Market investigation into payment protection insurance

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1 Market investigation into payment protection insurance 29 January 2009

2 Competition Commission 2009 Website:

3 Members of the Competition Commission who conducted this inquiry Peter Davis (Chairman of the Group) Professor John Baillie Christopher Bright Professor John Cubbin Richard Farrant Martin Stanley Chief Executive and Secretary of the Competition Commission The Competition Commission has excluded from this report information which the inquiry group considers should be excluded having regard to the three considerations set out in section 244 of the Enterprise Act 2002 (specified information: considerations relevant to disclosure). The omissions are indicated by. Some numbers have been replaced by a range. These are shown in square brackets. Non-sensitive wording is also indicated in square brackets. The following typographical corrections have been made to the version of this report published on the CC website on 29 January 2009: Practical corrected to practicable in paragraphs 79 and Appendix 10.1 personal quote for stand-alone and short-term income protection has been amended to remove the following words which were inadvertently included If you want to buy PPI from us you may contact us 24 hours after [the conclusion of the credit sale period] or we may contact you from 7 days after this date and To take out this PPI please ring xxx xxx xxx or visit after xx.xx.2009 [this date is at least 24 hours after the conclusion of the credit sale period]. iii

4 Market investigation into payment protection insurance Contents Page Summary... 1 Findings Introduction The roles of the FSA, the OFT and the CC in the oversight of PPI Events leading up to this investigation Conduct of the investigation Publication of evidence and other materials Report overview PPI underwriting and distribution What is PPI? Short-term income protection Possible alternative policies Sales of PPI and shares of supply Customers Organization of the PPI value chain Underwriters Distributors Vertically-integrated businesses Intermediaries Stand-alone provision How PPI is sourced and sold Contractual relationships between underwriters and distributors The sale of PPI to customers Market definition for the distribution of PPI Summary Introduction Product market The responsiveness of PPI demand to PPI prices The substitutability of different levels of PPI cover sold at a point of sale The substitutability of PPI policies offered by different distributors Substitutability of stand-alone PPI and short-term income protection The substitutability of other insurance products with PPI Substitution between combinations of PPI and credit The position of non-standard credit consumers Geographic market Conclusion on market definition The impact of our market definition on our analysis of competition Indicators of the extent of competition between PPI providers in the supply of PPI. 78 Summary Introduction Variation of PPI prices over time Indicators of non-price competition New PPI policies Innovations within existing products Reasons for introducing new and amended PPI policies Advertising/marketing Price dispersion Search Switching Switching PPI without switching credit product Claims ratios iv

5 Profitability How we examined profitability of PPI distribution Results of profitability analysis Documentary evidence on profitability Conclusions on profitability Conclusions on the extent of competition between distributors Coordination in the distribution of PPI Factors affecting the nature and extent of competition in the supply of PPI Competition between PPI providers Search Benefits to search Barriers to search Conclusions on search Switching Barriers to switching The effect of single-premium policies on switching Conclusions on switching Barriers to entry and expansion The point-of-sale advantage What is the point-of-sale advantage Evidence for the existence of a point-of-sale advantage The causes of the point-of-sale advantage The advantages gained by distributors from selling PPI at the point of sale The advantages gained by customers from PPI being sold at the point of sale. 121 How the point of sale affects competition The possible competitive constraint from new stand-alone products The effects on consumers of the level of competition in the market Conclusions on factors affecting the nature and extent of competition Retail PPI Introduction Retail PPI What is retail PPI Who sells retail PPI? Possible alternative policies Sales of retail PPI Organization of the retail PPI value chain How retail PPI is sold Market definition Substitutability of retail PPI with short-term IP and stand-alone CCPPI The substitutability of the retail credit and retail PPI combination with alternative combinations of credit and PPI The substitutability of the goods, retail credit and retail PPI bundle with alternative bundles of goods, credit and PPI Geographic market for retail PPI Conclusion on market definition Indicators of the extent of competition between retail PPI providers in the supply of retail PPI Variation of retail PPI prices over time Indicators of non-price competition Advertising Price dispersion Profitability Recent developments in the supply of retail PPI Conclusions on the extent of competition between distributors Factors affecting the nature and extent of competition in the supply of retail PPI Competition between retail PPI providers v

6 Search Switching Barriers to entry and expansion The point-of-sale advantage The effects on consumers of the level of competition in the market Conclusions on factors affecting the nature and extent of competition The underwriting of PPI Market definition Product market Geographic market Conclusion on the market definition for underwriting of PPI Is there evidence of market power being exerted by underwriters? Concentration of the market Capacity Entry, exit and expansion Countervailing buyer power Profitability of underwriting Documentary evidence from the parties Financial performance of underwriting Conclusions on the profitability of PPI underwriting Conclusions on the underwriting market Vertical integration Vertically-integrated businesses Ways in which vertical integration might harm consumers Reducing the number of bidders for non-integrated underwriting business Limiting the size of the underwriting market Removing the competitive pressure on in-house underwriters Creating a greater incentive for (in-house) underwriters to reject PPI claims Conclusions on vertical integration Findings The distribution of PPI The underwriting of PPI Vertical integration Remedies Introduction Framework for the assessment of remedies and relevant customer benefits General issues Impact of ICOBS regulation The impact of the economic downturn Impact on the protection gap Increased risk of adverse selection Comparison with extended warranties and store cards Recent competitive developments Remedies the CC has decided to implement Prohibition on selling PPI at the credit point of sale and within a fixed time period of the credit sale (the point-of-sale prohibition ) Summary of this element of the remedies package How the point-of-sale prohibition contributes to addressing the AEC Risks of a point-of-sale prohibition Effectiveness of the remedy and alternatives to a point-of-sale prohibition Conclusion on the need for a point-of-sale prohibition The design of the point-of-sale prohibition Obligation to provide a personal PPI quote Summary of this element of the remedies package How the obligation to provide a personal PPI quote addresses the AEC The content of the personal PPI quote vi

