Mortgage protection has become a political topic. Rarely has the Government shown such an active interest in insurance protection. However, mortgage protection has been hailed as the solution to the defaults and reclamations that haunted the 1990s by reducing state benefits and protecting mortgage lenders as well as the homeowner. Moreover, such protection would allow greater lending relaxation, enabling borrowers to capitalise on the UK’s fast growing retail sector.
There are signs, however, that all is not well. The Government-backed Sustainable Homeownership scheme looks unlikely to hit its target of 55% of mortgages protected by July 2004. Indeed, there was only 22.5% take-up by the end of 2001 and, despite heavy campaigning by the Council of Mortgage Lenders (CML) and the Association of British Insurers (ABI), only 2.5 million policies are in force.
This presents further problems. Since 1993, the Government has systematically cut mortgage benefits in order to encourage the take-up of private insurance. Since 1995, people with new mortgage liabilities have been unable to claim mortgage relief from the Government for the first nine months after redundancy or disability. Even after nine months the eligibility criteria will exclude most people and state benefits are only payable on the first £100,000 of mortgage liabilities and do not cover ancillary products such as life cover and buildings insurance.
This presents a dilemma. With take-up of mortgage protection low and Government benefits slashed, the mortgage safety net is severely weakened. Additionally, the CML argues that mortgage protection take-up has been fuelled by consumer awareness, not Government benefit withdrawals. This suggests further Government cuts are unlikely to fuel greater mortgage protection take-up, but weaken the safety net further. One thing is certain, the current scenario, with low protection from Government and insurers, is a potential timebomb.
There are problems with the actual cover offered by the different forms of insurance. One of the key criticisms is that the protection is expensive and inefficient and difficult for consumers to understand. Moreover, the existence of two concurrent types of mortgage protection creates confusion and uncertainty.
Currently, two fundamental forms of mortgage protection are used. Mortgage payment protection insurance (MPPI) typically provide a short-term fix, with benefits for a limited period after the claim (normally 12 or 24 months). They are annual contracts of around £5-6 per £100 benefit, and are not individually underwritten. Benefits are capped (at £1,000-£1,500) and cover mortgage liabilities, rental payments and other commitments.
Income protection (IP), however, is quite different. Plans are individually underwritten, term specific and premiums may be guaranteed or reviewable. Most provide benefit upon accident or illness, but fewer provide redundancy benefits. Plans are generally written for a longer term and a deferment period can be varied to accommodate any other income protection measures.
There are major drawbacks. The benefit period offered by MPPI is insufficient for those suffering from a long-term illness or those debilitated by an accident. Equally, mortgage protection has a reputation for being expensive and complicated and containing unconscionable exclusions to avoid payouts.
There are also concerns over duplication. Many companies now offer income protection policies as an employee benefit, guaranteeing income in accident or sickness. If there is duplication of insurance policies, benefits may be reduced or even refused on claims, regardless of any extra premium costs.
Look at the alternatives
This produces a situation where the only way to get comprehensive cover is to take out an MPPI policy in conjunction with an IP policy ‘ a scenario which is costly and far from ideal.
What is clear is that alternatives to current mortgage protection need to be considered. Many suggestions have been proferred by the industry, but these can mostly be broken down into either product improvements or other initiatives. Product improvement could prove a difficult task. The reason for the existing two tiers of MPPI and IP is because combining it into one would create an extremely high-risk product.
In turn, such a risky product is likely to be extremely expensive, which in turn is likely to prevent further take-up. Given the current Government stance on reducing mortgage benefit, such a move could be viewed as compounding existing problems with the mortgage safety net. Furthermore, developing such a product could devalue existing products leading to worse take-up on these.
A suggested solution to the product dilemma has the introduction of protection ‘menus’ which allow borrowers to choose specific protection policies. The more they spend on the policies, the greater the discount they get, leading to cheaper costs for comprehensive mortgage protection.
Scottish Provident has already launched such a menu system, which offers MPPI, critical illness, IP and life assurance policies. This idea of a menu system for protection policies could prove popular, especially due to the rising premiums of policies such as critical illness. Any attempt to reduce the cost of cover has to be seen as a positive, especially in the mortgage protection market place, where negative sentiment over cost remains.
The menu system also has to be viewed as particularly pertinent, given the move from traditional style mortgages to flexible offerings. Conventionally, term assurance would provide decreasing cover over the length of the mortgage, thereby ensuring protection for the insured. Flexible mortgages mean the cover needs to be as flexible as the mortgage product, and menu style systems are capable of offering this to a certain extent.
Outside of adapting and refining individual products there are a number of steps that could be considered to improve mortgage protection. One key factor has to be competition ‘ the primary focus of recent industry reports and the Government’s recommendations on financial services reform. We have seen time and time again that the most efficient driver for cheaper products has come from greater competition among product providers.
With MPPI, and mortgage protection, relatively embryonic in the industry, it is understandable that the product is not totally efficient. Increased competition would necessitate greater efficiency to remain competitive, and to retain customers. With the move towards independent mortgage advice, and the ‘best advice’ process, providers not offering competitive rates will not make it onto product panels and will, therefore, not win clients’ business.
The introduction of the menu style system may be a catalyst to the improvement of competition within the mortgage protection arena. However, there needs to be much greater competitive pressure to significantly push down prices, especially with the likes of critical illness rising in cost.
However, it appears apparent that the price and attractiveness of the product alone will not be the solution to mortgage payment protection woes. Indeed, a far more holistic approach to extending the safety net needs to be taken.
Firstly, the Government needs to reconsider its policy of reducing state funded support for those who run into difficulties with their mortgage payment. It is clear the MPPI targets will not be hit and the Government needs to reverse policies which have been implemented on those assumptions. In particular, the Government should only be supporting those most in need and those with the worst financial difficulties. Such support could be used more selectively, meaning that the Government would not face the same fiscal pressures as previously. Such a U-turn may be considered politically unfeasible, and such a move is unlikely to be popular with the Exchequer.
Equally, more responsible lending procedures need to be put into place. Although repossessions are at their lowest level since 1984, and mortgage arrears since 1982, this situation is fuelled by a typically low interest rates. With this unlikely to be sustainable in the longer term, lenders need to put into place stricter criteria to ensure we do not face the problems seen in the early 1990s.
Furthermore, given that unemployment could rise over the next 12 months as the bear markets start to affect business performance, arrears and repossessions could rise again. If such factors come into play, it is also important more sympathetic arrears management is introduced. This could be viewed as ethically necessary, given that lenders may have been less than strict in their initial lending criteria.
Nonetheless, much of the onus for the mortgage safety net still rests with the protection industry. With the Government unable to encourage people to adequately save for pensions, it is unlikely that people will save for potential mortgage shortfalls. mortgage protection may well prove to be the only financial product which can directly address the mortgage safety net.
However, this more holistic approach to extending the mortgage safety net has to be taken. Each party, be it the Government, the lenders or product providers, needs to work together to ensure consumers are aware of the dangers, and that there is adequate provision when things go wrong. Now is an excellent time for the mortgage industry to take action.
Charles Ansdell, head of corporate communications at Inter-Alliance
The CML argues the increase in MPPI is due to consumer awareness not benefit withdrawal.
With companies offering income protection as an employee benefit, duplication of benefits is a danger.
Flexible mortgages need flexible protection, such as menu based products, that can be tailored to changing needs.