Modern Bank Behaviour

Kenneth A. Loparo, Kenneth A. Loparo, Kenneth A. Loparo, Kenneth A. Loparo

• Publisher: Palgrave Macmillan
• Year: 2015
• ISBN:
  9781137001863
• Topic: Business
• Subtopic: Corporate Finance
• Index: Business

Updated insight into key facts impacting on financial institutions after the financial crisis, highlighting areas of major policy and academic interest. The book includes ten chapters analysing contrasting issues such as intellectual capital, cost efficiency, bank stability, credit risk and business models for the wealth management industry.

1

The Mis-selling of Payments Protection Insurance in Mortgage and Unsecured Lending Markets

John K. Ashton and Robert S. Hudson

1.1 Introduction

In January 2009, the UK competition law judgement body, the Competition Commission (hereafter CC), stated that the joint sale of credit or payment protection insurance (hereafter PPI) with lending, including unsecured, mortgage and credit card borrowing, was to be prohibited after 2010. This judgement also required that single premium insurance policies should not be employed in this market, demanded that greater customer information provision be provided, and required PPI to be unbundled from other financial services when sold. Although these measures were legally challenged in October 2009 by Barclays plc on the grounds that prohibiting the sale of credit insurance reduced customer convenience, they were largely upheld in a provisional decision by the Competition Appeal Tribunal, published in May 2010 (CC, 2010).

Concurrent with this legal debate was a major growth in the number of customer complaints as to their dealings in PPI markets and principally as to whether this insurance service had been sold inappropriately to them, and also whether a premium refund could be sought if they had paid a single premium and then repaid the debt to which it related. Many, yet not all, banks rejected many of these complaints, which were then forwarded to the UK financial services arbitration service, the independent Financial Ombudsman Service. This body accepted that the vast majority (over 80 per cent) of these complaints were valid. Further, following the rejection of the legal appeal by Barclays plc on the CC judgement, the Financial Services Authority (FSA) started a process of redress for customers mis-sold PPI with lending (FSA, 2010). This process involved firms settling the substantial backlog of PPI complaints and claims for customer redress for mis-selling.

This examination outlines the form, scope and function of PPI markets, the criticisms of these markets which led to the regulatory intervention, whether or not this major regulatory step was justified, and the outcome of this judgement for the financial services industry.

Assessment of these legal and regulatory judgements of the UK PPI market is important for many reasons, relating to both the scale and profitability of these markets for the financial services industry and the consumer distress apparent in the mis-selling of this financial service. First of all, mis-selling has historically been very expensive for firms in terms of customer redress, with past cases of mis-selling costing UK financial firms nearly £15bn, of which £3bn was paid in customer redress for mortgage endowments mis-selling, £11.8bn was paid in customer redress for pension mis-selling and £195m was paid in customer redress for split capital investment trust mis-selling (see FSA, 2011). This area of activity has also occupied financial regulators, and prior to the financial crisis heavily influenced press coverage of financial regulatory matters. Not least, financial mis-selling also adversely affects customers who when faced by mis-selling are exposed to substantial personal financial risks and can lose confidence in otherwise highly beneficial financial services such as saving and investment. Indeed the role of PPI in encouraging the rise in over-indebtedness is repeatedly identified by the UK government (e.g. Department for Business, Enterprise and Regulatory Reform, 2007; hereafter BERR). In the light of these characteristics of financial services mis-selling, it is perhaps surprising that to date so little has been recorded within the academic literatures on this issue.

