of cancellation or switching by consumers in this market exert any serious pressure on the prices of PPI.

Value for consumers

6.48 We have identified the following that, together, indicate that consumers may be receiving poor value from PPI.

Low claims ratios

6.49 We have defined the claims ratio as claims paid as a percentage of GWP. The market is characterised by extremely low claims ratios, particularly compared with all other insurance products. Our business survey of insurers shows that the mean claims ratio in 2005 was highest for first charge mortgage PPI (33 per cent), 18 per cent for
unsecured personal loans; just 12 per cent for retail credit; 22 per cent for motor finance; 14 per cent for credit card PPI and 16 per cent for secured loan PPI. This represents a mean claims ratio of 20 per cent for all PPI policies. This was broadly in line with the figures extracted from our financial pro-forma exercise which show an overall claims ratio for the sector of 19 per cent in 2005. Over 50 per cent of insurer profits appear to be earned from unsecured personal loans. Compare these figures to comprehensive motor insurance (82 per cent of GWP), household insurance (54 per cent of GWP), pet insurance (72 per cent of GWP) and medical insurance (80 per cent of GWP).47
6.50 While we appreciate that it is difficult to draw direct comparisons with other insurance products, claims ratios of below 20 per cent (see below) for PPI compared to other general insurance products, are sufficiently different to be beyond questions of differences in comparability or risk.
6.51 Possible cross subsidy as between PPI and credit related income in relation to unsecured personal loans and secured loans, profit sharing 48 and common cost issues make analysis difficult and whilst we have attempted to establish where profits are going, most distributors were unable to separate out the element of their costs attributable to PPI products, which makes assessment of profitability very difficult.
6.52 Based on the financial information received, the claims ratios reported by insurers declined from around 27 per cent to 19 per cent between 2003 and 2005. However, the benefit of this appeared to pass to distributors, as commission paid as a proportion of net earned premiums increased by around13 per cent from 52 to 65 per cent over the same period.49
6.53 In the absence of cost data, no estimate can be made of distributors’ profitability. However, claims ratios of around 20 per cent leave over 80 per cent of GWP to cover the costs and profits of insurers and distributors. Given pressures to restrain costs, and the potential benefit of spreading costs and profit across a range of businesses within the large operators (vertical integration is a feature of the market), it seems reasonable to suggest that distributor profitability on this product is sizeable.

High commission rates

6.54 The evidence from our survey of insurers suggests that commission rates paid by insurers to downstream intermediaries (distributors and non-lending intermediaries, including profit sharing deals) look to be high by comparison with other general insurance products. For example we have anecdotal evidence to suggest that commissions paid by motor insurers can be as low as 10 per cent. By contrast, our business survey suggests that average commission rates for single premium PPI policies vary from 50 per cent of GWP for first charge mortgage PPI to 67 per cent of GWP for those selling motor finance PPI. The average commission rate for all single premium PPI policies was 59 per cent. Rates for single premium second charge mortgage, unsecured loan and retail credit PPI were 66 per cent, 59 per cent and 61 per cent respectively.
6.55 Average commission rates for regular premium PPI policies varied from 35 per cent for first charge mortgages to 70 per cent for retail credit. The average commission rates were typically lower for regular premiums than single premiums, excepting retail credit PPI; with the average rate for all regular PPI polices being 53 per cent 50 . Prices for PPI differ greatly which cannot be accounted for by differences in quality
6.56 Our analyses confirmed the presence of price differentials which could not be accounted for by differences in cover offered.
6.57 Obtaining comparable information in order to reach this conclusion was actually quite difficult as PPI is complex. The wide range of policies on offer and the lack of clear information did not make it easy for an OFT researcher who knew what he was looking for. It is difficult to see how a consumer, with limited knowledge of PPI, would fare better. Nevertheless, we were able to ascertain that prices for PPI differ
greatly, and to an extent which cannot be accounted for by differences in quality. This applies particularly to unsecured personal loans and credit cards, although less so for first charge mortgage PPI. For example, we found that for a £5000 unsecured loan over five years, monthly PPI repayments for an accident, sickness and unemployment
policy (ASU) range from £16 to £40 with little obvious difference in the cover provided. The variation in PPI repayments for a £100k 20 year mortgage was less extreme with £32 a month for the cheapest ASU policy and £45 for the most expensive (though the most expensive is still 40 per cent more than the cheapest).
6.58 In 2004 Datamonitor 51 surveyed 50 firms providing PPI for unsecured
personal loans and found that the cost for the most expensive policy premium was almost three times greater than the cheapest available PPI policy premium. London Economics on behalf of OFT recently carried out a similar analysis of more up to date Defaqto information (2006) on the cost of repaying a £5000 unsecured personal loan over four years. The cost of the most expensive cover was nearly four times more
expensive than the cheapest. In the absence of a higher quality product in return for a higher price, it would appear that consumers are receiving poor value for money and the market is not serving its function of keeping prices in check.

