Payment Protection Insurance: The Challenges Ahead

Despite much recent discussion of the need to protect the interests of the UK’s financial services industry and the key players within the industry, 2011 has been, in many ways, the year of the consumer. This was demonstrated no better than when the British Banker’s Association abandoned its legal fight over the mis-selling of payment protection insurance (PPI).

PPI policies are intended to cover loan repayments if someone falls ill or loses their job. Last year the Financial Services Authority (FSA) and Financial Ombudsman (FOS) found that of the 16 million of these policies sold to consumers since 2005, many of these may have been mis-sold to customers who did not need the policy, or indeed know it was being sold to them. Others found that despite expensive premiums, they couldn’t claim on the policies when they needed to.

FSA statement and the financial impact

In its policy statement issued in August 2010, the FSA required all banks and other PPI sellers to re-examine their previous sales to see if there was any evidence of mis-selling, as well as provide compensation in respect of legitimate PPI complaints. This was subsequently challenged in the courts by the BBA but, in May this year, their case suddenly collapsed: and shortly afterwards the British Bankers’ Association announced they would no longer appeal the ruling of the high court.

The financial impact on firms of settling PPI claims, which began prior to the BBA’s challenge and will continue long into next year and probably beyond, is huge. At the time of the ruling, the FSA estimated that banks would have to pay up to £4.5bn to settle tens of thousands of claims. Last month, Lloyd’s Banking Group announced that the cost to their business alone stood at £3.9bn, suggesting that the FSA’s figure was a massive underestimate.

The case has affected both providers and distributors, large and small – the number of firms affected is estimated to be about 5000. The redress calculation often involves the distributor providing premium refunds even where they have only received the commission element, thereby increasing further the impact of redress payments in a difficult economic climate.

In addition to the financial impact to firms of compensating consumers, finding the appropriate resources and expertise to redress the problem will further burden Complaints and Compliance teams. The FSA’s regulations regarding redress are complex and it may be difficult for smaller firms to resource the exercise competently, with the added risk that when the FSA comes to check up on their efforts, remedial activity may be required. Resourcing is further complicated by the fact that demand is unpredictable with peaks and troughs in consumer complaints.

In the case of PPI, the FSA has taken a prescriptive approach to the complaints handling and redress process. However, the scale and complexity involved will be unchartered territory for many firms who will lack the expertise necessary to implement compliant processes and calculations. Their difficulties may be compounded where the necessary underlying data is held by a third party, the provider or underwriter and where the elapse of time – years in many cases – will have made that data difficult to access due to intervening event such as systems migrations and archiving.

Apart from banks, the impact of the ruling may also have been felt by claims management firms. These companies have become a feature on the legal landscape since pensions mis-selling and endowments, and have ensured that the consumer awareness of the issue is greater than ever before. However, given that the major banks have set up operations to speedily process claims for compensation directly, many claims management firms will have missed out on processing and obtaining a commission on consumers’ claims despite expecting a windfall.  

Proactive approach needed in 2012

As we move into 2012, the focus will shift from complainants to non-complainants. In what represents a painful sting in the tail in the FSA’s Policy Statement, firms are required to take a proactive approach to contacting customers who may have been mis-sold PPI even though they have not made a complaint. This will demand rigorous root cause analysis, i.e. determining what went wrong in the PPI sales process, and will require investigative or forensic skills that many firms will lack. The alternative, i.e. to provide conclusive evidence that nothing had ever gone wrong, will surely be even more difficult given a skeptical regulator.

Most of the industry should by now understand the importance that the FSA attaches to prompt and effective customer redress programs and that the consequences of failure almost invariably include Enforcement action.

Having fought off an unsuccessful industry challenge, the FSA will be keeping a careful eye on industry compliance in PPI complaints handling and redress going forward and has already indicated that next year there will be a step up in thematic visits to firms. Based on experience, it is very likely that these visits will result in requirements for S166 for a high proportion of firms visited – an additional financial and compliance burden on firms.

The FSA is highly alert to the risk of a repeat of the PPI issue and earlier this year it published its proposals for powers to intervene and ban products that it considered sufficiently risky. This paper was produced in response to an acceptance by the regulator that its previous responsive approach has been inadequate, as in the case of PPI, and that it needs to be able to intervene before consumer detriment occurs.

Many of the strategies outlined in the paper are already being implemented by the FSA to a greater or lesser extent, either as part of its intensive and intrusive approach to supervision, felt most keenly by the major retail providers who unsurprisingly invest most in product development, or in their numerous thematic reviews – for example, more risk analysis for products and more scrutiny in the value chain.

Guidance for future product design

Further, the Office of Fair Trading and the FSA have recently issued draft guidance for firms in relation to PPI product design and governance arrangements, following the Competition Commission’s review of the PPI market earlier this year. The key requirements proposed are that firms should identify and address properly the needs of their target market, and that the product should meet those needs if claimed upon, there should be no unfair barriers to switching, and product risk should be managed throughout the product life cycle.

These are messages that have been broadcast repeatedly since the launch of TCF, if not earlier. The FSA has taken it one step further with the specific application to this type of products. The familiar content may explain why the FSA have set such a short consultation period  – responses have to be in by 13 January 2012, a tight deadline given the holiday season.

However, if the messages are uncontroversial, there remain some key areas where the FSA may have to revisit its thinking. This became apparent at the recent FSA’s industry roadshows, where there was a lively discussion regarding the scope of the guidance. For those affected the point is more than technical – it risks creating an unfair advantage for those in the credit sector not subject to the FSA’s onerous standards.

The PPI scandal is a major shake-up for the industry. Heated debate will no doubt continue on regarding the real causes for the saga. What remains to be seen is how firms cope with the considerable financial and operational challenges ahead in both providing appropriate redress and delivering the next generation of income protection products that properly meet a genuine market need. One thing is certain – those firms that have failed in their duty to treat customers fairly in the past will pay a heavy cost, hopefully ensuring that this is one lesson that will not be forgotten.