7 Obligation to provide information about the cost of PPI and key messages in marketing material Summary of this element of the remedies package How the provision of information in marketing materials will address the AEC Issues raised The design of a common price metric An obligation to provide information to OFT and FSA for monitoring and publication and to provide information about claims ratios to third parties Summary of this element of the remedies package How the requirement to provide information to third parties will address the AEC Prohibition on the selling of single-premium PPI policies Summary of this element of the remedies package How the prohibition of single-premium PPI policies will address the AEC Issues raised Obligation to offer retail PPI separately from merchandise cover when both are offered as a bundled product Summary of this element of the remedies package How the requirement to unbundle retail PPI from merchandise cover will address the AEC Issues raised An obligation to provide annual statement of PPI cost and a reminder of the consumer s right to cancel Summary of this element of the remedies package How the requirement to provide an annual statement will address the AEC Issues raised The design and implementation of this measure Implications of remedies package for providers of stand-alone PPI and short-term IP Options we decided not to pursue Further standardization of PPI information given to the consumer at the point of sale All PPI policies to be renewed annually Alternative remedies to a prohibition of single-premium PPI policies Minimum standards for elements of PPI policies that act as a barrier to switching Obligation to share information about customer claims Obligation to share information about consumers credit card and retail credit balance with a nominated underwriter Price caps Relevant customer benefits Potential customer benefits of the point-of-sale advantage Knowledge by credit providers that a consumer will take out PPI Lower credit prices The effectiveness and proportionality of the package of remedies The rationale for implementation of all elements of the remedies package Benefits and synergies of the remedies package Modification of the remedies package for relevant customer benefits Extent of consumer detriment The cost of the package of remedies Conclusion on effectiveness and proportionality Implementation of remedies How the remedies should be implemented The timescale for implementation Monitoring compliance and effectiveness Summary of our decisions on remedies vii

8 Summary 1. We found that each distributor and intermediary faces little competition for the sale of Payment Protection Insurance (PPI) when it is sold in combination with the credit it insures. We found that there were features of relevant markets which led to an adverse effect on competition (AEC) in these markets and in turn resulted in consumers facing higher prices and less choice than they would if there was effective competition between PPI providers. As a result of this lack of competition we found that it is highly profitable for distributors to sell PPI, though we found that some of the resultant profit is used to subsidize credit prices. We concluded that there were serious deficiencies in the competitive process for selling PPI policies, and, in order to remedy the adverse effects identified, a package of remedies would be required which includes some significant restrictions on what parties selling both PPI and credit can do (and also impose some burden on parties that offer only PPI to consumers). We concluded that such an intervention in these markets would enhance overall consumer welfare, and that the scale of the problem identified warranted a significant intervention. 2. We concluded that we should impose: a prohibition on distributors and intermediaries from selling PPI to their credit customers within seven days of a credit sale, unless the customer has proactively returned to the seller at least 24 hours after the credit sale; a prohibition on selling single-premium PPI policies (where the premium is paid in one upfront payment, generally by adding the premium to the credit borrowed); a requirement on retail PPI distributors to offer retail PPI separately when they also offer retail PPI bundled with merchandise cover; and several requirements to provide specified information in marketing materials, at the points of sale of credit and PPI, and each year after the PPI policy has entered into force. Background 3. On 7 February 2007 the Office of Fair Trading (OFT) referred the supply of all PPI (except store card PPI) 1 to non-business customers in the UK to the Competition Commission (CC) for investigation under section 131 of the Enterprise Act 2002 (the Act). The reference followed the receipt of a super-complaint about PPI on 13 September 2005 from Citizens Advice. This document, together with its appendices, constitutes our final report. 4. PPI covers repayments on the insured credit product if the borrower suffers an insured event usually accident (A), sickness (S), unemployment (U) or death (referred to as life (L) cover). PPI is sold to cover a variety of credit products, but nearly 95 per cent of PPI sold in the UK in 2007 was either personal loan PPI (PLPPI), credit card PPI (CCPPI), mortgage PPI (MPPI) or second-charge mortgage (also known as secured loan) PPI (SMPPI). We looked at two other forms of PPI during our investigation. The first was motor finance PPI (motor PPI) where the credit is given for the specific purpose of buying a car. We found that motor PPI was PLPPI and our conclusions on PLPPI in this report apply to motor PPI unless otherwise specified. The other form of PPI is retail finance PPI (retail PPI). We found two types of retail PPI (see paragraph 6.2 for further details): personal loan retail finance PPI, which we concluded was a form of PLPPI; and credit account retail finance PPI. We consider credit account retail finance PPI ( retail PPI ) separately from other forms of PPI in this summary, and in Sections 6 and The OFT Terms of Reference define store card PPI as services supplied for the purpose of protecting a store card holder s ability to maintain repayments due under the store card agreement. 1

