Newcastle University

The selling of payment protection insurance with personal loans has led to excessive premiums and the exploitation of customers, according to new research published today. 

A  joint study by Newcastle University Business School and the University of East Anglia found that over a 10-year period banks cross-subsidised the cost of personal loans by offering over-priced payment protection insurance (PPI). This varied by the type of financial institution offering the insurance, with profit maximising banks on average charging significantly more than mutually owned building societies.  

The insurance covers repayments on credit products if the borrower is unable to make them, for example due to accident, sickness or unemployment. The vast majority of policies are sold at the same time as a consumer takes out credit, such as a loan, credit card or mortgage. However, concerns have been raised about uncompetitive pricing, possible mis-selling of policies and companies refusing to pay out on claims.  

The new research, published today by Economic and Social Research Council (ESRC) Centre for Competition Policy, based at UEA, used monthly data from financial information provider Moneyfacts. It covered a 10-year period from January 1998 to December 2007 and was based on the cost of a £5000 personal loan with and without PPI. Data was provided for 211 different products offered by 85 financial firms (ultimately owned by 52 organisations), including high street names such as Barclays,  Royal Bank of Scotland, Tesco and Sainsbury’s, and for a range of market sectors, such as car purchase and existing customers. 

On average the monthly costs of a £5000 personal loan with PPI was £186.75 and £162.37 without. These costs also changed over time, with the monthly cost of a £5000 personal loan without PPI being £173.14 in 1998, falling to £158.32 in 2007. However the costs of PPI have been less flexible, with the average monthly PPI cost being £25.73 in 1998 and £24.97 in 2007.  

These lending costs varied substantially among the firms supplying the market. Over the period studied the minimum and maximum monthly cost of PPI was £8.27 and £49.58 respectively, indicating that some firms profited far more than others from supplying PPI jointly with personal loans. The PPI costs as a percentage of the total loan costs varied between 8.2% and 16.9%. The degree of cross-subsidy from PPI to personal loans was also significantly lower for building societies than banks.  

Commenting on the findings, study author Dr John Ashton from the ESRC Centre for Competition Policy said consumers were becoming aware of concerns with credit insurance but there was still a need for improved financial information. 

“It is surprising to see such a high level of variability in the costs of payment protection insurance. Clearly some firms are exploiting customers far more than others,” said Dr Ashton, a lecturer in banking and regulation. “The de-regulation of financial services and subsequent joint provision of insurance and banking services has had some adverse results for consumers. They can feel pressurised into taking out PPI and often don’t realise that they can shop around, compare products and go with another PPI provider. Assessing if firms act in a way that exploits these customer limitations and challenging these circumstances when they happen should be a regulatory priority.” 

Co-author Prof Robert Hudson, Professor of Finance at Newcastle University Business School, added: “In light of our findings it is important for customers to search a wide range of financial services providers before undertaking any financial commitments.”  

The latest findings follow a judgement by the Competition Commission in January 2009 that PPI should not be sold jointly with personal loans. Measures expected to be introduced during 2010 include a ban on selling insurance during the sale of the credit product and for seven days afterwards, no single-premium policies, annual reviews and improved information for consumers to make it easier to compare and search for products and switch policies. Barclays, supported by LloydsTSB and Shop Direct Group Financial Services, is appealing against the decision. 

While banning the joint sale of loans and credit insurance will improve the situation for many customers, Dr Ashton and Prof Hudson warn that those who are not easily persuaded to buy credit insurance jointly will lose out by paying more in unsecured loan costs. Also, if sales of insurance fall, loan costs may rise as banks increase their margins to accommodate the greater risk of uninsured defaults.  

According to the Competition Commission there are more than 12 million PPI policies in the UK. The most common form of PPI is for unsecured personal loans, accounting for 45pc of the overall credit insurance market and worth £1.8bn in 2007. Unsecured personal loans are also the most common form of borrowing in the UK.