The financial services regulator believes consumers would do well to ask themselves if they actually need cover on their loan repayment, writes Laura Slattery

Expensive. Bad value. Flogged using high-pressure sales tactics. Full of annoying little exclusions designed to make claims impossible.

The above could describe many different types of insurance, but not least payment protection insurance - the kind on which it emerged last week that 65,000 of Bank of Ireland's personal loan customers had been overcharged.

The payment protection premiums were lumped in with the main loan repayment, so when customers paid off their outstanding balance early they also paid the insurance premiums relating to the remainder of the term, when there was no loan left to insure. They should then have received a refund of the unused premiums.

The Bank of Ireland error is not the first financial scandal involving this product, which is highly profitable for the banks.

Last year it was revealed that AIB charged 570 mortgage customers for this strictly optional type of insurance without actually asking the customers if they wanted the cover.

There are many reasons why consumers might want to shun payment protection insurance, which covers loan repayments for up to 12 months in the event the borrower suffers from a specified illness or is made redundant.

First of all, there's the cost. A personal loan survey by the Irish Financial Services Regulatory Authority (Ifsra) shows that, on a €10,000 loan being repaid over five years, the cost of payment protection ranges from €1,001 to €2,153, depending on the lender.

With prices like that - a minimum of 10 per cent of the original loan value - the risk of going uninsured will often be worth taking. Some borrowers will also already have cover through their employer in the event they get sick, while statutory redundancy benefits should take the edge off an immediate financial crisis if they lose their job.

According to Ifsra, which is in the middle of an industry-wide investigation into the sale of payment protection, the product has a very low rate of claims. At some banks, the rate of successful claims was as low as 1 per cent of all policies sold.

The financial regulator suspects that many of the one in two consumers who take out payment protection insurance believe that it is a compulsory part of the loan deal.

But although mortgage borrowers must take out an entirely different product, known as mortgage protection, that will clear the loan in the event that they die, payment protection insurance is an added extra.

The reason for this may lie in the way loan repayments are quoted.

"Very often a lender will tell the customer: 'Your loan will cost you x, including payment protection'," Ifsra's consumer director Mary O'Dea said at the launch of the regulator's draft consumer protection code earlier this year.

Ifsra plans to force lenders to isolate the price of the cover and give insurance-free quotes to borrowers so that they can see exactly how much it is costing them. Lenders will also be obliged to ask consumers to sign a form declaring that they are aware that the insurance is optional.

Ifsra has called its new factsheet on these policies Payment protection insurance: do you need it? - something of a leading question.

"We want consumers to question if they need it at all and, secondly, if they do need it, how much are they paying for it," said O'Dea. "If you're in very secure employment and you are taking out a five-year car loan, do you really need insurance?"

On personal loans and credit cards, the repayments may well be manageable even in an emergency.

For mortgage borrowers, however, even the vaguest threat of repossession can cause people enough anxiety to gladly pay up for what insurers call "real peace of mind", despite perfect health and permanent employment.

But, according to financial adviser Richard Morton of Moneywise Financial Planning, there is a cheaper and better way to insure against the disaster of not being able to repay your mortgage due to illness: income protection.

Otherwise known as permanent health insurance (PHI), income protection is sold by life assurance companies such as Irish Life and Friends First, while Hibernian Life & Pensions and Eagle Star sell it on a group basis to employer-sponsored schemes.

Unlike payment protection, income protection does not cover redundancy and it usually only kicks in after 13 weeks, compared to a month under the terms and conditions of payment protection.

"But people will often have some provision at work that will mean they will get some benefit for the first few months of illness," says Morton. "And people should have an emergency fund put away to cope with expenses for a few months just in case."

Plenty of exclusions apply to the redundancy cover under payment protection anyway. If the redundancy or unemployment is seasonal, due to the expiry of a fixed-term contract, if the person is self-employed or if the redundancy commences within 90 days, there will be no cover.

There are other differences between the products. For example, income protection lasts for as long as you are out of work due to an accident or illness - or at least for as long as you are able to prove that you are unfit for work.

If you keep paying the premiums, you may be able to claim more than once, Morton points out.

But payment protection insurance usually expires after 12 months, meaning the maximum benefit on the product is very low in proportion to the cost of the premiums.

It also means that claimants who are still ill or unable to find work after a year could suffer a nasty shock when they discover they have to meet their loan repayments from there on or risk defaulting.

Income protection is also cheaper than payment protection, especially if borrowers opt to limit the term of the insurance to their mortgage term, which can be done under Friends First's mortgage income protection product. According to Permanent TSB's loan calculator, someone borrowing €300,000 over 25 years will pay €56.25 per month in order to protect the monthly repayments of €1,438 (based on a rate of 3.1 per cent).

But a 25-year-old male non-smoker could take out a 25-year policy from Friends First that will pay a value of €2,000 a month - enough to meet the mortgage repayment plus household bills - for just €26.63.

At Friends First, the premiums are guaranteed, although at Irish Life they are reviewable.

The premiums are also tax deductible, although the benefit is taxable. And people who are older when they are applying for an income protection policy typically pay more, as will those with hazardous occupations.

Nevertheless, the advantages of income protection over "rip-off" payment protection policies far outweigh the disadvantages, Morton says.

Lenders stress that payment protection is only available when borrowers are first taking out a loan, making it seem like a "now or never" deal for under-pressure consumers unused to the burden of intimidating repayments.

"It's presented as another box to tick on the application form," says Morton. "If it's a good product, shouldn't it stand up on its own?"

Weigh up the options before taking cover

DO

- decide if you need the cover. You should consider your circumstances before you decide if it is worth paying for. Are you entitled to a period of paid sick leave from your employer? What is the risk of redundancy in your job? Do you have existing life, serious illness or income protection insurance?

- ask how much extra the insurance will cost. Ask your lender for the monthly loan repayment figure with and without payment protection. Ask what the policy will cost you over the period of the loan.

- ask if you are paying for the insurance upfront. Some banks and credit unions automatically add the full cost of the insurance onto your original loan. This means you pay interest not only on the loan, but also on the insurance. If you pay the loan off early, you may be entitled to a refund.

- check the policy conditions before you buy to see what is and isn't covered. Most policies have a list of exclusions. For example, specific types of illness may not be covered under all policies, including common conditions such as stress or back injury.

DON'T

- assume you have to take this cover. It is your choice and, before deciding to take out this policy, you need to weigh up the benefits against the costs of the cover.

- automatically think it is the best cover for your needs. Check out the costs of income protection, personal accident insurance or serious illness cover. Look at options such as illness or accident cover through your job, sports club or other professional association.

Source: Ifsra

Ifsra's factsheet on payment protection insurance is available from its helpline: 1890 777 777, on its website at www.itsyourmoney.ie and from its information centre at College Green in Dublin.