9 PPI distributors and their business models 5. Most PPI policies are sold by distributors 2 at the point of sale of the credit being insured (referred to as the point of sale in this report). There are a few providers of PPI policies that do not also supply the credit to be insured (stand-alone PPI), and of short-term income protection (short-term IP), which provides a pre-agreed amount of money in the case of an insurable event occurring. We found that short-term IP is a form of PPI and that short-term IP policies sold as a result of a referral during a credit sale are effectively sales of PPI at the point of sale. PPI is also sold via intermediaries. This is particularly evident with MPPI where intermediaries are significant players, but they tend not to sell the distributor s MPPI policy with its mortgage. In this report we use the term PPI providers where we refer to distributors, intermediaries and stand-alone providers selling PPI. 6. The PPI policies sold are underwritten by insurers (usually referred to as underwriters). Four of the largest distributors of PPI also have insurance businesses within their organizations which underwrite some or all of the policies they sell (these are referred to as vertically-integrated businesses). Other distributors rely on external underwriters. 7. In 2007 customers in the UK paid 3.8 billion in PPI premiums. Distributors are contractually entitled to a percentage of this gross written premium (GWP) the amount of money paid by customers, net of insurance premium tax as commission, to cover expenses and contribute to profits. Typical commission rates are 50 to 80 per cent for PLPPI and CCPPI and 40 to 65 per cent for MPPI. The remaining GWP is passed to the underwriter to cover expenses, including claims. We found that between 11 and 28 per cent of GWP is paid out in claims (net of rebates), depending on the product. In the event that claims levels are less than expected, the resulting profit is generally split between the underwriter and distributor according to an agreed profit share percentage; typically 90 to 100 per cent in favour of the distributor. A separate profit share arrangement will typically apply to any investment income earned by the underwriter on premium income and may also apply to tax benefits on life business. 8. PPI is predominantly sold through three distribution channels: face to-face contact in branches, over the telephone, and over the Internet. Over half of all policies are sold through face-to-face contact with a sales adviser. PPI is sold either on an advised basis, where a personalized recommendation is provided as to the suitability of the product for a customer, or a non-advised basis, where no personalized recommendation is made. 9. PPI policies are paid for either by a regular monthly premium or a single premium. The single premium is a lump-sum payment to cover the cost of PPI for the term of the policy, and is almost always paid for by the credit provider advancing the cost of PPI, adding to the amount borrowed when the loan is agreed. This arrangement means that the customer pays interest on the whole amount borrowed, including that borrowed to pay for the single-premium PPI. Most PLPPI and about two-thirds of SMPPI policies are paid for by a single premium. MPPI, CCPPI and retail PPI are paid for using regular monthly premiums. 10. The amount paid for a PPI policy varies significantly between PPI providers, and can be significant compared with the interest payable on the credit. For most PLPPI policies we looked at, the cost of PLPPI over the term of the loan was greater than 2 See paragraphs for details. 2

10 the interest payable on the loan. However, whilst prices vary between PPI providers, we saw little price movement over time we saw many PPI policies (especially SMPPI, MPPI and CCPPI policies) whose price did not change at all over the period 2002 to 2006, whilst those that did change generally saw infrequent price increases (there were very few examples of price decreases). While prices did not change, the terms and conditions did change from time to time (for example, through removing an exclusion that had prevented customers claiming for a particular event, such as sickness due to a stress-related condition). Customers and customer behaviour 11. PPI consumers are more likely to earn less than the national average income or come from socio-economic groups C and D. Various surveys show that the most frequently cited reasons given by consumers for taking out PPI relate to peace of mind. 12. Not many consumers compare different policies before purchasing PPI. By far the greatest level of search was among consumers looking at MPPI, where 21 per cent of consumers compared policies. Most people who did compare policies did so by looking at different combinations of credit and PPI. 13. Once consumers have a PPI policy they tend not to switch PPI without also switching the underlying credit product. When consumers switch the PPI and credit combination, the primary driver does not appear to be a better PPI policy or a better deal on the PPI; drivers for change include the end of a time-limited mortgage deal, 0 per cent annual percentage rate (APR) on balance transfer offers for credit cards, and better APR deals on loans. Market definition 14. We looked at market definition, in order to use it as a framework for considering the extent of competition between PPI providers. We considered the market definition for retail PPI separately from other types of PPI policy (see paragraphs 21 to 26). 15. We looked at the product market from two perspectives. First, we looked at the competitive constraints imposed on a PPI provider by other PPI providers and from alternative types of insurance. Second, we looked at the extent to which distributors and intermediaries supplying combinations of credit and PPI constrained one another. 16. We found that PPI distributors and intermediaries were not constrained by other PPI providers or by alternative types of insurance: (a) The internal documents and testimony from the distributors of PPI indicated that demand for their own PPI policies is unresponsive to changes in price. (b) Our analysis of the evidence on consumer search and switching patterns indicated that relatively few customers shop around for PPI. A survey we commissioned of PPI consumers also indicated that limited numbers of PPI consumers compared two or more PPI policies before their purchase. Our analysis of these results indicated limited responsiveness of an individual distributor s PPI demand to changes in the price of its PPI policies. (c) We assessed each potential source of competitive constraint in turn and found that there was no strong evidence that any of these was likely to constrain prices. 3

