PPI commissions are being investigated by the Competition Commission. This has put pressure on traditional providers to get the right balance of price and product design. Ian Moffatt reports

The outcome of the OFT's payment protection insurance (PPI) market study was published in October, and the results of the FSA's second phase review are imminent. The reports have raised a number of concerns and led to speculation as to the likely consequences, particularly in relation to a subject close to the heart of many industry players - commission levels.

The report highlighted a huge disparity in the levels of commission charged for PPI, ranging from as low as 20% to as much as 80%, and it now seems that the OFT will refer this issue to the Competition Commission.

The question is whether this will force rates down. Good news for consumers perhaps, but how will this impact the PPI market?

The UK PPI market is currently worth an estimated £5.5bn-£6bn according to Datamonitor.

Mortgages account for the largest lending amount, but mortgage payment protection insurance (MPPI) is worth only about £800,000 of this total value. This means that the vast bulk of the market is made up of PPI sold alongside credit cards and personal loans - the sector of the market that charges the highest levels of commission.

If the Competition Commission decides to force commission rates down to the levels already being charged by some of these new entrants of around 25%, this would impact the current overall market by over £2bn.

Commission represents a significant issue for the industry to address - or be forced to address - particularly as variances in rates do not appear to reflect any difference in product quality.

A policy tailored to meet the needs of an individual customer can be less expensive than traditional 'one size fits all' accident, sickness, and unemployment cover.

London Economics surveyed PPI products in the personal loans market on behalf of the OFT. They all offer similar cover and similar benefits, and yet the cost of the most expensive policy was four times that of the cheapest policy.

How can some distributors offer the same product for so much less than others? Are these variances due to greed on the part of the distributor, or do they mask the true cost of distribution?

KPMG points out in a survey* that providing face-to-face advice and establishing the suitability of a product for a customer increases the cost of sale, which the customer will bear in the long run.

The survey also highlights the range of services that distributors provide in addition to the sales process itself, such as premium collection, policy administration, and even branding. The consultancy cites these as costs that should be borne in mind when looking more closely at the levels of commission charged.

Masking costs
Yet, whether the cost of these services can really defend commission levels is up for debate. Rather than masking costs of services, are they actually masking the cost of offering low annual percentage rates (APRs) and zero balance transfers in order to attract and secure customers?

Research by both the OFT and Defaqto found that some loans which advertise very low headline APRs become much more expensive when PPI is added to the loan.

Arguably, these distributors simply would not be able to provide these price-led propositions if not supported by the insurance element of their offering that underpins the low APRs.

Can this type of business model withstand the impact of a dramatic reduction in commission levels?

In a more transparent business environment that should have the customer's interest at heart, these very high levels of commission cannot be sustained, particularly if there is no apparent difference in benefit between an expensive cover and a cheaper policy.

The natural outcome surely has to be that interest rates on personal loans and credit cards will increase, and the value of the PPI market will reduce, as commission levels come down and products become less expensive.

While the actual value of the market will fall, volumes for those distributors who can offer a cheaper and better value product should increase and help counterbalance this reduction.

Still, reducing the cost is not the only answer. Any increase in take-up based on price is likely to be short term, as the value perception among consumers changes.

If the product itself does not suit the need of the individual, and the products continue to fail to live up to consumer expectations, how long will they continue to buy on price alone?

New offerings
The PPI market has seen a rush of new offerings come to market over the past 12 months, despite all the negative publicity.

These new entrants are predominantly stand-alone providers operating web-based business models who have seemingly pre-empted any potential action by the OFT or Competition Commission, not only by charging vastly reduced commission rates, but also by driving different levels of value into their offering.

They provide consumers with new levels of choice and flexibility to allow them to tailor insurance cover to suit their individual needs and budgets. The new breed of PPI products, such as those offered by The Matrix from Assurant Solutions for example, offers more than 250,000 unique product variations.

Not only does this flexibility result in a better product, it can also be cheaper to the alternative traditional products.

If greater transparency is forced on the market, traditional distributors could well see their market share eroded, unless they address the design of the products they offer as well as the ultimate price charged to the consumer.

No one wants to see a price war. Nor is it in anyone's interest - especially consumers' - to see cheap products introduced at the expense of the quality of cover provided.

While the size of the market is likely to reduce, PPI can continue to play a strong part in helping consumers protect their debt in the future, and represent a viable income stream for brokers, but an appropriate balance must be found between product design and price.

Consumers need the freedom of choice to select the cover they need at a price that

they are comfortable paying, while allowing distributors to generate sustainable volumes of business. IT

Ian Moffatt is managing director of Assurant Solutions

*Payment Protection Insurance Sales Practices Survey - June 2006