In a judgment handed down in April of this year, the High Court dismissed a judicial review application made by the British Bankers Association (BBA) and Nemo Personal Finance Limited (Nemo) against complaints handling rules relating to the mis-selling of payment protection insurance (PPI).

The ruling has upheld the Financial Services Authority’s (FSA) Policy Statement 10/12 (Policy Statement), which introduced stricter requirements on the handling of PPI complaints by firms. At the time of the judgment there had been over 1.5 million complaints made about PPI since 2005. It had been estimated that full compliance with the measures would cost the industry between £1bn and £3bn, largely to be incurred in the payment of redress to consumers. This estimate has since proved conservative, with Lloyds Banking Group alone announcing that it had reserved £3.2bn for potential costs. The final bill is now estimated to be over £5bn.

The Problem with PPI

The FSA’s concerns with the marketing of PPI were made clear in the Open Letter to firms which made up an appendix to the Policy Statement. This letter listed 15 common types of failings in PPI sales, including failings related to customer eligibility for PPI products, price disclosure and the disclosure of exclusions and limitations.

The FSA considered that sales of PPI products which contained one or more of these common failings would usually involve the breach of an FSA rule or a rule of general law. It was under the backdrop of such widespread industry failings that the FSA framed its policy on PPI.

The FSA Policy & the Challenge Made Against It

The Policy Statement was designed to address perceived weaknesses in the PPI market by enhancing the FSA’s approach to complaints handling as set out in the FSA Handbook, including its Principles for Business. It also obliged firms to conduct analysis on the root cause of recurrent failings and adopt proportionate measures of redress, even for those customers who had not yet made a complaint. The policy was challenged by the BBA on three counts:

Ground 1: It was an error of law for the FSA to state that the FSA Principles for Business gave rise to obligations owed by firms to customers.

Ground 2: It was an error of law for the FSA to state that an entitlement to redress could arise from a breach of Principles where other specific rules exist.

Ground 3: It was an error of law for the FSA to address the mis-selling of PPI through a policy statement, rather than through a specific remedy given to the FSA in statute. [Section 404 Financial Services and Markets Act 2000 (Consumer Redress Schemes)]

Ultimately the High Court rejected each ground of review, a decision which has not been appealed by Nemo, the BBA or any of the BBA’s constituents. This has left financial institutions, including banks and insurers, with the prospect of having to satisfy a vast number of compensation requests from consumers.

What Next?

Since the judgment, attention has now turned to the steps which firms must take to comply with the FSA Policy Statement.

There is certainly expected to be a backlog of complaints at firms. During the course of the PPI judicial review process there was an understandable reluctance on the part of firms to commit to redress payments where these might be affected by a forthcoming judgment. Although the FSA reminded firms in January 2011 that they still had an obligation to handle complaints where the substance of a given complaint did not relate to the judicial review, it is thought that only now will firms fully engage with the redress programme. The Financial Ombudsman Service (FOS) has confirmed that it received 104,597 complaints regarding PPI policies in the financial year 2010-2011. In anticipation of greater complaints-handling, we have seen the major players in the PPI market (both banks and insurers) make sizeable provisions to meet the expected number of complaints, costs which will partly be allocated to recruiting new staff and training existing staff.

But what exactly are firms required to do in the handling of PPI complaints?

Solving a Problem like PPI

Following the success of the FSA in defending the BBA’s challenge, the FSA Principles for Business have been confirmed as being at the centre of the regulatory regime. These Principles demonstrate that the handling of PPI complaints cannot simply be a case of adhering to rules in a form of ‘tick-box exercise’. The Policy Statement, through its incorporation of the Principles as a foundation for redress, shows that it is the approach of firms to wider issues, such as ‘treating customers fairly’, which will be a barometer of successful complaints handling, in addition to compliance with detailed rules.

Existing Complaints

The primary exercise which will need to be undertaken by firms in reviewing complaints is to consider, in light of all information held, whether a breach of FSA rules has taken place. This will involve a review of the information brought by the complainant and further information which the firm holds on its own sales practices, such as information which may be gleaned from a ‘root cause analysis’ exercise (see further below).

Where a breach has been found, firms are required to apply a ‘but for’ test to the given sale: “but for the breach, would the complainant still have bought the PPI product?” If the answer to this question is yes, no redress will be due to the complainant. If the firm concludes that the complainant would not have bought the PPI product which was purchased, the complainant will be provided with redress that, as far as practicable, will put the complainant in the position he would have been had he not bought the product.

In the case of single-premium PPI products, where the firm concludes that but for the firm’s breach the complainant would have bought a regular premium contract, instead of a single premium contract, the complainant must be offered redress that puts him/her in the position he/she would have been in had a regular premium policy been purchased.

Modes of Redress

In most cases the FSA policy envisages that compensation will be the appropriate form of redress, with a sum to be paid which reflects the detrimental effect of the breach or failing made by the firm. This could include a return of the premium paid by the consumer and accrued interest.

However, the Policy Statement makes clear that compensation is not the only form of redress which is available. For example, where a firm failed to disclose a limitation to the complainant, a firm may consider severing this limitation from the wider policy: continuing to perform the policy, but ensuring that the given limitation does not operate to the detriment of the consumer.

Root Causes of Complaints and Other Customers

Firms are duty-bound to take reasonable steps to ensure that systemic problems are identified and remedied. This will require a consideration of recurrent failures in the handling of individual complaints. However, where systemic problems are found in the sales practices for a particular PPI product, a firm should consider whether it should act proactively in relation to consumers who have suffered detriment but who have not yet complained. In some cases, this could include contacting all customers sold such products, whether complainants or non-complainants, to ascertain the extent of problems with a given product.

Moving Towards a Pragmatic Solution?

Ultimately, it may be that firms will take a commercial decision on their relative exposure to PPI mis-selling and, rather than contesting each complaint on the facts, will make settlement offers based on sales information held. Inevitably, such decisions will be guided by the nature of involvement a given firm has had in the PPI market.

Where firms do not institute proper internal complaints-handling mechanisms, a high profile publicity campaign by the FOS has meant that it is likely that many consumers will have a greater awareness of their right to pursue their complaints with the FOS.