11 (d) The high margins earned on PPI are indicative of a low responsiveness of demand for PPI policies to changes in their prices. 17. We considered the potential competitive constraint imposed on PPI distributors or intermediaries by the complementary relationship between PPI and the credit products that they insure. We found the constraint that distributors or intermediaries supplying combinations of credit and PPI imposed on one another to be low. The evidence leading to this conclusion included: (a) We found that the responsiveness of consumers in general to changes in prices of PPI policies was low. The responsiveness of credit sales to changes in the price of PPI was lower still. (b) Internal documents received from the largest distributors showed that they were not deliberately or consciously constraining their PPI prices because of the prospect that high PPI prices might damage their credit sales. (c) The CC GfK NOP 2008 survey indicated that the majority of search involved searching on the bundle ; however, the incidence of search was low. CC analysis indicated that the level of search was insufficient to drive PPI prices down from the currently high prices to competitive levels (see paragraph 16(d)). (d) Our analysis of the main distributors sales data did not show clear evidence that increases in PPI prices in the past had resulted in a significant reduction in credit sales. (e) The profit margins that PPI distributors earn on the underlying credit product are far lower than those earned on PPI. Credit sales therefore have a proportionately lower impact on profits than the loss of a PPI sale. 18. We found that individual distributors and intermediaries supplying PPI combined with credit were not competitively constrained by other PPI providers, or by alternative types of insurance policies. We also found that distributors and intermediaries supplying PPI combined with credit did not constrain one another. 19. We therefore concluded that the product market was an individual distributor s, or intermediary s, sales of a particular type of PPI policy. However, we found that whilst PPI sold by distributors and intermediaries is not competitively constrained by standalone PPI, asymmetric constraints mean that stand-alone PPI is constrained by PPI policies sold by distributors and intermediaries. 20. We found that the geographic market was the area within the UK in which a distributor or intermediary sold PPI. 21. In considering the market definition for retail PPI, we identified three ways in which retail PPI customers could potentially react to a small but significant non-transitory increase in price (SSNIP) in retail PPI and which could result in that SSNIP being unprofitable. These were that customers could substitute to other insurance policies, customers could substitute to other forms of insured credit and customers could substitute to other retailers that offered a credit account and retail PPI. 22. We found that a lack of suitable alternatives to retail PPI, the limited sales of possible alternatives, their limited effectiveness as substitutes and the limited impact that they appeared to have on retail PPI sales following a price rise indicated that the prospect of customer substitution to alternative types of credit insurance was a weak constraint on retail PPI distributors. 4

12 23. With regard to substitution between bundles of credit and PPI, we found that it was more difficult (and certainly no easier) for retail PPI consumers to consider the whole cost of a bundle including retail PPI when compared with other types of PPI. We saw no clear evidence to suggest that retail PPI customers were intrinsically more likely to substitute between bundles of credit and PPI than customers of other types of PPI. We also received conflicting views from the retailers regarding the extent to which their customers substitute between bundles in response to changes in retail PPI prices and terms. We concluded that the possibility that retail PPI customers may substitute to alternative bundles of credit and PPI, in response to an increase in retail PPI prices, was a weak constraint on retail PPI distributors. 24. We also found that it was likely to be difficult for retail PPI customers to substitute between retailers offering retail credit accounts and retail PPI. We received conflicting views from the retailers regarding the extent to which their customers would substitute in this way in practice and none of the parties was able to provide primary evidence that customers substitute between retailers in response to changes in retail PPI prices. We concluded that the possibility that retail PPI customers may substitute to other retailers offering home shopping, retail credit accounts and retail PPI, in response to an increase in retail PPI prices, was a weak constraint on retail PPI distributors. 25. Because the constraint on retail PPI distributors from each of the three potential sources of substitution was weak, we concluded that a narrow market definition was appropriate, and that it would be inappropriate to include other types of credit insurance, or other bundles of credit and PPI, or other bundles of merchandise, credit and PPI within the relevant market. We therefore defined the relevant product market as the supply of retail PPI by a distributor to its own retail customers. 26. We defined the relevant geographic market as the supply of retail PPI by distributors to their customers within the UK. Indicators of the extent of competition between PPI providers 27. We assessed a series of indicators of the level of competition between PPI distributors and intermediaries. The purpose of this was twofold. First, it acted as a check on whether our market definition was correct. Second, it allowed us to understand the extent to which PPI providers actually competed with each other. We considered retail PPI separately from other forms of PPI (see paragraphs 64 to 66). 28. We found that there is little variation in PPI prices over time, and there is little evidence of PPI distributors seeking to win sales from each other by competing on PPI prices. 29. There is little evidence of PPI distributors seeking to win sales from each other by competing on non-price factors such as quality, innovation or choice. We consider that it is unlikely that there is vigorous competition on non-price factors because these factors are particularly difficult for consumers to observe and compare. 30. There is very limited advertising of PPI. Advertising spending is on the credit product and where PPI is included in advertising literature, the focus of advertising is predominantly on the underlying credit product. 31. PPI prices and the prices of PPI combined with credit are widely dispersed even when differences in quality are taken into account. We found no evidence of a clear relationship between PPI price and quality in either PLPPI or CCPPI and a relatively weak relationship between price and the quality of MPPI. 5

