Payment Protection Insurance (PPI)

Payment Protection Insurance (PPI) is a type of insurance designed to act as a financial safety net for borrowers. It was typically sold alongside credit products like personal loans, mortgages, credit cards, or car finance. The promise was simple and alluring: if you, the borrower, were suddenly unable to make your repayments due to a specific life event—such as illness, an accident, or losing your job—the PPI policy would step in and cover your payments for a limited time. In theory, it offered peace of mind, ensuring a temporary setback wouldn’t spiral into a full-blown debt crisis. However, the reality of PPI, particularly in the United Kingdom, veered dramatically from this noble intention. It became the star of the UK's biggest financial mis-selling scandal, a cautionary tale of aggressive sales tactics, consumer exploitation, and the long-term cost of prioritizing profits over people.

Imagine you take out a five-year loan to buy a new car. The bank advisor enthusiastically suggests you add PPI to your loan. You agree, and a small extra amount is added to your monthly repayment. Two years later, your company unexpectedly makes you redundant. Panic sets in as you wonder how you'll keep up with the car payments. This is where PPI was meant to shine. You would file a claim, and after a review process, the insurance provider would start making your monthly loan payments directly to the bank. This coverage would typically last for a set period, often 12 months, giving you a crucial breathing room to find a new job without the risk of defaulting on your loan and losing your car. It was marketed as a responsible choice for the prudent borrower.

The PPI story turned sour because the product was incredibly profitable for banks and lenders, creating a massive incentive to sell it at all costs, whether the customer needed it or not. This led to a widespread, systemic mis-selling campaign that lasted for years. The regulators, such as the Financial Conduct Authority (FCA), were eventually forced to intervene, leading to billions of pounds in compensation payments that hit the balance sheets of major banks like Lloyds Banking Group and Barclays. The mis-selling took several common forms:

• Lack of Consent: Policies were often “pre-ticked” on application forms or added without the customer's clear knowledge or permission. Many people had PPI without even knowing it.
• Pressure Selling: Customers were frequently told that taking out PPI was a condition of being approved for the loan or that it would significantly improve their chances of approval. This was almost always untrue.
• Ineligible Customers: PPI was sold to countless people who would never have been able to make a successful claim. This included the self-employed, retired individuals, or people with pre-existing medical conditions that were excluded in the policy's fine print.

This wasn't just a few rogue salespeople; it was a fundamental breakdown in corporate culture, a textbook example of what happens when governance fails and sales targets trump ethical conduct.

For a value investor, the PPI scandal is more than just a historical event; it's a powerful lesson in analyzing a company's character and the sustainability of its profits.

1. Look Beyond the Numbers: Banks selling PPI showed impressive profits from their insurance divisions for years. However, a savvy investor would ask: “Where is this profit coming from?” If a significant chunk of a company's income relies on a product with questionable ethics and a high number of complaints, it's a huge red flag. This speaks directly to the Quality of Earnings. These profits were not high-quality; they were built on a house of cards that eventually collapsed, wiping out value for shareholders through fines and remediation costs.
2. Reputational Risk is Real: The damage wasn't just financial. The scandal shattered public trust in the banking sector, creating a long-lasting reputational hangover. A company with a poor reputation will struggle to attract and retain customers, ultimately impacting its long-term competitive advantage.

While PPI itself is no longer widely sold, the principles it teaches are timeless for any consumer.

• Be the Sceptic: When a salesperson offers you an add-on product, especially insurance tied to a loan, your first question should be, “Is this for my benefit, or for your commission?”
• Unbundle Your Products: Insurance bundled with a loan is often poor value. You can usually find better and cheaper coverage by shopping around for a standalone policy. For example, a dedicated income protection insurance policy is far more comprehensive and flexible than PPI ever was.
• Build Your Own Safety Net: The best insurance is often self-insurance. Building a robust emergency fund of 3-6 months' worth of living expenses gives you ultimate flexibility. It can cover any unexpected event, not just the narrow list of circumstances covered by a restrictive policy like PPI.