Parliamentary Commission on Banking StandardsWritten evidence from the Competition Commission

Executive Summary

1. The Competition Commission (CC) is an independent authority responsible for conducting in depth investigations into mergers and into markets where competition may not be working well, and some regulatory matters. All the CC’s inquiries are referred to it by another organisation and it cannot initiate its own investigations. Recent CC market investigations that have involved markets for credit are Store Cards, Home Credit and Payment Protection Insurance (PPI).

2. The Office of Fair Trading (OFT) referred the market for PPI to the CC in February 2007. The terms of reference for the inquiry required the CC to investigate whether any feature or combination of features of the market for PPI services prevents, restricts or distorts competition. The CC had no mandate to investigate any aspects of the market that did not relate to competition.

3. The CC published its report in January 2009. It found there to be little competition among distributors and intermediaries in relation to the supply of any type of PPI policy sold at the credit point of sale. This and other features of the market gave rise to an adverse effect on competition, which resulted in higher prices, less choice, and less innovation than could be expected in a competitive market. The CC estimated the harm to consumers at significantly more than £200 million annually, and proposed to impose remedies to address the competition problems it found

4. In March 2009, Barclays Bank plc challenged aspects of the CC’s final report before the Competition Appeals Tribunal (CAT). The CAT upheld the CC’s conclusions in relation to the competition problems in the market but ruled that the CC must further consider the possible loss of convenience to customers caused by one of its remedies—a prohibition on sale of PPI at the point of sale of the associated credit product. The CC carried out a detailed analysis of the impact of the point of sale prohibition. In October 2010 it confirmed its package of remedies and in March 2011 implemented them by Order.

5. Although the CC had no role or mandate for investigating or remedying non- competition issues in the PPI market, it was aware of concerns about sales quality. The CC worked closely with the Financial Services Authority throughout the investigation to ensure that the authorities’ responses to a complex market were co-ordinated and their decisions were compatible.

1. The CC’s Remit in Relation to Unsecured Credit Products and PPI

6. The CC carries out in-depth investigations into mergers, markets and regulated sectors, upon reference from other bodies, or occasionally, from Ministers. The CC cannot initiate its own investigations; every case must be referred to it by another agency, usually the OFT. As such the CC has no on-going regulatory remit related to unsecured credit products or PPI.

7. The Enterprise Act enables the OFT (and some of the sector regulators) to investigate markets and, if they are concerned that competition may not be working effectively, to refer those markets to the CC for in-depth investigation. On receipt of such a reference, the CC is required to decide whether any feature or combination of features in a market prevents, restricts or distorts competition, thus constituting an adverse effect on competition (AEC). Market investigations enable the CC to undertake a broad, in-depth assessment of a market as a whole rather than investigate a single aspect of it or the conduct of an individual firm within it. If the CC finds that features of a market are harming competition, it must seek to remedy the harm either by introducing remedies itself or recommending action by others. The CC has no powers to investigate issues that arise in a market that are not related to competition.

8. Market investigations are carried out by a Group of Members, drawn from a standing panel appointed by the Secretary of State for Business, Innovation and Skills. They direct and oversee the work by CC officials, hear and assess written and oral evidence and are responsible for the final decision. The Group is supported by a staff team, led by an Inquiry Director, and comprising professional staff (including economists, legal advisers, financial and business advisers) and an administrative team. The CC is obliged to complete its investigation and publish a report in a period of 24 months.1

9. The CC has carried out three market investigations into credit and insurance markets in recent years:

Store Card Credit Services (18 March 2004 to 7 March 2006).

Home Credit (20 December 2004 to 30 November 2006).

Payment Protection Insurance.

reference received 7 February 2007;

report published on 29 January 2009;

remittal notice received 29 November 2009;

remittal report published 14 October 2010; and

publication of the final Order implementing remedies 24 March 2011.

In each case the CC has found features (or a combination of features) that created an adverse effect on competition, and has implemented remedies.2

2. An Account of the CC’s Investigation into PPI

The course of the CC’s investigation and the remittal

10. The Citizens Advice Bureau (CAB) complained to the OFT using the “super complaint” process provided for in the Enterprise Act in September 2005. The OFT opened a market study into the provision of PPI services and published a consultation document in October 2006 setting out its intention to refer the market to the CC. The OFT referred the market to the CC in February 2007 with the terms of reference covering the supply of PPI services (except store card PPI services) to non-business customers in the UK.