13 32. Despite this dispersion in prices, and the apparent benefits to search and switching that this would seem to confer, the incidence of substitution between PPI policies, or combinations of PPI and credit, is low. 33. The claims ratios (the claims incurred and provided for in the year as a percentage of net premiums earned) on PPI policies are low and, to the extent that consumers are aware of this, consumers who would rationally buy this insurance are likely to be those: who place a high value upon it and have a high aversion to risk, risk high consequential losses in the event of being unable to make payments, and/or have a belief that they are of above-average risk. 34. When analysed separately from credit, PPI distribution is highly profitable. We calculated that the 12 largest distributors made profits after tax in excess of the cost of capital on PPI of 1.4 billion in 2006, representing a return on equity (RoE) of 490 per cent. Of the total economic profits of 1.4 billion, PLPPI contributed 645 million, CCPPI contributed 336 million, MPPI contributed 112 million, and SMPPI contributed 126 million. Other forms of PPI made up the remaining 147 million. The RoEs in 2006 for PLPPI, CCPPI, MPPI and SMPPI were similar to the overall level of 490 per cent. We found that the results for 2007 were similar to The evidence on how intermediaries sell PPI included: that an intermediary or intermediary network typically sells one MPPI product or a small selection of MPPI products (sometimes referred to as a panel of products); that the MPPI offering for each intermediary does not change very often; rather intermediaries tend to sell the same PPI products for a considerable period; and that the level of commission is used as a marketing tool for MPPI distributors or underwriters and intermediary networks in attracting intermediaries to sell their PPI. 36. We considered that these findings were consistent with our findings that there is limited substitutability between PPI policies provided by different PPI providers and that PPI distributors and intermediaries are not competitively constrained by the potential for customers to substitute between their PPI policies. The evidence therefore supported our market definition. 37. These findings indicated to us there was less competition on prices and other competitive variables between PPI providers than would be the case in a wellfunctioning market with vigorous and effective rivalry between market players. Factors affecting the nature and extent of competition among distributors and intermediaries 38. Having established that there is little competition among distributors and intermediaries in relation to the supply of any type of PPI policy sold at the point of sale, we looked at why this is the case and what factors are involved. The purpose of this was to see if there are any features or combination of features of relevant markets which are preventing, restricting or distorting competition in the supply of PPI to consumers. We considered retail PPI separately from other forms of PPI (see paragraph 67). 39. We focused on five factors which might contribute to the lack of competition: (a) the extent to which distributors or intermediaries actively seek to compete with each other; (b) whether comparing PPI policies is beneficial and whether there are barriers to search; 6

14 (c) having taken out PPI, whether consumers switch between PPI policies, and whether there are barriers to switching; (d) whether there are barriers to entry into the supply of PPI by new distributors and intermediaries, or barriers to expansion by PPI providers already in the market; and (e) whether there is an advantage for distributors or intermediaries to selling combinations of PPI and credit at the point of sale (the point-of-sale advantage) and whether this contributes to the lack of competition we found. 40. We then looked at whether some stand-alone PPI and short-term IP products which have recently been introduced to the market might impose a competitive constraint in the short to medium term. The extent of competition between providers 41. The evidence we saw indicated that PPI distributors and intermediaries do not compete with one another based on the price of PPI. Nor did we find compelling evidence of competition on non-price factors. In addition, we saw little evidence of advertising of PPI to customers (as opposed to details of the policies being available on distributors websites) the evidence suggested to us that the point of sale of credit was the time PPI was advertised to customers. Benefits of, and barriers to, search 42. Next we looked at whether there are benefits to consumers in comparing PPI policies and whether, given that we found that there is only limited search going on, there are barriers to search. We found that there are benefits to comparing policies the terms and conditions and prices of policies vary considerably. It is therefore worthwhile searching for the best-value product; however, search on price alone will not guarantee that the best value product is purchased. 43. In terms of consumer search for PPI policies, we identified five significant barriers to effective search, which impact consumers to different extents depending on the type of PPI policy involved. 44. The first barrier we identified was that it is time-consuming to obtain accurate quotes, with some firms only providing accurate price illustrations for PPI by going through a full credit application. The making of a full credit application will also have an impact on the credit footprint of the customer. 45. The second barrier we identified was that it is difficult to make comparisons with the information currently available. Price comparison websites, whilst useful, are limited in their offer of comparisons. The websites focus on price, and there are several combinations (such as bundles of PPI and credit) on which it remains difficult to search. 46. The third barrier we found was the complexity of PPI policies. Variations in pricing structure (particularly, but not only, with respect to single-premium policies), policy terms and conditions, and the manner in which information is provided by firms, mean that the cost of PPI is not presented in such a way that it is easy to make comparisons, and this has a detrimental effect on consumers ability to understand that information. 7