To add to the, albeit limited, academic coverage of financial mis-selling and PPI, this chapter examines the foundations and implications of the CC’s judgement of PPI and the subsequent process of customer redress of PPI mis-selling led by the FSA. This examination is undertaken by means of a range of approaches. After a review of the academic literatures, we first undertake a thematic review of wider regulatory or ‘grey’ literatures examining PPI sales in the UK, USA and Europe, and secondly assess regulatory principles breached in the final notices issued and fines imposed by the FSA in cases of PPI mis-selling before this prohibition was imposed. The third form of assessment examines the key assumption underlying claims that the PPI market was anticompetitive; that a cross-subsidy developed between PPI and the loans these insurance services protected. The two largest PPI markets in the UK – PPI sales with unsecured lending and mortgage finance – are examined in this assessment using two different data sources. Lastly, the consequences for the firms involved in this PPI mis-selling episode are considered, with particular emphasis placed on the levels of fines imposed by the FSA and the levels of customer redress expected to be paid by firms. In conclusion, we summarize these results and suggest areas for future research.

1.2 The UK market for PPI

PPI provides varying combinations of accident, sickness and unemployment insurance, and is used to protect the loan payments of policyholders in the event of them losing their income. PPI provides cover in the case of a borrower having an unexpected fall in income, and is designed to pay off the debt as repayments if the policyholder is adversely affected by accident, sickness or unemployment. This financial service is perhaps unusual in that it provides cover to both the borrower, who will not default on their debt after an unexpected event, and also the lender which is assured their lending will be repaid if this policy pays out.

The UK PPI market is substantial; in 2006 it is estimated that 20 million PPI policies were in operation in the UK (Office of Fair Trading, hereafter OFT, 2006). Unsecured lending PPI plans accounted for 45 per cent of the overall UK credit insurance market, and were valued at £2,013m in 2006 (CC, 2007), and mortgage payment protection insurance for first and second charge mortgages accounted for 24.9 per cent of the PPI market, valued at £1,099m in 2006. This sector also expanded rapidly, with annual growth rates of 15 to 20 per cent for the period 2000–2005 (OFT, 2006), and currently is experiencing a decline (CC, 2008). For example the take-up of mortgage PPI on all new mortgage contracts fell from a high point of 24 per cent in 2003 to 18 per cent in 2007. A further feature of the PPI markets is the very high proportion of policies that have been provided at point of sale with the loan contract (for example, estimates for mortgage PPI vary from 88 per cent (Ford et al., 2004) to 95 per cent (OFT, 2006).

While most forms of PPI have emerged as private sector solutions to the costs of loan default, in the area of mortgage provision this insurance also acts as a complement to the system of state income support (Department for Environment, Transport and the Regions, 2000). As a buoyant owner-occupied housing market contributes to a successful economy (Department of Environment, Transport and the Regions, 2000) this form of insurance has been encouraged by successive governments. Indeed this use of PPI has been observed internationally (see Ross and Tootell, 2004). The requirement for wider provision of high quality mortgage PPI has also increased substantially in the last decades. Since the 1970s, UK home ownership has become more diverse in socio-economic terms, with the proportion of borrowers from lower-income households, unskilled workers and older people rising (Ford et al., 2004); this movement was supported by a range of UK government policies including the right to buy (Ford and England, 2000). These changes occurred concurrently with the re-regulation of the UK mortgage market, leading to a major growth in the variety and range of mortgages, often with non-standard features (Scanlon et al., 2008). While these shifts have had positive outcomes, such as reducing the number of households which could not access credit, and reducing discriminatory practices such as not lending to single persons and women, this change has reduced the quality of UK mortgage lending overall (Stephens and Quilgars, 2008). These changes, in combination with variable or short-term fixed rate mortgage contracts being the norm in the market, resulted in UK mortgagors facing more uncertainty than mortgagors in most other nations (Miles, 2005) hence needing additional financial protection – such as that provided by PPI.

The market for mortgage PPI developed partly in response to changes in government support for mortgagors. Since 1948 the UK government has supported mortgagors claiming unemployment benefits via arrangements variously named national assistance, supplementary benefit, income support and jobseekers allowance (Ford and Quilgars, 2001). Prior to 1987, mortgagors in receipt of these subsistence benefits would receive payment of their full mortgage interest payments (Ford and England, 2000), and historically mortgage lenders collaborated with this system and exercised forbearance by not initiating home repossession from recipients of this state welfare, an agreement given semi-legal status in 1991 (Ford and Quilgars, 2001). This welfare safety net was curtailed in 1987 and 1995, more recently extended in 2009 but further reduced in 2010, when the level of interest supported was limited to the Bank of England lending rate.