11. The CC published provisional findings in June 2008 (and provisional findings relating to the market for retail PPI—payment protection insurance relating to retail credit, often issued by home shopping retailers—in October 2008). The CC’s report was published in January 2009.

12. The CC’s report found features of the market that created an adverse effect on competition and set out a number of remedies including a prohibition on selling PPI at the same time as credit—the point-of-sale prohibition (POSP); a prohibition on selling single-premium PPI policies (where a multi-year policy is paid for in one up-front fee, added to the cost of the loan; the FSA took action on this in parallel and there are now no single-premium personal loan PPI policies sold) and various remedies to increase and improve information flow and transparency.

13. Barclays Bank plc challenged the lawfulness of the CC’s findings and its decision to impose a remedies package in March 2009. The CAT upheld the CC’s findings on competition grounds but ruled that the CC must consider further the loss of convenience for consumers which would flow from one of the CC’s remedies—the prohibition on selling PPI at the point of sale of credit and remitted the question back to the CC.

14. Following a remittal from the CAT in November 2009, the CC carried out a detailed analysis of the impact of how consumers would benefit from the POSP on customers’ convenience, including conducting a customer survey (the CC’s assessment of the loss of convenience for consumers of the POSP can be found at Chapter 5 of the final remittal report, October 2010). In October 2010 the CC confirmed the POSP for all forms of PPI except retail PPI (a small part of the overall PPI market).

15. The CC published its final Order in March 2011 implementing a package of remedies to increase competition in the market (remedies are set out below).

16. All the documents published by the CC in the course of the investigation and the remittal are available on the CC’s website at http://www.competition-commission.org.uk/our-work/directory-of-all-inquiries/ppi-market-investigation-and-remittal.

17. During the investigation and the remittal, the CC liaised closely with the industry regulator, the Financial Services Authority, which takes the lead on regulating sales practices and tackling mis-selling, as well as the Financial Ombudsman Service, which deals with consumer disputes. The CC’s focus throughout was on examining whether there was effective competition in the market as a whole.

The CC’s findings

18. Competition in markets for PPI: the CC found there to be little competition among distributors and intermediaries in relation to the supply of any type of PPI policy sold at the credit point of sale. The CC found the following features of the market gave rise to an AEC:

Distributors and credit intermediaries fail actively to seek to win customers from their rivals by using the price or quality of their PPI policies as a competitive variable.

the extent of competition between providers was limited (on both price and non price factors);

there were barriers in terms of customer search for PPI policies (time consuming, limited information available, complexity of policies, misunderstandings in relation to PPI improving the credit application process, low level of stand-alone provision);

barriers to switching (eg access to consumers’ credit information); barriers to entry and expansion; and

the point of sale advantage in selling PPI combined with a credit product meant that stand alone providers were at a competitive disadvantage, raising barriers to new entry and stand-alone provision (see Chapter 5 “Factors affecting the nature and extent of competition in the supply of PPI” of the January 2009 final report).

19. Consumer detriment arising: the CC found that the detrimental effect of these features was that customers experienced higher prices, and less choice of PPI products than would be expected in a competitive market. It also concluded that it was possible that there was less innovation than would be expected in a competitive market. The CC found that the largest PPI distributors earned profits in excess of their cost of capital of £1.4 billion in 2006, representing a return on equity of 490%. Net consumer detriment after taking account of any possible benefits to customers through lower credit prices was significantly more than £200 million per year while some elements of consumer detriment could not be quantified (see Chapter 10 “Remedies” of the CC’s January 2009 report).

Remedies

20. The CC’s 2009 report concluded that the package of remedies that would form as comprehensive a solution as was reasonable and practicable to the AEC and its detrimental effects comprised:

a prohibition on selling PPI at the point of sale of the credit until seven days after the credit sale or, if later, seven days after the supply of a personal PPI quote (the point of sale prohibition or POSP);

an obligation to provide a personal PPI quote, setting out the cost of PPI along with details of the cover provided;

an obligation to provide information in marketing material about the cost of PPI and “key messages”, for example making it clear that PPI is optional and available from other providers;

an obligation to provide information to the Office of Fair Trading (OFT) and the Consumer Financial Education Body (CFEB) for monitoring and publication;

a recommendation to the CFEB that it uses the information provided to it to populate its PPI comparison tables;

an obligation to provide information about claims ratios to any person on request;

a prohibition on the selling of single-premium PPI policies;

an obligation to provide an annual review setting out the cost of PPI and including a reminder of the consumer’s right to cancel; and

compliance reporting requirements, including commission of independent “mystery shopping” exercises by the largest providers (see Chapter 10 “Remedies” of the CC’s January 20009 report for a full description of remedies).