15 47. The fourth barrier was that significant numbers of consumers perceive either that PPI take-up will have a positive influence on their credit application process or that it is a condition for taking the credit. Whilst they think that this is the case, they incorrectly perceive that they have a very limited incentive to search around for alternatives to the combination of credit and PPI offered by the distributor, such as sourcing the credit product from one supplier and searching separately for the best PPI policy. 48. The final barrier we identified was the relatively low level of stand-alone provision. This restricts consumers ability to search for PPI on a stand-alone basis (although it is still possible to search for combinations of PPI and credit). 49. We found that all these barriers were present when consumers search for PLPPI, MPPI and SMPPI. We concluded that all of these barriers, except for the first barrier (that obtaining quotes was time-consuming), were present when consumers search for CCPPI. The effect of these barriers to search is to impede the ability of consumers to make comparisons, and therefore effective choices between PPI policies. They also, therefore, act as barriers to expansion for other PPI providers, in particular providers of stand-alone PPI. Barriers to switching 50. We identified four significant barriers to switching in addition to the barriers to search that we identified. We found that access to consumers credit information was restricted to the credit provider and that, for CCPPI, this meant that other PPI providers could not offer insurance which would track the outstanding balance. It is therefore difficult for stand-alone PPI providers to offer as high quality a product as the point-of-sale distributor, because of this inability to track the balance. 51. The second barrier we identified was that the initial exclusion period at the commencement of PPI policies acts as a deterrent to switching. When a policy commences there is usually an initial period during which claims cannot be made. A consumer with a PPI policy who considers switching to another PPI provider has to be willing to, in effect, not be insured for the duration of the exclusion period. 52. The third barrier we identified was the existence of exclusions for pre-existing conditions. This could be a barrier to switching for a consumer who has developed a condition whilst already having a PPI policy. Whilst the consumer may be covered for that condition under his existing policy, moving to a new policy may result in the condition being considered a pre-existing condition and the new insurance policy excluding claims for that condition. 53. The final barrier to switching we identified was the rebate policy on single-premium policies. Rebates are not given on a pro-rata basis; they take account of the higher risks we were told underwriters face earlier in the life of a PPI policy. As a result, if a consumer cancels a PPI policy, the rebate given is not enough to take out an identical policy to cover the remaining balance for the rest of the term of the loan. We calculated that the shortfall could be significant, amounting to between 50 and nearly 80 per cent of the cost of an identical replacement policy. 54. We concluded that two of these barriers initial exclusion periods and exclusions for existing conditions applied to all types of PPI policies. In addition, the lack of access to customers balance information was a barrier to switching for CCPPI policies, and rebate profiles for single-premium policies was a barrier to switching for consumers of PLPPI and SMPPI. These barriers to switching limit consumer choice. They also, therefore, act as barriers to expansion for other PPI providers, in particular providers of stand-alone PPI. 8

16 Barriers to entry and expansion 55. We considered whether there are barriers to entry or expansion, either for providers selling stand-alone PPI or short-term IP, or distributors selling PPI combined with credit. We concluded that in addition to the barriers to search and switching that we have identified, there are three significant barriers to entry and expansion for providers of stand-alone PPI. 56. The first barrier we identified was adverse selection. Providers of stand-alone PPI are at greater risk of being asked for cover by consumers who think they are likely to experience an event for which they could make a claim than is the case with distributors and intermediaries supplying PPI at the point of sale of credit. This is because at the point of sale distributors and intermediaries can try and sell PPI to everyone taking out credit. These will include some consumers that may think a claimable event is likely to happen soon, as well as consumers who want the insurance for events they do not currently expect to happen. We received evidence from a party which had entered the stand-alone market, and subsequently exited it, showing that PPI claims in its stand-alone business were significantly higher than those in its point-of-sale business. 57. The second barrier we found was poor consumer awareness of PPI. We found that a significant number of consumers did not consider PPI before approaching their lender for credit; moreover, a significant number of customers did not know that they could take out PPI from someone other than their credit provider. This low consumer awareness and poor understanding of options restricts the ability of providers of stand-alone PPI successfully to enter or expand into PPI markets. 58. The third barrier to entry we identified was that, in order to attract customers in sufficient numbers to purchase stand-alone PPI, there are high marketing costs relative to those of linked credit and PPI sales by credit providers. The evidence we received suggested that marketing campaigns by providers of stand-alone PPI have had only limited success. The point of sale 59. We considered next whether the ability of credit providers to sell PPI at the point of sale gave them an advantage and whether this impeded competition. We concluded that there was a point-of-sale advantage associated with selling PPI combined with a credit product. We found that distributors focused their PPI marketing at the point of sale, and at current prices and the current market structure this appears to be the only effective way of marketing PPI. This means that providers of stand-alone PPI without access to consumers at the point of sale are at a competitive disadvantage. 60. We found that there are economies of scope for distributors and intermediaries associated with selling both credit and PPI at the point of sale, although this appears to lead to distorted spending patterns by consumers for both PLPPI and credit. Further, some distributors offer PPI only at the point of sale, and others do not promote its availability after the credit product has been sold. This means that consumers who have not researched PPI before approaching their lender can feel it is now or never for this PPI policy, and may feel it is safest to buy it. 61. We concluded that there are barriers to effective competition associated with the sale of PPI at the credit point of sale, and that these affected: the ability of both other distributors and intermediaries, and providers of stand-alone PPI to compete for customers; and consumers choice. 9

