The regulators’ pressure on the payment protection insurance (PPI) market was increased when the FSA announced a major development in its third phase of work designed to clean up the industry. The FSA’s agreement with the industry is likely to fuel a wave of mis-selling complaints and a hefty bill for administration costs.

On 28 March the FSA announced details of its agreement with a number of key trade associations (including the Association of British Insurers, the British Bankers’ Association, the Council of Mortgage Lenders and the Finance & Leasing Association) regarding the treatment of single premium PPI policies. With a single premium policy, the customers pays one lump sum for the PPI cover. This extends over the entire term of the underlying credit product. This contrasts with premiums that are payable on a monthly or regular basis which permit customers to cancel their policies mid term without any financial penalties.

The concerns

The FSA has identified two main areas of concern for consumers who purchase PPI policies on a single premium basis:

  • The single premium is paid upfront at the start of the underlying contract. However the cost of the PPI cover is usually added to the loan Accordingly, interest is charged on the PPI premium over the whole term of the loan.
  • A significant proportion of personal loans and credit facilities, which PPI policies are designed to protect, are repaid by the customers before the end of their term. However, single premium policies typically prevent customers from obtaining a refund of premium in respect of the unused part of the cover, ie for the balance of the original term. The industry refers to this concept as a “nil refund”. The FSA has found that nil refund clauses may breach the Unfair Terms in Consumer Contracts Regulation 1999 (UTCCR) because, contrary to the requirement of good faith, the provisions cause a significant imbalance in the parties’ rights and obligations to the detriment of the consumer.

The FSA’s concern regarding nil refunds is not a new area. Back in October 2006, the FSA published their findings following their second phase of thematic work into the PPI market. One of the key problem areas highlighted in the report was firms’ bias towards selling single premium policies, rather than regular monthly premiums, even though they were not suitable for customers. Specifically, customers who pay premiums on a monthly basis incur no further costs if the PPI policy is cancelled to coincide with the early repayment of the underlying credit product. The FSA considers such ‘nil refund’ terms to be unfair under UTCCR . Consequently, the term is viewed as unenforcable against the consumer.

Importantly, a breach of UTCCR also constitutes a breach of the FSA’s requirement to treat customers fairly (TCF) and the obligation that “firms must pay due regard to the interests of its consumers and treat them fairly”. The FSA view UTCCR as underpinning their work in this area and they have urged firms to take into account “the legal, reputational and operational risks of a court finding a term to be unfair”.

Furthermore, the FSA has authority to ask a firm for an undertaking that the firm will amend any unfair terms. All such undertakings given by firms are published on the websites of the OFT and FSA.

For example during June 2006, the FSA received a number of undertakings and statements in the PPI market. Each of the firms concerned had issued PPI contacts containing unfair cancellation terms which stated that if consumers repaid their loan early, they would not be given any refund of the single premium paid for their PPI policy. Each company involved agreed to stop using the term and stated that it would not to rely on it in relation to existing policies.

The agreement

However, following the FSA's recent agreement, the treatment of nil-refund customers has been standardised across the industry. Going forward, all firms will be required to:

  • not include nil refund terms in contracts for new PPI customers
  • not rely on nil refunds in contracts with existing customers (the refund) 
  • treat their customers fairly if they need to reissue the associated loan in order to cancel the PPI
  • contact existing customers if their PPI policies contain nil refund terms, and advise them how refunds will be dealt with in practice (the mail-out)
  • calculate the PPI refund due to customers fairly taking into account a firm’s reasonably incurred costs. These might include administrative fees, a proportion of commission and the uneven spread of the risk across the length of the policy. To this extent, the FSA has also said that firms “may find it useful” to carry out a review of their refund terms to ensure they comply with the requirements of UTCCR and TCF. To this end, firms should ensure that all contract terms are expressed in plain, intelligible language and should consider asking a noninsurance person to confirm they understand the terms and are satisfied they are fair 
  • include in new policies examples or a table to illustrate how refunds will be calculated to improve transparency. Firms which have nil refund terms in their contract must change their contracts so that new contract terms which provide partial refunds are included. Firms should provide partial refunds if the consumer cancels the policy for any reason. This is unless a policy is very near to its end, a claim has already been paid under the insurance policy or the consumer has chosen to continue with the policy as freestanding cover.

