Payment protection insurance: the ‘root cause’ of concern for providers

The British Bankers Association (BBA) recently lost its challenge by judicial review to new regulatory provisions imposed by the Financial Services Authority regarding complaints about the sale of Payment Protection Insurance (PPI). The ramifications of the decision, not just for banks, but for all providers/sellers of PPI insurance could amount to as much as £2.5bn to £4.2bn. The BBA has until the 10th May 2011 to appeal.

The FSA’s new rules and guidance

In August 2010 the Financial Services Authority (FSA) published Policy Statement 10/12 “the Assessment and Redress of Payment Protection Insurance Complaints”. This Policy Statement made various amendments to the rules and guidance issued by the FSA as to how firms involved in the selling of Payment Protection Insurance should handle complaints made by consumers and how the complaints should be decided. The Policy Statement also included an Open Letter setting out what the FSA considers to be the most common failings in the sale of PPI to the general public. The new rules came into effect in December 2010.

The Policy Statement effects various changes to the procedure for the sale of PPI including specifically setting out that a firm is required to explain key features of a PPI policy to a consumer and must be able to prove that it made it clear to the consumer that the PPI policy being offered was optional. These specific changes and many others in themselves are not particularly controversial. The controversial element is how these changes will be applied to firms involved (or previously involved) in the sale of PPI.

The first controversial change initiated by the Policy Statement was that a failing by a firm selling PPI in its sales procedure would be considered a breach of the FSA’s Principles for the selling of insurance products which would then obligate the firm to compensate its customer. Furthermore, the new provisions and guidance set out in the FSA’s Policy Statement effectively applied the new standards to all sales of PPI since January 2005 (i.e. the new rules and guidance would have retrospective effect). In its media press releases, the BBA likened this to having a road with a speed limit of 30mph which was later changed to 20mph and then deciding to hand out speeding tickets to anyone who drove at 30mph before the limit was reduced.

By far the most controversial new measure was the FSA’s guidance on the “root cause analysis”. This new guidance obligated providers and sellers of PPI to look at all previous PPI complaints and identify any major failings (i.e. a root cause), with the potential implication that firms may need to contact consumers that had purchased PPI and pay redress for losses to those consumers even though they had not actually complained.

Judicial Review

The British Bankers Association (BBA) mounted a legal challenge by way of judicial review against the FSA and the Financial Ombudsman Service regarding the new regulatory provisions and guidance as set out in the FSA’s Policy Statement. It has been estimated that the cost of compensating purchases of PPI could exceed £1.3 billion in next 5 years and that the cost of reviewing previous PPI sales and pro-actively contacting customers to offer redress could cost up to £3.2 billion; the banking industry is by far the largest sector hit by complaints regarding the sale of PPI.