In recent months you’ll have seen lots of comment in the UK press about the evils of Payment Protection Insurance. In our view, the problem is not so much about what the insurance does, but more about how it’s sold.

Payment Protection Insurance protects borrowers who fear they’d be unable to maintain their debt repayments if they lost their income due to illness, accident or unemployment. The basic idea of the insurance is sound but the problem is that to make a valid claim, you have to satisfy certain criteria and quite a few people fail to do this. For example, if your job is seasonal or casual, or your illness was due to back pain, you won’t be able to claim. In fact only 4% of policyholders make a claim and one in six of claims are rejected.

However, the worst aspect is that lenders have clearly pressurised some people into buying Payment Protection Insurance when they really didn’t need it - either because their employer will continue to pay them if they’re off ill or they already have other types of insurance that provide similar benefits or the nature of their employment would disqualify them from claiming. Indeed, according to Defaqto the financial researcher, 60% of online credit card companies and 30% of loan providers fail to show you the terms and conditions for the insurance before signing you up. It’s these terms and conditions that tell you when you can’t claim.

Only a few months ago FSA’s published the results of its mystery shopper investigation into Payment Protection Insurance. This concluded that around half of the lenders shopped failed to explain the details and exclusions to customers or ensure the insurance was suitable for their clients. Whilst the investigation didn’t conclude that lenders were compulsorily selling PPI, they found it was frequently added to loan quotations without it being explained that the insurance was optional.

And even worse in our view, many lenders do not explain the full cost of the insurance. In many cases the full cost of the insurance (for the entire period of the loan), was being added to the loan as a lump sum at the outset rather than being paid as a monthly premium. This effectively means that the borrower cannot cancel the insurance without paying off the entire loan - and interest is charged on the insurance premium!

Now after months of deliberation the Financial Services Authority (FSA) has at last shown its teeth. It’s told Banks, Building Societies and other lenders that they could be forced to cease selling Payment Protection Insurance alongside loans and mortgages if they fail to clean up their act.

In a confidential letter sent to the Council of Mortgage Lenders leaked to the National Press, the FSA threatens to bring in “corrective actions” if Payment Protection Insurance continues to be miss-sold. The memo goes on to indicate that the FSA would prefer the lenders to put themselves in-order, but if necessary, the FSA threatens action. Its most likely directive would be that sales PPI must be made quite separately to the sale of the loan or credit facility. This will clearly hit lenders profits as last year alone they earned over Ј1 billion, yes BILLION, in profits from Payment Protection Insurance.

Over the years lenders have certainly honed their ability to charge for PPI. Only a few months ago we came across a high street bank that charged Ј5,150 for PPI to cover a loan of Ј16,000. They then added the cost of the insurance to the loan increasing the amount borrowed to Ј21,150. This meant that of the Ј300 monthly repayment, about Ј70 represented the cost of the insurance. What the lender never told the borrower was that equivalent insurance could be bought on the Internet for around Ј20 per month and the insurance from the Internet was cancellable at any time without penalty.

According to the Managing Director of British Insurance Ltd, Simon Burgess, the big high street banks typically charge Ј30 per Ј100 of loan insured. This compares with between Ј4 and Ј6 if the policy is bought separately on the Internet. This price comparison view broadly supported by uSwitch the price comparison service, which says taking out PPI with banks can increase the cost of the insurance by nearly 500%.

So is PPI a good idea and what’s the best way to buy it?

If you are in any way concerned that you’ll be unable to maintain mortgage or other debt repayments if you are off work due to illness, accident or unemployment, then PPI could be a good idea. But you need to do a bit of homework first: -

If you’re ill and off work, how long will your employer continue to pay you and is that at your full rate of salary? If they’re generous, you might not need insurance!

Do you have any other insurance that will pay out if you’re ill?

Then search the Internet for “payment protection insurance”. We can almost guarantee that that’s where you’ll find it cheapest.

Always shop around on the Internet for competitive premiums.

Always, choose a policy that charges you a monthly premium.

Then, before you buy online, check out the policy’s conditions. Especially find out how long you need to be off work before you can claim and whether the claim can be back-dated to the first day you were off work. Also check out the conditions that allow you to make a claim. Does the nature of your job or your current state of health make it unlikely that you’d be able to claim? If so, don’t buy!

Remember, PPI can be a good idea, but don’t be forced into making a quick decision. Make sure the cover applies to you and it’s good value. Follow our advice and you’re unlikely to go wrong. You can then sleep soundly at night.

Michael writes for Express Life Insurance who offer Mortgage Insurance and Life Assurance.

Michael Challiner