21. The CC’s final report, following the remittal from the CAT and further consideration of the impact of the POSP, found that if a POSP were introduced there would be an overall benefit to consumers of all main types of PPI, and that any loss of convenience of having to wait to buy PPI was outweighed by an increase in sales due to an expected reduction in price as competition between providers developed. The CC identified that parties had been developing new products in response to the 2009 report, largely short-term Income Protection products (capable of being sold on a stand-alone basis away from the credit point of sale), increasing the CC’s confidence that competition between providers would develop.

22. The CC’s final Order (March 2011) implemented the package of measures for all forms of PPI including short-term income protection (but excluding retail PPI). The Order set out in detail the obligations of providers created by these measures and by the package of remedies for retail PPI (essentially PPI sold to cover repayments on revolving credit accounts offered by mail order catalogues), which incorporated some of these measures as well as an obligation to “unbundle” retail PPI from merchandise cover. The Order included templates for the personal PPI quotes and annual reviews.

3. CC’s Chief Executives Since 1999

23. The CC Chief Executive is the CC’s Accounting Officer and is responsible for the management of the CC, but has no decision making role in cases. Decisions in cases are the responsibility of inquiry groups (see answer to Q4).

24. The CC’s recent Chief Executives have been:

Penny Boys (1999–2001), Chief Executive and Secretary, now a non-executive director of Ofwat and recently appointed as a non-executive member of the CC’s Council.

Robert Foster (2001–2004), Chief Executive and Secretary, now Commissioner, National Lottery Commission.

Martin Stanley (2004—2009), Chief Executive, now independent consultant.

David Saunders (2009 to present), Chief Executive.

4. Lead Persons Responsible for PPI Since 1999

25. The Members of the Group that was set up to investigate the PPI market were:

Peter Davis, Chairman of the Group and Deputy Chairman of the CC. Peter Davis left the CC in August 2011 and is currently Senior Vice President at Compass Lexecon.

Professor John Baillie. Professor Baillie left the CC in January 2011 and is currently Chair of the Accounts Commission for Scotland.

Christopher Bright. Mr Bright left the CC in September 2009 and is currently a consultant at Shearman and Sterling.

Professor John Cubbin (current Member of the CC and Emeritus Professor of Economics, City University).

Richard Farrant (current Member of the CC). Mr Farrant stood down from the group in July 2009.

26. The Members of the Group established to consider the remittal in November 2009 were

Peter Davis.

Professor John Baillie.

Professor John Cubbin.

Malcolm Nicholson (current Member of the CC).

27. The Group was responsible for investigating the PPI market for the duration of the inquiry (February 2007 until to the CC’s final report was published in January 2009 and, with its membership adjusted as described, following the CAT’s remittal in November 2009 until the CC published its final report in October 2010). The Group was then dissolved. The Inquiry Director who led the staff team throughout this same period was Anthony Pygram. Anthony is currently Associate Partner, Enforcement and Competition Policy at Ofgem. After publication of the 2010 report, the same Group oversaw the development of the CC’s Order implementing the remedies. The CC official leading this process was Adam Land, Director of Remedies and Business Analysis, who is still at the CC.

5. CC’s Analysis of the Pricing of, and Profit Margin on PPI

28. The CC looked at how PPI prices had changed over time, to see if this showed evidence of competition between providers. The CC also looked at price changes of all PPI policies for which usable data was obtained from the 12 largest distributors. The evidence suggested that for all types of PPI, the variation in prices over five years was very limited. The general trend was for PPI prices to remain stable or rise. Further analysis can be found at paragraphs 4.5 to 4.11 of the CC’s January 2009 final report.

29. The CC considered reasons why prices had not varied much. The parties told the CC that while the price of PPI might not have varied a great deal during the period 2002 to 2006, the level and quality of the cover did, such that consumers were getting better value for money (see Appendix 4.1 of the CC’s January 2009 report for details of the views of the parties). The CC noted, though, that terms and conditions were not advertised to any significant degree; parties did not appear to try and win business by promoting the terms and conditions of their policies. Moreover, there had been increasing numbers of complaints to the Financial Ombudsman Service, increasing amounts of adverse media coverage, and increasing regulatory scrutiny and intervention in PPI by the FSA.