1.3 Criticisms of PPI markets

1.3.1 The regulatory journey to PPI mis-selling

Despite the scale, utility and public policy importance of PPI, this form of insurance has been the focus of repeated regulatory scrutiny internationally, and surrounded by persistent allegations of poor value and inappropriate sales. Initially the provision of PPI faced strong criticism (e.g. Department for Environment, Transport and the Regions, 2000), and investigation and subsequent legislation by UK central government (BERR, 2007). This legislation considered the modernization of the UK consumer credit law and the role of PPI in credit decisions, within both a white paper (DTI, 2003)¹ which detailed the perceived high cost and low quality of cover offered by PPI, and the subsequent Consumer Credit Act (2006). Of greater pertinence to this discussion, PPI was also repeatedly investigated by three UK regulators concerned with consumer protection, competition policy and financial services markets (see OFT, 2006; CC, 2007, 2008; FSA, 2007a). These investigations followed concerns raised initially by consumer bodies such as the Citizens Advice Bureau (CAB) which reflected an increasing frustration with industry practice in the sale of PPI (CAB, 2005) and growing numbers of consumers using the Financial Ombudsman Service after their claims of PPI mis-selling had been rejected by the banks concerned.

The FSA examined PPI issues repeatedly from 2005, using thematic reviews of the PPI market in both supervisory investigations into and mystery shopping studies on (FSA, 2005, 2006, 2007a) firms sampled from the wide range of companies distributing PPI, including retailers, car dealerships, brokers, banks and building societies. Problems were particularly identified in firms which do not undertake financial services as their main line of business, especially car dealerships which sell PPI alongside car finance. General concerns which have persisted throughout these visits include limited information given to consumers, a lack of awareness of product exemptions, and a failure to indicate the voluntary nature of PPI. Indeed whilst pressured selling has been rare, firms often present the acceptance of both the loan and PPI as the norm and expect an explicit rejection of PPI by the customer (FSA, 2007b).

Following this FSA activity and a super-complaint² by the CAB, PPI provision was examined by the UK competition law enforcement and consumer protection agency, the OFT (2006). This report indicated that significant concerns existed as to the sale of the PPI, and subsequently the provision of PPI was referred to the competition law investigative and judgement body, the CC. This investigation, in turn, led to the prohibition of the joint sales of PPI that we considered in the introduction to this chapter. A detailed legal discussion of the PPI case is provided by Grey (2011).

It is also important to recognize that concerns with mis-selling PPI are not restricted to the UK, and that these criticisms have been mirrored in other nations. In the USA, the ‘packing’ of credit insurance within credit services such as home and consumer loans (Federal Trade Commission, 2001; hereafter FTC) has been criticized, even involving Senate hearings in the 1970s. This regulatory attention focused on home and consumer loans, and raised concerns including the mis-selling of PPI, misleading advertising, including i...

Table of contents

• Cover
• Title page
• Copyright
• Contents
• List of Figures
• List of Tables
• Notes on Contributors
• Introduction
• 1  The Mis-selling of Payments Protection Insurance in Mortgage and Unsecured Lending Markets
• 2  The Relationship between Mortgage Credit and Property Prices: The Chinese Case
• 3  Bank Restructuring and Bank Stability in Latin America
• 4  Monetary Policy and Trade Credit: Evidence for Spain
• 5  The Assessment of the Net Stable Funding Ratio (NSFR) Value. Evidence from the Financial Crisis
• 6  Distance and Efficiency in the Italian Banking System
• 7  Total and Financial Cost Efficiency in Spanish Savings Banks
• 8  Empirical Analysis of Intellectual Capital Disclosure Practices in Banks in Spain, Portugal and Greece
• 9  Too Small or Too Low? New Evidence on the Four-Factor Model
• 10  A Business Model Map in the Wealth Management Industry
• Index