For several years, the United Kingdom’s financial institutions have been embroiled in a scandal involving the mis-selling of payment protection insurance (PPI) products, resulting in compensation payments of more than £15 billion. Emily Saint-Smith investigates what led to the crisis – which has been labelled the biggest mis-selling financial scandal in British history – and whether it could happen in Australia…
The Australian financial services industry has been suffering from some bad press of late. First, the Government’s proposed reforms to the Future of Financial Advice legislation were labelled by the mainstream media as ‘disastrous’ for consumers, and as a ‘ploy by the big banks to weaken consumer protections’. Then the industry was rocked by the Senate Economics References Committee (SERC) report into the Commonwealth Financial Planning (CFPL) advice scandal, which uncovered serious failings on the part of CFPL and the regulator. Following hot on the heels of this report were the interim findings from the Financial System Inquiry, suggesting that underinsurance and access to quality financial advice were ‘significant consumer issues’. And now a further Parliamentary Joint Committee inquiry into financial advice has been established, this time looking into the education and professional standards of those operating within the industry.
As the Association of Financial Advisers’ Phil Anderson said at a recent roadshow, it’s going to take the industry a long time to climb back from this.
But Australia’s financial services providers are not the only ones to be struggling with consumer distrust. In the UK in the early 2000s a scandal was brewing which has now resulted in the payout of more than £15 billion in customer compensation. In 2014, the UK banking sector received its lowest Trust Index score since 2009, as measured by the Nottingham University’s Business School. Author of the Index, Professor James Devlin, added that “…consumer perceptions of the financial services industry in its entirety remain thoroughly underwhelming”.
While it is not always easy to predict when a crisis is looming, throughout the 2000s there were certainly signs that UK consumers were being put at risk through mis-selling and poor disclosure practices. And with international markets continuing to converge, Australia’s regulators and financial services providers would be well advised to take note of the key learnings from the UK’s PPI scandal.
What is payment protection insurance?
Payment protection insurance (PPI) is a product used to cover loan or mortgage repayments for a set period of time, in the event the policy holder suffers an illness or injury, is made redundant, or dies. Also known as ‘loan protection’, ‘credit insurance’, and ‘accident, sickness and unemployment insurance’, this type of cover is very similar to Australia’s consumer credit insurance. It is usually offered as an ‘add-on’ by banks and other lending institutions when a customer applies for a loan.
PPI is a simple-application insurance product, requiring minimal or no underwriting. In order to deliver a simple application process, the products usually contain exclusions and/or complex eligibility criteria. In some cases, extras like critical illness cover and hospitalisation benefits can be included with the policy. Despite the simple nature of the purchase, the products themselves are described as ‘complex’ by the UK regulator.
How did the scandal arise?
Payment protection insurance (PPI) products began to emerge in the UK market in the 1990s, but it was during the early 2000s that PPI sales became increasingly commonplace. Because of the profitability of these products, banks and other institutions began to offer sales incentives designed to increase the take-up of PPI by banking customers.
These sales incentives led to a range of mis-selling practices, including:
- Customers being pressured into taking out PPI in order to secure their loan
- Banks failing to make it clear that PPI was optional
- Customers taking out cover for which they were excluded, due to their employment status and/or pre-existing medical conditions such as back and mental health conditions
- PPI policies being automatically added to a loan without the customers consent or knowledge
In 2004, media investigations highlighted the issues associated with PPI and mis-selling, in particular the significant profits being made on the products and the comparatively small claims payouts. Consumers began to seek compensation from their financial institutions.
The Citizens Advice Bureau, a free community advice advocate, took up the cause in 2005, calling for the then UK financial industry regulator, the Financial Services Authority (FSA), to investigate issues with what it described as ‘inflated premiums and anti-competitive behaviour’.
The FSA released its first report on PPI products and sales processes in November 2005, finding the practices employed by the majority of firms selling PPI products posed a risk to consumers, due to the various aspects of their selling practices and/or their lack of proper compliance controls.
that one in three customers with PPI cover had been mis-sold
The FSA began to fine institutions it deemed were involved in inappropriate selling practices.