Cross subsidy between PPI and underlying credit products

6.59 We received anecdotal evidence that some unsecured personal loan providers, and possibly some credit card providers are offsetting low margins on their credit offerings with profits generated from the sale of PPI. The distributors we spoke to differed in their response as to whether or not this happens. Our research suggests that, broadly there may be some evidence of unsecured loans with very low APRs being loaded with expensive PPI policies, although the evidence is far from clear cut. So, for example, we found a £5000 loan payable over 5 years with an APR of 6.7 per cent where the total cost of the loan without PPI was £5934. By adding the £2106 PPI policy (ASU) the total cost of the loan with PPI was £8040 (PPI accounts for 26 per cent of the overall cost). This compares with an equivalent loan with an APR of 16.9 per cent, costing £7271 without PPI, rising to £9067 once the PPI policy of £1789 is added. On the surface still an expensive PPI policy compared to some, but accounting for a smaller proportion of the overall cost (19 per cent). We have seen examples of apparently similar combinations of credit and PPI with greatly differing prices for the
credit, for the PPI or both. Cross subsidy is possible, particularly where penetration of PPI is high. Without carrying out a detailed examination of the underlying costs [of sourcing the credit] we have not been able to reach firm conclusions.
6.60 A possible outcome of this practice is that it could exacerbate the extent to which consumers are misled by the APR about which is the best credit and PPI deal. If there is cross-subsidy it also could be argued that those consumers who do not take out PPI (which could be over 50 per cent for some types of PPI) are effectively being subsidised by those who do.

Claims

6.61 As the low claims ratios imply, few people claim on a PPI policy. Of the consumers contacted during our consumer survey (over 1000) only 126 had ever made a claim on a PPI policy and only 38 had claimed on a policy that had been taken out since January 2005. However, it should be noted that when a claim is made many consumers (64 per cent) were satisfied with the outcome. Two-thirds of consumers also received a reply from their insurer in less than a month regarding their claim. It
was notable, however, that given the concerns raised earlier about available information that of those who had their claim rejected, two in five had it rejected because they did not meet the criteria. This indicates that they had either forgotten what the policy covered or had not been informed correctly. Insurers from our business survey indicated that the most common reason for turning down a claim was due to a pre-existing condition. Something the consumer should have been made aware of.

Scope for consumer savings

6.62 In view of the market features outlined previously, it is likely that there is significant consumer detriment associated with the sale of PPI. We have identified three ways in which the economic interests of consumers may be adversely affected.

Product suitability - as a result of product complexity and a lack of information transparency on price and quality products may not be suitable for some consumers although the FSA’s rules and supervision and enforcement work should help address this.
High (if not excessive) prices - consumers may be paying too much for their PPI as reflected in low claims ratios 52 and high rates of commission relative to other lines of general insurance.
Refunds- if these do not reflect incurred costs and consumer risk profile then they may be unfair.
6.63 By using the current average claims ratio for the PPI sector and then hypothesising what the average claims ratio might look like in a competitive market (i.e. relatively high profits would be competed away in a more competitive market increasing the claims ratio as a result), we have, albeit simplistically and with the limited data available, estimated that the potential consumer savings from making the market more competitive could be around £1bn. Competition would have to increase substantially for these savings to be gained over time.