17 New entry 62. Having found that there are some significant barriers to effective competition, we considered whether this situation might change in the foreseeable future. New shortterm IP policies have been launched as stand-alone insurance policies during the course of this investigation, and we considered whether they might be expected to develop so as to offer a competitive constraint on distributors and intermediaries that supply PPI at the point of sale. 63. However, we concluded that we did not expect them to do so. Evidence of the difficulties experienced by new entrants in the past indicated that, in the current market structure, there are significant difficulties associated with building sufficient scale to achieve a sustainable and profitable business without access to customers at the point of sale. Indicators of the extent of competition between retail PPI providers 64. We assessed a series of indicators of the level of competition between retail PPI distributors: (a) The level of price variation over time that we saw was consistent with there being few significant competitive pressures on retail PPI providers. In particular, retail PPI prices have only been changed three times in six years by the four largest distributors of retail PPI; two of these distributors did not change their prices at all. (b) We found that distributors do not compete to any significant degree on the nonprice aspects of retail PPI. We found that many of the changes to non-price factors that we identified were due to regulatory or compliance issues and that there was little evidence that changes in non-price factors were driven by, or reactions to, competitors retail PPI offerings. (c) We found that retail PPI distribution is highly profitable. Commission levels are high in relation to the costs incurred in selling PPI and the capital requirements are low, reflecting the low-risk nature of the activity. 65. These indicators suggested that there was a lack of competition in retail PPI distribution. 66. In terms of competition between retail PPI providers, these findings indicated that prices, and other competitive variables, are less favourable than would be the case in a well-functioning market with vigorous and effective rivalry between market players. We considered that these findings were consistent with our finding that there is limited substitutability between retail PPI policies provided by different providers and that retail PPI providers are not competitively constrained by the potential for customers to substitute between their PPI policies. The evidence on the extent of competition between retail PPI providers therefore supported our market definitions. Factors affecting the nature and extent of competition among retail PPI distributors 67. We considered the factors affecting the nature and extent of competition among retail PPI distributors. We found that, as with other forms of PPI, most distributors fail actively to seek to win retail PPI customers by using the price or quality of their retail PPI product as a competitive variable. We found that there are benefits for 10

18 consumers in searching, but that customers face significant barriers in comparing products. If the benefits of policies were clearer to consumers, and if retail PPI were available separately from merchandise cover, distributors would have a stronger incentive to compete with each other to show consumers that their retail PPI product offer was the best value. In addition to the costs of search already found, we concluded that there were barriers to switching associated with: the inability of standalone providers to offer insurance which tracks the outstanding balance on a credit account, or to offer merchandise cover; initial exclusion periods on retail PPI policies; and exclusions for pre-existing conditions. We concluded that there are significant barriers to entry and expansion for stand-alone PPI providers seeking to sell retail PPI products without access to customers at the credit point of sale and to customer account information. We found that the sale of retail PPI at the initial point of sale and continued exclusive access to customer accounts restricts the extent to which other PPI providers can compete effectively. The underwriting of PPI 68. We concluded that the underwriting market is relatively concentrated, and that some distributors think that not all underwriters are sufficiently large to be able to underwrite their business. There do not appear to be significant barriers to entry or expansion. However, switching costs may be significant and incumbent providers of underwriting services do appear to have an advantage over other underwriters when re-tendering for a contract. 69. On the other hand, the tender process leads to underwriters competing vigorously with each other in order to win contracts that will give them access to a significant number of customers at the point of sale of a credit product. The evidence relating to profitability that we have seen indicated that underwriters appear to be making reasonable, but not excessive, rates of return on PPI business. This suggested to us that underwriters were unable to exert a significant degree of market power. 70. We conclude, therefore, that there is a significant level of competition between underwriters of PPI, and as a result there are no features of the relevant markets which prevent, restrict or distort competition for the supply of PPI underwriting services. Vertical integration 71. Our analysis on vertical integration of PPI underwriters and distributors did not identify issues which would prevent, restrict or distort competition in the underwriting market to the detriment of consumers. We did not identify any issues with respect to the distribution of PPI policies which are unique to vertically-integrated distributors. Features 72. We conclude that there are features of the markets for PPI which, alone or in combination, prevent, restrict or distort competition in the supply of PPI to nonbusiness customers in the UK. These are described in Sections 5 and 6 of the report and may be summarized as: (a) Distributors and intermediaries fail actively to seek to win customers by using the price or quality of their PPI policies as a competitive variable. (b) Consumers who want to compare PPI policies (including PPI combined with credit), stand-alone PPI or short-tem IP policies are hindered in doing so. Product 11