Despite this action, the Office of Fair Trading became involved in 2007, referring the issue to the Competition Commission, an independent public body employed to help ensure healthy competition between UK companies, similar to Australia’s ACCC (note: the Competition Commission was replaced by the Competition and Markets Authority in April 2014). The Competition Commission concluded that businesses that offered PPI alongside credit faced little or no competition, recommending that credit providers be prevented from selling a PPI product at the same time as a credit product. The Commission also called for improved consumer information to make it easier for them to compare and search for PPI products.
These recommendations were supported up by UK consumer advocate Which?, who conducted its own investigation into the issue, finding that one in three customers with PPI cover had been mis-sold.
In 2009 the FSA banned one of the worst types of PPI product, known as ‘single premium’ cover.
Consumer complaints began to escalate, as customers attempted to claim compensation for mis-selling. In December 2010, after significant industry consultation, the FSA issued guidance on how PPI products could be sold. Importantly, the FSA guidance was to apply retrospectively, meaning any client who had been sold a PPI product outside the guidelines was entitled to compensation from the product issuer.
The British Banking Association (BBA) launched a High Court challenge against the FSA guidelines, arguing the retrospective nature of the requirements was unfair. The High Court ruled in favour of the FSA, and initial estimates put the cost of compensation at around £3 billion. The BBA decided not to appeal the judgement.
PPI is now the most complained about UK financial product of all time, with The Telegraph reporting in July 2014 that the ombudsman continues to receive 5,000 complaints each week about mis-selling. Over £15.1 billion in compensation has been paid out by the issuers of PPI products since January 2011.
In March 2014, Australia’s financial services regulator, the Australian Securities and Investments Commission (ASIC), played host to Financial Conduct Authority CEO, Martin Wheatley. The purpose of the visit was to share some of the learnings from the UK PPI crisis, in order to identify similar risks within the Australian market. These learnings have been summarised below. (Note: the FSA was replaced by the Financial Conduct Authority in 2013.)
“The companies selling this product realised that PPI was a very high profitability product, and so their sales staff were heavily incentivised to make sure the product was sold alongside the loan,” said Wheatley.
He explained that an investigation by the FSA into remuneration and reward structures found that many banking institutions were using PPI sales as a ‘catch-all clause’ at the base of staff bonus programs.
“When we looked at the remuneration structure that many banks had created … there were different rewards for different types of products. But many of these programs had a ‘kicker’ at the end, which said: ‘In addition to the sales targets you have to achieve a PPI sales penetration of 80%’… And if you didn’t hit the 8 out of 10 hit rate, not only were you unable to receive the PPI bonus, but all of your other measures were set to zero. That’s the sort of sales incentive structure that was created within the organisations to drive PPI sales.”
While rules were in place which required firms ‘not to give or accept inducements if these are likely to conflict to a material extent with the duty the firm owes its customers’, most firms utilised commissions and incentive structures which the FSA believed could encourage mis-selling.
initial estimates put the cost of compensation at around £3 billion
Sales scripting was employed by a number of companies, to guide staff through customer conversations. One of the issues identified by the FSA in its initial review of PPI sales was that staff who were not licensed to provide personal advice were straying from their scripts and potentially giving customers recommendations that could be deemed as personal advice, without taking into account the customers’ individual circumstances.
Where PPI products were sold with advice, the FSA found that sellers were failing to determine the customer’s suitability for the product before the sale. This included asking questions about the client’s health, occupation, existing insurances and determining whether the customer could afford the cover. In some cases, the FSA found product providers were using pre-populated, pro-forma documents to record the customer’s needs, or providing insufficient detail about the individual customer.
The FSA’s new regime for the sale of PPI in the UK introduced the following guidelines:
- PPI cannot be sold until at least seven days after the loan/credit product is acquired
- Borrowers must be given a personalised insurance quote, detailing the cost and the cover provided
- Customers must be told in writing that PPI is an optional extra
- PPI providers must state how many customers are successful in claiming on their policies
While a direct comparison cannot be drawn between the PPI scandal and the recent CFPLadvice issues, there are similarities in the environment in which they occurred. All four of Australia’s ‘big banks’ have a wealth management business and make no secret of their desire to cross-sell wealth product to their banking customers.
A recent survey by Roy Morgan Research highlighted that there was still significant room for banks to cross-sell financial products to their customers.
