Insurance Review: Stress test for IP cover

Checking for IP or CI cover should be obligatory for all lenders and it would make sense to do it alongside the other stress tests 

Mark Graves Pink 2015

The UK financial services market has been hit by one misselling scandal after another in the past few years. Payment protection insurance and endowments probably spring to mind for most people and the spectre of interest-only claims has been discussed for a few years now. But what if the scandal of the next few years was not what we have sold but what we have not?

As the public become more financially aware (and as claims firms look for the next bandwagon to jump on), I wonder when the first claim will come from someone who says they lost their house or livelihood because they became ill and had not been told about income protection or critical illness cover by their mortgage adviser.

There are two moral questions around this issue. First, why are lenders interested only in the asset they are lending on and not in the human beings who are paying for it? Second, why do some advisers think it is fine to help saddle people with the largest debt they are ever likely to take out but not even discuss with them how they might pay for this if they were no longer able to work for a lengthy period?

At the moment, lenders’ IT systems are not sophisticated enough to log why a borrower stops paying their mortgage but it would be interesting to find out how many people are in arrears because they became ill or lost their job and therefore found they had no means of keeping up their payments. In fact, I foresee a time when the FCA wakes up to this element of consumer protection and makes it obligatory for a lender to look at the reasons why someone starts having payment difficulties.

I do not understand why, in post-MMR affordability calculations, it is seen as a negative to have an IP policy. Surely instead, especially in borderline cases, someone with IP should be granted a mortgage over someone who does not. The person with the policy will clearly be in a better position to continue paying their mortgage if something unforeseen should happen to them, so they are a much lower risk in lending terms than someone who does not have any protection in place.

I believe that checking whether an IP or CI policy is in place should be on the application form. Lenders already check whether a borrower with an interest-only mortgage has a repayment vehicle in place so why not use the same process to check for protection policies that will help someone to continue paying their mortgage?  It would make sense for these checks to be done alongside the other stress tests carried out by lenders.

In fact, it is ironic that lenders check if someone has an Isa with which to repay their interest-only mortgage but do not check whether that person could continue paying into the Isa if they were to become sick. Do people with interest-only mortgages really not get ill? 

We are obliged to stress test whether borrowers could afford their repayments if interest rates were to rise. But, unfortunately, before this rate rise happens, within a year or so a notable number of people are likely to be affected by serious ill health.

There surely has to come a time when IP becomes an essential part of taking out a mortgage, in the same way that lenders used to insist that a borrower had a life assurance policy assigned to their mortgage. 

This ought to become a ‘win-win-win’ situation for the borrower, the lender and the Government. The money provided by the state is pitifully low but still makes a serious hole in the public coffers at a time when the UK’s debt burden remains terrifyingly high.

Most borrowers remain in blissful ignorance of how little money they would receive from the state or their employer if they were to become ill – unaware that they would lose 80 per cent of their income when relying on state benefits if they previously earned £40,000 a year.

As lenders do not keep statistics on how many people stop paying their mortgage because of sickness or unemployment, they are, to my knowledge, unaware of how much this costs them. 

The government-led policy of forbearance brought in during the credit crunch is likely to mask this further as it has kept repossession rates artificially low.

Rather than turning a blind eye to the issue of protection, the Government should exempt from tax key IP and CI products. We should treat IP in the same way we do pensions. Even if there were an initial upfront cost, it would be more than compensated for by ensuring that people could remain financially independent. At the same time, lenders would be likely to have far fewer defaults.

There was an amount of publicity about the fact that all Pink brokers now discuss IP with their clients at their first meeting with them. We had two objectives behind this new policy. 

The primary one is to ensure that every person even thinking of taking out a mortgage is made aware of how much or how little money they would have to live on if they could not work for any reason. 

Clients are also educated about how little it costs to protect themselves. In most cases, this can be worked into the monthly amount initially allocated for their mortgage payments.

The second objective is to ensure that every Pink broker is on record as having discussed protection with their client, and whether the client either decides to take out a policy or chooses not to.

If you have not had the conversation upfront, now is definitely the time to revisit those clients to let them know exactly what their options are – even if you have not seen them for a long time.

Every responsible broker should dread the day when someone they have advised comes to them, either ill or unemployed, in danger of losing their home and asks them why they never had that conversation about vital protection products.