The impact of the FSA’s recent agreement is likely to be significant and far-reaching. The two most important aspects for firms will be the FSA’s requirement for the mail-out and refund.

The mail-out

For the purposes of a mail-out, the industry is going to face considerable administrative costs reviewing all their old PPI policies and contacting the relevant customers to advise how refunds will be dealt with in the future. A mail-out on this customerspecific basis will therefore have certain similarities with product providers issuing endowment customers with re-projection letters. As the industry is all too aware, the cost of the reprojection exercise has been very substantial and was not an overhead that was factored in when these types of policies were first sold. It is therefore possible that the administrative costs of the mail-out to existing nil refund customers could be on a similar scale.

Equally, nil refund customers who receive a mail-out from firms may treat the communication as an invitation to complain - not simply about the lack of refund provisions when the policy was first sold, but a wider complaint concerning the general mis-sale of the PPI policy itself. Comparisons can be drawn here with mortgage endowments. A significant proportion of endowment mis-selling claims appear to have been triggered by customers receiving re-projection letters advising of a potential shortfall in the value of their investments as against the capital loan at maturity. The industry know to their detriment that endowment mis-selling is likely to cost many billions of pounds in compensation before it is over.

In light of this, there is a prospect of a flood of PPI mis-selling claims arising from the estimated 20 million policies that are currently in force. Some of these complaints are likely to be valid given the FSA’s comments last month in which they indicated that PPI has been systemically mis-sold over a prolonged period of time. Indeed, some commentators have already speculated that PPI mis-selling could even overshadow the endowments scandal, and cost the industry more than £10bn in compensation.

Given the prospects that the proactive mail-out is likely to invite complaints, firms who are involved in this exercise should consider whether they need approval from their professional indemnity insurers before they issue the mailings.

The refund

The second serious implication for firms is the cost of the refund. The PPI market is extremely profitable for the industry, with policies purchased in 2005 worth over £5.5bn.

The success of the PPI market stems from high commissions and lower than average claims ratios, ie the percentage of total premiums paid out in claims. However, part of the profitability of the PPI market also hinges upon firms reaping the risk-free rewards of nil refund premiums for PPI policies covering principal credit facilities that have already been settled.

The FSA’s requirement for firms to provide refunds to eligible customers means that going forward, the PPI market is not going to be as profitable as the industry has been over recent times. Equally, the industry now faces the prospect of a very large bill for refunding eligible single premium customers. That bill will not have been accounted for when policies were first sold, or as a provision in firms’ accounts for their current profitability.


At this stage, it is not clear whether firms will be able to claim from their PI insurers for of the costs of the mail-out and refund. It is likely PI insurers will argue that these costs do not stem from mis-selling and are not claims for compensation. However, it will be more difficult for PI insurers to argue there is no claim where the mail-out triggers a PPI customer to complain.

Perhaps more troubling will be those complaints where firms failed to draw a PPI customer's attention to the extensive exclusion clauses. This could cause product providers to provide indemnity that would ordinarily be excluded under a PPI policy, especially if the matter is considered before FOS. Product providers are therefore likely to look to the selling firms for the indemnity paid. These types of mis-selling claims against firms are likely to be of the highest value and therefore of the greatest concern to the PI insurers.


In conclusion, the FSA will be monitoring firms’ compliance with the new requirements for the treatment of single premium customers very carefully. If firms do not satisfy the terms of the agreement, and fail to treat their customers fairly, the FSA will take further regulatory action as appropriate.

The FSA’s announcement marks yet another notch in the PPI misselling scandal, which is rapidly gathering momentum fuelled by pressure from consumer bodies, competition authorities and Parliamentary groups. Firms are used to dealing with mis-selling scandals in the financial services arena, but perhaps this is the first to affect the industry since the FSA took over regulation of general insurance. Given the size of the PPI market and the amounts at stake, the impact on firms could be enormous.