The best payment protection: don't borrow so much

published 3 October 2007

This feature is part of our FREE weekly personal finance email, MoneySense, written by MoneyWeek editor, Merryn Somerset Webb. To sign up for MoneySense, click here: free personal finance email

More properties were repossessed in 2006 than in any year since 2000. Why? A press release from British Insurance tells us: it is all down to "higher interest rates and first time buyers taking greater financial risks often borrowing in excess of five times their salary and opting for 25 year plus prepayment policies." So what does the insurance company think we should do about these "disturbing" numbers? Buy fewer houses perhaps, or at least not take out such huge mortgages that we are almost guaranteed to get into trouble. Of course not. It wants us to carry on borrowing just as much money and taking just as much risk but to buy more expensive insurance from it at the sam e time. Never, says the firm's spokesman Simon Burgess "has the need for Mortgage Payment Protection Insurance been so apparent." Take it out and you'll have a vital "safety net" if things go wrong.

Why banks love payment protection insurance

Well, maybe, maybe not. Payment protection insurance (PPI) is a favourite of high street bank financial advisers and insurance salesmen across the country. Why? Simple. It is overpriced and hard to claim on, so they make an absolute fortune from selling it to you. Paymentcare estimated last year that of the £4 billion spent by borrowers on PPI every year a massive £2.5 billion is stripped out immediately in commission payments they know they aren't going to need it to pay claims.

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The idea of PPI and MPPI - one of which you will be offered it every time you take out a mortgage, a credit card or a loan of any kind is that if your circumstances change such that you are unable to repay your debt, the insurance will do it for you. The sales pitch will be that buying it is the sensible thing to do, that if you are made redundant, get very ill or have a serious accident you will need it.

Do you need PPI?

But even if you do need insurance you may find that PPI doesn't fit the bill. It tends to come with a great many get-out clauses included - to the benefit of the insurer: you won't be able to get a payout if you have a part-time not a full-time job, if you are self-employed, if you find you can't work as a result of a health condition that was pre-existing or if you are working on a short-term contract. Many policies are also "any occupation" rather than "own occupation" meaning that they only insure you if you are incapable of working at any job rather than just at your own job.

You may also find that just because you think you have a serious illness doesn't mean your insurers will. As Angus Maciver of Prudential pointed out in The Daily Telegraph last week "suffering from any of the big three cancer, heart attack, stroke will feel critical' to a consumer," but now that diseases are diagnosed so much earlier than before and treated much more quickly a diagnosis won't necessarily trigger a payout. Even if you think you might need some kind of income insurance this is not a good one to have. Only 4% of people who take out PPI ever claim on it and 25% of those claims end up being rejected. Look at it like that and it's not much of a safety net', is it?

You may also not need insurance at all. Note that most employers (85%) offer more than the statutory sick pay: many pay your salary for six months or so after you become ill before reassessing things so you should be able to cover any loan payments from that. Furthermore, while if you are taking out an ordinary loan odds are you won't have much in the way of savings (or I suppose you wouldn't need the loan), if you are thinking of a big mortgage you really should have a good six months' worth of income in a savings account to provide for emergencies anyway.

Why you should think carefully before insuring your loans

PPI is also outrageously expensive, particularly if you get it from one of the high street banks they can charge up to five times the level of premiums of the discount insurance groups (www.Britishinsurance.com, is, to be fair, one of these). The banks also often have a nasty habit of frontloading' the cost of PPI. They calculate the cost of the insurance but instead of demanding a monthly premium they simply add the full amount to the value of your loan and have you pay interest on the whole lot over the term of the loan. There's no logical reason for this. It is just a way to get more money out of you.

The Mail on Sunday last year pointed to a case where someone had borrowed £16,000 from HSBC. The insurance was calculated at £5,150 (about a third of the value of the loan!) making a total of £21,150. The borrower paid off about £6,000 of the debt in instalments and then came up with the cash to pay off the rest early, only to find that she was to get no refund on the insurance at all. Over £5,000 had disappeared for nothing. Which? magazine has warned very strongly against PPI, pointing out that it can double the cost of a £5,000 loan. So it can only be good news then that the PPI industry has now been referred to the Competition Commission for a full investigation and that the Office of Fair Trading has announced an investigation into the sale of MPPI.

It will take a while for these investigations to be completed but in the meantime it is worth thinking very carefully about insuring your loans. Or perhaps about not borrowing so much money in the first place. If you must borrow at least remember this: the UK banks are dead set on what they call cross-selling, which means always trying to sell you more than one product. Open a current account and they'll try to sell you a credit card, take out a mortgage and they'll have a go at pushing critical illness insurance on you, pay a bill over the phone and they'll be selling you contents insurance. The drive to sell PPI is just one example of this. But as long as you are aware of this passion to find ever new ways to separate you and your cash you should be OK. You can, you see, figure out for yourself if you need it or not and then just say no.

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Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast - but still writes for Moneyweek monthly.

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.