Speaking about the findings, Roy Morgan Industry Communications Director, Norman Morris, said: “While the ‘Big Four’ banks have made some small gains in product cross-sell since 2010, overall they have not performed well. Reasons for this include lack of incentive for customers to consolidate, competition from specialists providers such as for superannuation and insurance, lack of product awareness, some concern regarding the spread of risk, and staff that may not feel confident in a selling role.
“It is clear from the analysis that there is plenty of scope for these banks to increase their business from their existing customers rather than chasing new ones.”
One of the key issues identified by the SERC inquiry into the CFPL advisers’ misconduct was what it called CFPL’s “toxic sales-based culture fostered by flawed remuneration arrangements”.
Maurice Blackburn Lawyers’ Principal, John Berrill, told the SERC that his work, on behalf of clients that the firm represented in various civil actions against CFPL, uncovered a: “…boiler room-like environment at CFPL, where advisers chasing commissions would systematically target clients in conservative positions, selling them into high-risk products that were inconsistent with their conservative risk profiles.”
sellers were failing to determine the customer’s suitability for the product before the sale
At least one instance of a CFPL adviser providing inappropriate insurance switching advice has also come to light, captured in the NSW Court of Appeal case of CFPL v Couper. The court ruled that the adviser had clear reasons to put the interests of himself and his fellow CBA employee (who had referred the client for advice in the first place) ahead of those of his client. The adviser received an upfront commission by switching the insurance policy and the referrer received a commission for the referral because a new product was sold to the client. The bank also benefited because the new policy was issued by its in-house wealth management business.
Reliance on disclosure
The other issue the PPI sales incentives caused, according to Wheatley, was that staff started to automatically include PPI with loan applications, in order to meet their high hit-rate targets.
“It evolved to the point where there wasn’t even a conversation with the customer – it was a case of ‘PPI is part of the product I’m selling you’,” said Wheatley.
Staff relied on the customer to read the PPI disclosure document and familiarise themselves with the benefits and exclusions of the product.
At the time of the scandal the UK regulator, FSA, used its ‘Principles of Business’, a set of 11 governing rules, to monitor the conduct of financial services providers. The Principles of Business included the following:
- Principle 6 – a firm must pay due regard to the interests of their customers and treat them fairly
- Principle 7 – a firm must pay due regard to the information needs of their customers, and all communications with customers need to be clear, fair and not misleading
In reviewing the PPI products and sales process in the market during its 2005 investigation, the FSA said it believed that, in order to comply with the rules listed above, firms should take reasonable steps to ensure that customers did not buy policies under which they were ineligible to claim benefits. The FSA investigation found that half the firms reviewed did not have adequate checks in place to ensure the customer was able to claim on their policy. In some cases, the sales scripts used by staff did not cover all the eligibility conditions relating to the policy being sold.
The learning for Australian product providers, said Wheatley, is that disclosure documents alone cannot be relied upon to ensure the client is fully informed about the product/service they are purchasing.
Referring to Australia’s direct insurance products, Wheatley remarked: “…if it’s very clear that pre-existing conditions are excluded then that’s fine. It’s when the product purports to give cover, but the exclusions – which are important – are not disclosed in a way that people can understand that you run into trouble… It’s not so much what’s in the design of the product, but actually in the disclosure of the product design to consumers.”
Similarly, for advisers, there is clear evidence that clients do not read PDSs or other relevant documentation. A number of recent court cases, including Ravesi v National Australia Bank and Swansson v Harrison and Ors, have highlighted that advisers have a duty of care to ensure their client fully understands the terms of their contract, and simply relying on the client to read a document will not be sufficient to prove this duty has been met.
Claims management industry
“An entirely new industry grew up on the back of this – the claims management industry,” said Wheatley, explaining how the PPI scandal escalated in 2011.
Following the High Court’s landmark judgement, a number of compensation claims management companies were established to help customers who had been mis-sold PPI cover to seek compensation from their financial institutions. Typically, these firms operate on a commission model, receiving up to 30% of the compensation payment if the claim is successful.
“The complaints management companies stepped into the space and maximised the publicity around this product,” said Wheatley. “Over the past five years, citizens of the UK have been inundated with radio, TV, billboards, and even text messages, telling them that they might have a claim for PPI.”
Despite the Ombudsman emphasising that there was no need for consumers to employ a third-party service to make a complaint related to a PPI product, the Citizens Advice Bureau estimated that at the beginning of 2014, there were around 1,050 claims management companies operating in the UK, and that these companies have pocketed up to £5 billion of consumer compensation.
we just didn’t know how big the problem was
In Australia, numerous law firms advertise themselves as ‘compensation experts’, and these companies have shown increasing interest in the superannuation insurance claims market.