30. In a competitive market the CC would normally expect to see price variations over time as firms sought to win business from each other. The level of price variation over time that the CC saw was consistent with there being few significant competitive pressures on PPI providers.

31. The CC found that, though PPI prices showed a level of dispersion across products, there was no clear correlation between PPI price and product quality. Further analysis can be found in paragraphs 4.24 to 4.31 of the CC’s January 2009 report.

32. The CC calculated that the average claims ratio in 2006 for PPI was approximately 14%, varying between 11 and 28% depending on the PPI product. For most kinds of insurance the claims ratio was over 50%. Claims ratios of under 50% meant that more money paid by consumers was going to pay expenses and profit of the providers than was paid out in claims to policyholders. Further analysis of the claims ratio and profitability of PPI services can be found at paragraphs 4.50 to 4.59 of the January 2009 report.

33. The CC looked in more detail at the profitability of PPI distribution, including the costs incurred by a distributor in selling a PPI policy and found that, based on 2006 data, out of £68 in commission and profit share payments made to the distributor, costs of just under £11 were incurred in selling a PPI policy. This left £57 as an additional contribution to common costs and profit, before tax and capital costs. A fuller analysis of the CC’s calculations can be found at paragraphs 4.60 to 4.82 and paragraph 4.88 of the CC’s January 2009 report.

34. Overall, the CC found that the largest PPI distributors earned profits in excess of their cost of capital of £1.4 billion in 2006, representing a return on equity of 490%.

6. CC’s analysis of whether or not banks who manufactured the PPI product within their wider banking group may have been more likely to mis-sell or cross-sell than those that did not

35. The CC’s mandate for investigating the PPI market was to consider competition issues alone. The 2009 Report investigated vertical integration between banks and insurance companies and found that this was not a feature that contributed to the AEC that it found. It did not consider the impact of vertical integration on sales incentives.

7. How the CC Became Aware that PPI was Being Mis-Sold by the Banks

36. While the CC was naturally conscious of the FSA’s regulatory role and of the growing concerns regarding mis-selling, which was reflected in its reports, it was not the CC’s role to investigate mis-selling.

8. What the CC’s response to PPI mis-selling was and what other courses of action were available to the CC in seeking to address PPI mis-selling

37. Although the CC was aware of the parallel issue of mis-selling in the market, it had no remit to investigate mis-selling and mis-selling and competition issues were not necessarily related. The CC did not find that mis-selling was a feature of the market that led to an adverse effect on competition, nor did it find that the features the CC found to have an adverse effect on competition caused mis-selling. The CC did find that there had been some unwanted sales of PPI; mis-selling might be one example of unwanted sales (though not all unwanted sales would be due to mis-selling). Appendix B of the 2010 remittal report sets out the CC’s findings on sales quality issues and customer complaints.

38. Some of the remedies introduced by the CC might be expected to reduce the ability and incentives for mis-selling to arise, by constraining the ability to conclude a PPI sale at the same time as offering credit, by providing better information to customers before taking out insurance, and by reducing the scope for abnormally high returns to be earned by selling PPI. Any beneficial effects on mis-selling however would have been a by-product of our remedies package, the purpose of which was to increase competition. The potential for reduced mis-selling did not form part of the CC’s assessment of competition in the market or of the appropriate remedial action.

39. The CC’s consideration of a range of alternative approaches to remedies and its reasons for rejecting them are described in Chapter 10 of the 2009 report.

9. What the CC Expected the Banks’ Responses to be as a Result of the Actions it Took

40. In its 2009 and 2010 reports, the CC concluded that the remedy package would remove barriers to searching and switching and would lead to a larger stand-alone market for PPI whilst still enabling banks and other distributors of PPI to offer combinations of credit and PPI and to compete on the terms of the combination as well as of its component parts. The remedy package would lead to more active competition for PPI consumers: through more active marketing before the credit sale; in response to increased consumer search just after the credit point of sale; and by encouraging switching during the life of the credit product. This competition would manifest itself through more PPI advertising and lower prices.

