Beware this £1 billion credit card rip-off!

This rip-off could be doubling the cost of your credit card, and you may not even realise it....

Recently, the Financial Services Authority (FSA) has been busily doing good deeds on behalf of consumers.

2-0 to the FSA

On 29 September, the FSA ordered an immediate review of all sales of loan payment protection insurance (PPI) made since 1 July 2007. In addition, it told lenders and insurers to re-open 185,000 previously rejected complaints into loan PPI going back to 14 January 2005. As I explained in this article, compensation of up to £195 million may be paid to borrowers.

On 7 October, the FSA hit another home run for the public by ordering sellers of mortgage PPI (MPPI) to return £60 million collected from policyholders following unfair premium increases. As I revealed in Good riddance to this £60m rip-off, the FSA also forced firms to reverse changes to their terms and conditions which lowered the benefits paid by MPPI policies.

So, having tackled loan PPI and mortgage PPI, I'm wishing for a hat-trick from the Financial Services Authority. In particular, I'm hoping that the financial watchdog will turn its attention to an equally problematic area of insurance: the sale of credit card PPI, often known as credit card repayment protection (CCRP).

Yet another protection racket

All insurance is a gamble, but with CCRP, the odds are weighted massively in the insurer's favour. This is largely because this insurance is vastly overpriced. In other words, profit margins for the lenders and insurers that sell CCRP are astronomically high. Typically, upwards of 80% of the premium charged is pure profit.

To show you just how breathtakingly expensive credit card and store card PPI is, I conducted the following exclusive research, with the help of lovemoney.com partner Moneyfacts. Here's what its database revealed:

The sky-high cost of card PPI

Source: Moneyfacts, 12/10/09

My table shows the monthly cost of insuring a balance of £100. Therefore, if your balance is £1,000 and your CCRP policy costs, say, 79p per £100 per month, then the yearly cost will be £94.80.

As you can see from the table, the monthly cost of protecting each £100 owed varies from 45p (at the Post Office) to £1.50 (for four different store cards), with the average being 82.5p.

The table also demonstrates that the market for CCRP is very anti-competitive, as a handful of insurance companies control the majority of the market. Indeed, 206 out of the 246 CCRP policies charge between 76p and 87p per £100 per month.

Now for the really damning bit: the average CCRP policy costs 82.5p per £100 per month. Thus, over the course of a year, a typical CCRP policy will add 9.9% to the cost of your credit card.

The average interest rate charged by a credit card is around 18.1% a year. Thus, on average, adding PPI to your card increases the cost of your card by more than half (55%). Even worse, the most expensive CCRP policies -- costing 18% a year -- can double the cost of credit. Ouch!

The billion-pound swindle

At the end of August, we owed £54 billion on our credit and store cards. If a fifth (20%) of this debt is protected by CCRP, then this amounts to £10.8 billion. With a typical CCRP policy costing 9.9% a year, we're paying roughly £1,070 million (more than a billion pounds) a year in premiums.

Any half-decent actuary (a mathematician who assesses insurance risk) will tell you that the true cost of providing this insurance is more like £220 million a year. Therefore, we're paying about five times as much as we need to for CCRP -- and this over-priced rubbish is making its sellers £850 million a year in excess profit.

Two more flies in the ointment

Another problem with CCRP policies is that no two are exactly the same. Some will pay you a monthly benefit of 2% when you're unable to work due to an accident, sickness or unemployment. Others will pay off a much more generous 10% or 15% of your balance each month. Hence, two policies charging the same premium could offer very different payouts when you make a claim.

Also, CCRP is amazingly poor value for 'full payers', as premiums are charged even if you pay off your entire balance each and every month. Yet sensible cardholders pay the same for CCRP as do 'revolvers' -- cardholders who roll over a balance from one month to the next. That's bonkers.

In summary

My advice to all cardholders is to check whether CCRP premiums are being debited from your credit card account. If so, find out what it covers and decide whether paying 10% a year or so for what's on offer is good value. You may, for example, be better off with an income protection policy instead. If not, always shop around for a cheaper replacement before cancelling your existing policy.

In short, most CCRP policies offer such incredibly bad value for money that you're almost sure to lose out with this rip-off insurance!

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