19 complexity (the variations in pricing structures (in particular in relation to singlepremium policies) and in terms and conditions, the way information on PPI is presented to customers); the perception that taking PPI would increase their chances of being given credit; the bundling of PPI with credit; and the limited scale of stand-alone provision act as barriers to search for all types of PPI policies. The bundling of retail PPI with credit accounts and with merchandise cover (also known as purchase protection insurance) acts as a barrier to search for retail PPI. In addition, the time taken to obtain accurate price information is a barrier in relation to the provision of PLPPI, MPPI and SMPPI. These barriers to search impede the ability of consumers to make comparisons, and therefore effective choices between PPI policies. They also, therefore, act as barriers to expansion for other PPI providers, in particular providers of stand-alone PPI. (c) Consumers who want to switch PPI policies to alternative PPI providers or to alternative insurance products are hindered in doing so. Terms which make switching expensive (in the case of single-premium policies) act as barriers to switching for PLPPI and SMPPI policies. Terms which risk leaving consumers uninsured (for a short period of time or in case they suffer a recurrence of a condition) act as barriers to switching for all types of PPI policies. In addition, the lack of access to consumers balance information acts as a barrier for switching for CCPPI and retail PPI, and the bundling of retail PPI with merchandise cover acts as a barrier to switching for retail PPI. These barriers to switching limit consumer choice. They also, therefore, act as barriers to expansion for other PPI providers, in particular providers of stand-alone PPI. (d) The sale of PPI at the point of sale further restricts the extent to which other PPI providers can compete effectively. 73. We find, pursuant to section 134(1) of the Act, that there are features of relevant markets which alone or in combination, prevent, restrict or distort competition in the supply of PPI and accordingly, there is an AEC within the meaning of section 134(2). The features are those that are discussed in Sections 5 and 6 of this report and which are summarized in paragraph 72. Detriments 74. We concluded that the detrimental effects on consumers of these features in relation to all types of PPI (except retail PPI) were higher prices for, and less choice in, PPI policies than would be expected in a well-functioning market. We also concluded that demand for PPI was distorted. We also concluded that it was possible that there was less innovation than would be expected in a well-functioning market. For retail PPI we concluded that the detrimental effects on consumers of these features were higher prices for retail PPI policies than would be expected in a well-functioning market. We also concluded that it was possible that there was less innovation than would be expected in a well-functioning market. 75. We considered the scale of the customer detriment associated with the AEC we found. First, there is a large category of dynamic benefits to consumers that we would expect to arise from increased competition in the provision of PPI. Such benefits will arise, for example, from arresting the decline in the size of the PPI sector that results from the current lack of competition (for example, negative publicity associated with high prices). Indeed, we would expect greater competition to bring about increased advertising and far more interest in (and awareness of) the sector, such that the demand for PPI should increase, once it is sold at competitive prices. A further example of the benefits we would expect to accrue is from selection pressure, encouraging companies that develop products which benefit consumers and 12

20 punishing those that develop poor products. Given the considerable size of the PPI sector even at the current high prices, we would expect these dynamic benefits of competition to be on a large scale, but we have not been able to put a value upon them. 76. Further, there are static welfare implications of the current high PPI prices inefficiencies associated with high PPI prices and low credit prices (ie the deadweight losses that stem from people not buying PPI at high prices who would buy it at competitive prices and, similarly, people being offered credit at lower prices than would be the case if PPI profits were not being used to fund the sale of credit). We noted that a distortion in credit prices is not intrinsically beneficial. Even if we assumed that all PPI profits are used to fund lower credit prices, we found that these considerations implied an annual net deadweight loss in PLPPI, MPPI and SMPPI in excess of 200 million a year, on the basis of our analysis of 2006 figures. We noted that a lower degree of pass-through of PPI profits than the full 100 per cent that underpins the figure above would imply greater potential static gains from competition for consumers for example, if one-fifth of the profits from PPI were not passed through in the form of lower credit prices, our lower-bound reasonable estimate for these static gains in PLPPI, MPPI and SMPPI would rise to 440 million a year. We were unable to make any estimate of the static consumer detriment for CCPPI, but note that the excess profits we identified in the sector ( 336 million in 2006) is consistent with substantial further static consumer detriment. 77. Further to this, we also identified a further static detriment that we are unable to quantify. This is that high PPI prices are likely to have resulted in adverse selection in the markets for PPI, resulting in increased claims costs on PPI policies and increased impairment costs on credit sold to PPI customers, compared with the levels that would arise given the lower PPI price levels that we would expect in a wellfunctioning market. A further detriment to consumers as a result of high PPI prices is therefore the increased costs of supplying PPI at high PPI prices due to adverse selection. We were unable to quantify the scale of the adverse selection problem in the supply of PPI. Our calculation of the static detriment to consumers is therefore an underestimate, as it does not include the effects of adverse selection. 78. We concluded, therefore, that the total consumer detriment (both static and dynamic) to be addressed would be significantly more than the 200 million per year of static detriment a year calculated assuming that all PPI profits were passed through to consumers as lower credit prices. Remedies 79. We decided that the following package of remedies would form as comprehensive a, solution as is reasonable and practicable to the AEC and detrimental effects on customers resulting from the AEC that we had identified: (a) A prohibition on selling PPI at the credit point of sale. PPI cannot be sold by the distributor or intermediary arranging the credit (or any business covered by the prohibition, see paragraph ) at the same time as the credit product, nor within seven days of the conclusion of the credit sale period, or the provision of a personal PPI quote, if one were not provided during the credit sale period. As a limited exception to this point-of-sale prohibition, the distributor or intermediary arranging the credit (or any business covered by the prohibition) may sell PPI to the consumer over the Internet or telephone 24 hours after conclusion of the credit sale period provided that the consumer has initiated the transaction and the consumer has confirmed that they have seen the personal PPI quote (paragraphs to ). 13

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