41. The CC recognises that insurance to cover periods of unemployment or sickness or following accidents could serve a significant need in society. The CC’s Order sets out a framework of rules designed to encourage greater competition in future and hence better outcomes for consumers; should providers properly seize the opportunity to provide good value insurance products, as a result of these market reforms, that could be expected to give rise to a far better functioning market.

42. All the elements of the remedies package only came together earlier in 2012, so it is too early to assess their impact on competition in PPI markets. Given the extensive regulatory activity in relation to mis-selling, it would also be particularly difficult to establish whether, as a by-product, the CC’s remedies had had any impact on mis-selling. The Order took effect on 6 April 2011, though the main obligations were introduced in two phases to coincide with annual government common commencement dates (April 6 and October 1) for new legislation and regulations and also to allow sufficient implementation time for providers. Some of the information requirements therefore came into force on October 1 2011 and the point-of-sale prohibition and other measures on April 6 2012.

10. How the CC interacted with other regulators, such as the FSA and OFT, and how such interaction aided or otherwise affected the CC’s action with the banks on PPI

43. The CC worked very closely with the OFT, who referred the PPI market to it, and with the FSA, and the Money Advice Service to whom it directed a recommendation. The CC stayed in close contact with the FSA throughout the inquiry, which helped to ensure that the CC’s remedies designed to increase competition had no detrimental effect on actions the FSA was taking to address mis-selling. That contact took the form of the CC taking formal written and oral evidence from the FSA, and of informal staff meetings and correspondence.

11. The CC’s Current Approach to Mis-Selling

44. On 24 March 2011, the CC published the final order detailing measures to introduce competition into the PPI market. The CC has no further remit or role in the PPI market. The OFT is responsible for monitoring and enforcing the Order and the FSA is the body responsible for conduct regulation of firms selling PPI.

12. The CC’s Assessment of the Root Causes of PPI Mis-Selling

45. The CC investigated features of the market that created an adverse effect on competition in the PPI market. In our 2009 report, we recognised that there could be a link between weak competition and the quality of sales. In particular, we thought that the high margins on PPI available to businesses gave them the incentive to maximize the uptake of PPI among their credit customers. The effect of this would be higher levels of sales than might otherwise be the case and that the quality of sales would not always be the paramount consideration for businesses. We noted in this respect that the FSA had been active in trying to improve sales of PPI products, and had taken action over poor PPI selling practices. The terms of the reference to the CC and the CC’s statutory role did not extend to mis-selling and its causes.

13. What the CC is doing to ensure that these root causes are being address by the banks, and monitored by the CC, to reduce the likelihood that similar mis-selling happens again

46. The CC has introduced the measures it considers necessary to address the competition shortcomings that it identified. As mentioned above, the CC has no further role in investigating and remedying the PPI market. The OFT is responsible for monitoring and enforcing the Order that the CC published in March 2011. The Order contains robust compliance obligations on PPI providers to assist the OFT in this role.

14. How the approach taken to similar investigations by the merged CC and OFT might differ to the approach taken by the two separate organisations in the past

47. The Enterprise and Regulatory Reform Bill which proposes to merge the CC with the competition functions of the OFT to form the Competition and Markets Authority (CMA) will not change the duties of the competition authority in respect of the market investigation regime (described in the answer to question 1 above).

48. The Bill does however make three changes which might affect the way an investigation of this kind could be conducted in the future:

The Bill introduces a power for the Secretary of State to intervene in market investigations on public interest grounds (as is currently possible under the Enterprise Act merger control regime).

The Bill introduces a power for the CMA to carry out cross market investigations ie to investigate practices which give rise to competition issues across two or more markets.

The CMA will have new statutory timetables for market investigations which the Government expects to speed up the overall time taken for the market investigation regime. The new statutory time limits will be:

the CMA will need to consult on making a market reference within six months of launching a market study and cannot take longer than 12 months to make a market investigation reference;

the time limit for a phase II market investigation will be reduced from 24 months at phase to 18 months, with a possible six month extension in special circumstances; and

a new six month statutory time limit for the CMA to implement remedies with a possible four month extension.

49. The CMA may therefore be in a position to complete an end to end market investigation process more quickly once a competition issue is suspected and identified. In practice the OFT, FSA and CC worked very closely in relation to the CC’s investigation of PPI; we do not expect creation of the CMA to make a material difference to the quality of joint working with the FSA’s successor organisations. There will be scope for the CMA to make further changes and improvements to the market investigation regime more widely; it will be a matter for it to determine how best to proceed.

18 December 2012