Ian Laughlin, Chairman of the Australian Prudential Regulation Authority, has drawn a link between the rising involvement of lawyers in insurance claims and the deterioration in insurance company profits.
Responding to questions about the issue before the Senate Economics Committee in July 2014, Mr Laughlin said: “There are two broad issues. The first is external. For example, changes in social attitude to mental health have been a bit of a surprise. The involvement of lawyers in claims processing has changed dramatically in recent times. And both of those things have increased claims. The industry was not necessarily well prepared for either of those…”
Pauline Vamos, CEO of the Association of Superannuation Funds of Australia, also reports that trustees are experiencing an increasing number of claims being lodged by lawyers.
According to UHG Managing Director, Dr Brandon Carp, the issue with lawyers targeting insurance claimants is that it is “…creating a more adversarial and litigious relationship than existed before – a relationship that really has no place in life insurance.”
Similarly, Craig Parker, General Manager of risk-specialist licensee, Affinia, believes claims management should be the domain of financial advisers, not lawyers.
“The increased involvement of lawyers in claims is worrying because this is a role advisers should be performing on behalf of their clients. The involvement of a lawyer will not influence the decision of an insurer. Claims advocacy is the role of the adviser,” Parker told riskinfo earlier this year. (See: Claims a Key Advice Proposition).
Influence of consumer groups
One of the drivers that led to the UK regulator taking action on PPI was a series of campaigns from consumer groups. The Citizens Advice Bureau and Which? both conducted investigations into the mis-selling of PPI, revealing the extent of the issue and recommending consumers seek compensation.
According to Wheatley, the FSA only assumed responsibility for the regulation of PPI in 2005. Intelligence subsequently began coming through to the regulator from these consumer advocate groups that they were receiving a lot of complaints about PPI, but the regulator required its own data before taking action.
“In 2005 the FSA started to do a series of analyses on the sector and took a number of actions. But none of those actions were sufficient, in and of themselves, to change the industry’s response to the ‘goose that laid the golden egg’,” said Wheatley.
“After a period of about five years, the FSA gradually ramped up its actions, gradually got more intrusive, but it wasn’t until the Office of Fair Trading got involved and did a competition study that it became apparent how big the issue was.
“One of the really big lessons for the regulator was that we just didn’t know how big the problem was.”
In Australia, CHOICE – the sister organisation of Which? – recently joined forces with a number of other consumer advocate groups to push for improved regulation of funeral insurance.
In September 2013, the collective of advocacy groups released a 13-point strategy to address what they called the ‘funeral insurance rip-off’. The groups said the funeral insurance industry was suffering from a lack of competition, poor disclosure from product providers and misleading advertising. (See: Consumer Groups Tackle Funeral Insurance Rip-off)
The campaign was launched despite ASIC already having engaged in talks with a number of direct insurance providers about the way their funeral products were designed and advertised. In January this year, ASIC Deputy Chairman, Peter Kell, said the regulator continued to monitor funeral insurance advertising.
“ASIC generally considers there are features of funeral insurance that can be particularly difficult for consumers to understand such as increasing premiums and that premium payments can exceed the actual benefit to be paid out under the policy,” Kell said.
Could it happen here?
In the UK, a number of factors collided to create the ‘perfect storm’, leading to the PPI scandal. As Wheatley pointed out, financial scandals rarely occur quickly.
“They may unfold very quickly, but very often you’ll find the products have been sold for many years, before it ‘suddenly’ becomes a scandal,” he said.
To avoid problems of the extent to which the UK regulator has experienced with PPI, Wheatley says Australia’s regulators should apply the following three tactics:
- Act early – Take steps to intervene where a product or service appears too complex or could put consumers at risk, and do so sooner rather than later
- Follow the money – Conduct a forensic review of businesses to determine which areas of the business are the fastest growing in terms of revenue, if there are products that are out of line with the rest of the market, or teams where staffing levels are increasing dramatically
- Examine business culture – Look at firms to determine whether their business model is a threat to the regulator’s objectives, such as consumer protection and market sustainability
Emily Saint-Smith is riskinfo’s Senior Journalist.