If you looked at the amount of money lenders make in interest from loans and credit cards, you’d be hard-pressed to think of anything that could rival it for putting money in the pockets of the lenders. That is, until you compare PPI insurance with it. Years ago lenders realised that the real money and profitability doesn’t come from loans or credit cards at all, but from selling insurance alongside them, or in recent years, mis selling PPI insurance.
How do banks make big profits on PPI – Insurance is designed to protect us in time of need in return for a monthly premium, but insurance companies know that most of us will never actually claim against them. They know this as they have access to a vast amount of data and information and can calculate how likely it is they will have to pay out on claims. For example let’s take health insurance. If a 25 year old were to take out health insurance, the insurers will know there is a very slim chance that he or she will ever make a claim. This is their ideal customer, someone who is young and healthy and very unlikely to make a claim so more profit for them! It is like free money to some extent.
To give you an idea of how much money they actually make from this scheme see the list below. These figures are from an investigation into the insurance industry which was undertaken by the Competition Commission back in June 2008. It shows the following payout rations;
* Car Insurance – 78% * Home insurance – 54% * Mortgage PPI insurance – 28% * Personal Loan PPI insurance – 15% * Credit Card PPI insurance – 11%
So out of every 100 paid to an insurance company for a PPI policy, there is only a 15% chance anyone will ever claim on it. So there is an 85% chance the banks will never have to pay out, meaning that for every 100 paid to them, 85 is sheer profit! The payout ratio on credit cards is even lower at 11%. Not a bad mark up eh?
Why does PPI favour the lender? Insurance companies mainly sell their financial products through high street lenders, like banks and building societies as well as directly to consumers. But contrary to popular belief, they don’t make the most money out of this enterprise; it is the lenders that make the majority of the profit. The price you are being charged by the lender is the not the price the lender is being charged by the insurer. In fact, there have reports that some consumers have been quoted up to 9 times the actual cost of the insurance by the lender than if they would have gone direct to the insurers themselves. If you analyse the monthly interest on a typical loan and compare it with the same loan but with Payment Protection Insurance, the PPI insurance is usually vastly higher!
Mis selling PPI insurance – When did it become so common? When lenders realised what a money spinner Payment Protection Insurance insurance was back in the late 1990s, they started pressuring their staff to sell as many policies as possible. They were given targets to hit and their pay was linked so if they didn’t sell their wages decreased. Some lenders even sacked their staff if targets were not met, whilst other lenders offered huge benefits and incentives to those who could sell the most in a day, week or month.
Customer service staff with no sales experience was forced to sell Payment Protection Insurance any way they could to keep their jobs. Bear in mind, until this point the in-depth knowledge needed to ensure a financial product was right for someone and that they understood what was involved lay in the domain of trained and experienced financial advisors. Lenders were muscling in, sending out staff with the most minimal of financial training to sell financial products.
Serious mistakes began to arise and peoples ethics went out of the window in the race for sales and profits. Consumers were being persuaded to take out policies even though they were not suitable for them, and when they came around to reclaim on their policy they found themselves being told, ‘sorry, computer says NO!’. This is one of the main factors why PPI has such a low pay out ratio and has led to a wave of PPI mis selling claims being made.
Don’t get me wrong, PPI can be a very useful tool if your finances take an unexpected turn or you are made redundant or become ill, but thanks to the behaviour of the lenders the reputation of Payment Protection Insurance will never be the same as what is was. It will be forever linked to the words ‘mis selling’.
If you have PPI there is a good chance it was mis sold to you. Use our PPI calculator to see how much you could reclaim.