No ifs or buts for this 'excuse for an insurance product'

As words go, "interim" and "report" don't sound as if they're capable of striking fear into any hearts. But they should serve as a warning for the banks and other lenders who sell payment protection insurance (PPI), which promises "peace of mind" for borrowers by guaranteeing their debt repayments in the event of sickness, accidents or unemployment.

Midway through a giant investigation into the way that PPI is sold on personal loans, credit cards and mortgages, the Office of Fair Trading (OFT) has now surfaced to update the industry on its findings and request that companies come forward for a "feedback" day on 24 August.

The regulator says it will use the opportunity to update those companies that sell PPI on its progress - and set out the likely direction of its next steps.

However, if its recently published interim report is anything to go by, the lucrative £5bn cover industry, which has been described by Citizens Advice as a "protection racket", could face major changes in favour of consumers.

If the OFT comes to the decision that PPI is unfair to customers, it can refer the industry to the Competition Commission. This body has been given the power to make sure markets work properly and openly and, in its hands, the industry could be forced to change the way its staff sell the cover, introduce greater transparency, and even suffer price controls.

Bad practice

Although the OFT makes it clear that its halfway report "is in no way intended to pre-empt such a decision" to hand over to the commission, it indicates that it has already discovered signs of bad practice.

"Our research suggests that, broadly, there may be some evidence of unsecured loans with very low annual percentage rates [APRs] being loaded with expensive PPI policies," the report says. "The outcome of this practice is that those consumers who don't take out PPI are effectively being subsidised by those who do. Not only is this an issue of fairness ... it is an issue of transparency."

In spite of the brouhaha surrounding this type of insurance, Nationwide building society has decided to raise the premiums on its LoanCare PPI cover. The monthly cost of repaying a loan of £5,000 over three years at a rate of 6.7 per cent will now be £18.41 - up from £15.06 per month.

A spokeswoman for the building society says it "regularly reviews the price of its products", and adds that it wants to "balance the needs of the business with offering competitive products to our customers".

While Nationwide is still competitively priced according to comparative tables, its move highlights one of the major issues raised in the OFT report - the difficulty consumers have in comparing different PPI policies. The diverse conditions attached to the cover and huge variance in price are made worse by a lack of transparency in the sales process.

According to the report's research, "it was not uncommon to see marketing literature without any information about the cost of PPI". Consumers may also not be alerted to exclusions in the policies; for example, some insurers don't allow claims from policyholders who have lost income due to stress or a bad back - the two most common causes for being off, or out of, work.

"Information [on websites] about exclusions tends to be more hidden and on occasions... misleading," says the OFT.

This view is shared by Andrew Hagger from the financial analyst Moneyfacts. "It is difficult for consumers to compare cover as it isn't sold as a separate policy [by nearly all lenders] and there are varying levels of cover on offer with complicated qualifying criteria," he says. "With so many PPI claims being unsuccessful it highlights the fact that many policies are sold without sufficient explanation about what is and what isn't covered."

Huge profits

Concerns about large profits earned on the back of low "claims ratios" in the PPI industry have exercised the OFT. It defines this ratio as the number of claims paid out by the lender, expressed as a percentage of the premiums paid by consumers.

Last year the OFT found that claims ratios for PPI on mortgages taken out by borrowers stood at 35 per cent. The ratio for unsecured personal loans was 18 per cent, while for retail credit, car finance and credit cards it was just 11 per cent.

Compared with other types of insurance, these percentages are low, the OFT report shows. While the overall PPI claims ratio is 17 per cent, the ratio for motor insurance is 74 per cent, and for home insurance 55 per cent. "This could suggest that gross profits are high in the UK PPI sector and implies customers are receiving poor value," the report says.

Horror story

Other major concerns highlighted in the OFT's report included nearly nine out of 10 unsecured loan providers that were contacted automatically including PPI in the quote for a loan. The problem is that borrowers can easily be led to believe they must have PPI in order for a loan to be approved. But this is not the case, and can inflate the overall cost.

Significantly, the OFT report said that, in the case of 37 out of 40 credit providers, the overall APR for the cost of credit was more than double that advertised when PPI was included.

And there are concerns that sales are being skewed by high commission rates. "This is unacceptable in any market that purports to treat its customers fairly," says Simon Burgess from the standalone PPI provider British Insurance.

"Commission rates are being used by firms to inflate their profits and carry other poorly performing products, and do not represent any sort of good value for the end consumer."

The consumer body Which? says the OFT's study "reads like a horror story". "It shows the industry is systematically dysfunctional," says its spokes-man, Pula Houghton.

"For years, we have said PPI is a poor excuse for an insurance product. Policies are complex, lack transparency and offer poor value for consumers - while being a good source of profits for the industry."

Ripped off

For now, anybody considering PPI must check first of all that they actually do need it, that they qualify - the self-employed and contract workers can often be excluded - and that they're not being ripped off.

While nearly half of borrowers shop around for credit products, only one in 10 shop around for PPI, the OFT report says.

"Consumers should not be pressurised into buying their cover from their loan provider," says Tracy North from Uswitch, the price comparison service. "But the banks are offering competitive APRs and then recouping money through PPI."

If consumers want PPI, it is still generally cheaper to get standalone cover offered by the likes of broker British Insurance and - a recent arrival in this market - the Post Office.

"Read the small print and check the policy you are buying is suitable for you," says Ms North.

Make sure you are not doubling up on insurance you already have in place. Short periods of illness may be covered by your employer's sick leave policy, and you may have other safeguards such as critical illness cover or income protection.

Loan ranger who went online for a better deal

Kyle Gordon, a postman from Braintree, Essex, took out a £5,000 loan with Alliance & Leicester in January this year in order to buy a new car.

When he applied for the loan, the 20-year-old was offered a PPI policy by his provider at a cost of £22 extra each month. This would have added around £1,000 in total over the four-year term of the loan.

Kyle felt this quote was a bit steep and decided to shop around for a better deal. "I came across British Insurance when I was browsing on the internet," he says.

"When I contacted the company, they were able to offer me a policy for just £4.81 a month - totalling £232 over the life of the loan. This really has made a big difference to my monthly outgoings."