Payment protection insurance has received much unwanted publicity recently, mainly because of confusion over what it covers. Steve Dutton details the covers provided

Payment Protection Insurance (PPI) is currently one of the hottest topics in the area of personal lines insurance. There have been a number of press articles concerning the way in which it has been sold to consumers.

Also, in view of the amount of complaints and adverse publicity for the product, the FSA has quite rightly taken a keen interest in it under its requirements for ensuring that customers are treated fairly.

Indeed, the FSA is in the midst of a four-phase programme that will involve visits to firms, enforcement action where appropriate, information aimed at consumers, and a review of current FSA rules on PPI.

Already a number of companies have had enforcement action taken against them by the FSA for mis-selling PPI.

The objectives of the FSA in this programme are to ensure that customers are:

• Told PPI is optional and provided with clear information about the product and what it will cost

• Given the assistance they need to be clear about what they are eligible for under the policy and what the exclusions are

• Where advice is given, recommended a policy that meets their needs; and offered a fair refund if they cancel the policy.

Despite the adverse publicity and current evidence of instances of mis-selling by some providers, PPI is far from being abandoned by the insurance market.

It is widely recognised, throughout the industry, that correctly devised products, targeted to appropriate consumers, can and do assist policyholders when they encounter financial difficulties in their lives.

So what is PPI, why should people buy it, how does it work and what is covered?

When you take out a loan to fund a new purchase, you are confident in your ability to pay it back.

However, life changes, often due to events beyond your control, so that meeting the loan repayments may become a real problem. If this happens, your credit rating could be badly affected so that you might find it difficult to gain credit in the future.

Worse, the goods could be repossessed and this can even mean your home, if it is your mortgage loan that has fallen into arrears. In some instances, you could end up with a county court judgment (CCJ) against you.

Many people do not recognise the need for payment protection insurance when they take out a loan. This is because they have confidence in the extent of their savings, the generosity of state benefits or the generosity of their employer should they become ill or other insurance cover.

If you are selling PPI each of these options needs to be explored with a customer to ensure that they have thought through how their repayments would be made if they were to become ill, injured, unemployed or redundant; or how the entire loan would be repaid in the event of their death.

It is worth, at this stage, exploring each of these in turn to look at the pros and cons of these methods as a way of supporting the loan repayments.

Savings: If the customer has generous savings this may be a reasonable assumption, but it could be helpful for them to think about the other costs that their savings would also have to fund.

It is also worth questioning whether it is better to use savings to repay loans or to let payment protection insurance take that burden and protect the savings for other uses.

State benefits: These depend very much on personal circumstances, but are rarely as generous as people imagine.

For example, it is now much more difficult to get mortgage payments taken on by the state, and income support cannot be paid to anyone whose partner works for more than 24 hours a week, or who has more than £8,000 in savings.

Employer sick pay: Many employers do continue to pay employees during periods of illness.

However, any payments above the amount of statutory sick pay (which is a relatively low amount compared to normal earnings) are discretionary and may not include overtime, bonuses or any other allowances that may have formed part of the employee's normal income.

Also in these days of frequent job changes the customer may be in a different job at the time he/she claims. It is important to remember that this is an insurance against change of circumstances and that a claim may occur years after the policy is taken out.

Other insurance: Other insurance policies can cover similar eventualities such as accident, sickness, or death. However, it is less common for them to cover unemployment or redundancy. It is therefore necessary to be sure that they will provide sufficient benefits to enable the insured to continue to meet loan repayments in the above circumstances.

So having decided that PPI is the best way to protect the policyholder against being unable to repay the loan from where do you buy a policy and are you eligible for the cover?

Consumers can visit a broker after they have made the loan agreement and purchase it there. However while this is an option, sales patterns indicate that people do not take it up; they are most aware of the need at the time of borrowing and therefore purchase at that time.

In view of this, policies are also not individually underwritten as underwriting individual applicants for insurance is time-consuming, costly, and usually implies some delay while the application is submitted and before cover can be confirmed.

This isn't ideal for a product such as PPI, where, as we have seen, the impetus for buying the cover is closely related to taking out a form of credit. In many situations cover needs to be confirmed at the same time as the loan, for the sale of the insurance to be achieved at all.

As a result, insurers set premium rates for groups of applicants, regardless of individual details. Even applicants who engage in dangerous hobbies are generally covered.

Groups can be made up, for example, of all the customers of a particular bank, or a particular retailer. If the customers of certain banks or retailers regularly submit more claims or have more costly claims than the average, their premium rate may be higher than that for cover provided to customers of other banks or retailers.

Rates may also vary according to the term of the loan being provided.

There will however be eligibility requirements for individual applicants within the groups. These general requirements relate to age and employment.

Applicants must be aged between 18 and 65. Any applicants who will be older than 65 (or a similar retirement age) when the loan is due to have been paid off will be excluded.

Applicants must be in full-time paid employment for more than 16 hours a week and have been in that job for at least six months.

If this requirement is relaxed, the policy usually requires them to have been employed for more than six months before any claim is made on the policy. They must also be unaware of any pending change in their employment circumstances.

Most policies do cater for the self-employed or those working on fixed term contracts. However, the definition of 'unemployed' will be different for them, and additional evidences will be required if they claim.

People are considered to be self-employed if they carry on business alone or with a partner; if they or a relative jointly or individually hold the majority of the voting rights in the company for which they work; or if they can decide the strategy for that company.

Contract workers who are on contracts with the same employer for more than two years, or 12-month contracts that have been renewed for a further term, would be regarded as employed.

Shorter contracts would still be eligible but a claim for unemployment at the end of the contract would not be accepted.

PPI policies often have a deferment period before any payment is made.

This is because a person's circumstances can change. Someone who is made redundant could find another job in the next week and someone who is ill could recover very quickly, so that claims could turn out to be very small.

Also, claims for short periods of time are costly to administer. By introducing what are known as 'waiting periods' insurers can discourage small claims and can thus keep premium rates down.

In PPI three main types of waiting period are common. They apply to accident and sickness cover, and to unemployment/redundancy cover and, to a limited extent, to hospitalisation. The three types are: franchise; excess; and modified franchise. They work in a similar way to excesses or deductibles on general insurances, but here they apply to time rather than an amount of money.

A franchise period starts from the first day of the event and if the event lasts beyond the end of the franchise, the claim is paid for the entire duration of that event.

An excess period starts from the first day of the event. If the event lasts beyond the end of the excess period of time, the claim is paid for any subsequent period of illness but not for the waiting period itself.

A modified franchise combines aspects of the franchise and the excess. The period starts from the first day of the event. If the event lasts beyond the end of the franchise period, the claim becomes payable, as with the normal franchise.

But, as with the excess, it is not payable from day one of the illness, but instead is paid from an interim franchise date. So if there is a 60-day modified franchise and a 30-day excess, the claim is paid if the event lasts over 60 days but is only recoverable from the end of the

30-day excess period. IT

Steve Dutton is with the Broker Academy