Essential cover for mortgage clients?
FOCUS MORTGAGE REPAYMENT SURVEY - 1ST SEPTEMBER 2003
Less than 20 per cent of current borrowers have accident, sickness and unemployment cover. The Government hope to increase this to 55 per cent by 2004. How?
In recent years mortgage payment protection insurance, often referred to as accident, sickness and unemployment cover, has become a mainstream product for both mortgage lenders and IFAs. This is partly due to the growing awareness of the need to protect homeowners against the consequences of unforeseen problems such as redundancy, illness and injury.
However, at the start of 2000, there were almost 11 million UK mortgages, with only two million protected by mortgage payment protection insurance. This means that around eight out of 10 borrowers do not have specific accident, sickness and unemployment cover to meet their mortgage repayments.
This is a major concern because over the last decade – a period encompassing recession and recovery – almost half a million properties were repossessed, with over 1.4 million people losing their homes. Moreover, the Government’s own statistics reveal that accident, sickness and unemployment account for a third of mortgage arrears and a quarter of repossessions.
This month marks the fifth anniversary of substantial cutbacks to State support for sick or unemployed homeowners. For mortgages arranged since October 1995, borrowers have a nine month wait before qualifying for income support for mortgage interest. Borrowers with mortgages in place more than five years ago still have a four-month wait before receiving ISMI.
In all cases, payments are limited to interest at a standard rate on the first £100,000 advanced, so shortfalls and arrears are inevitable. Furthermore, ISMI is means tested so having savings, a working partner or other income can reduce or rule out entitlement. The Benefit s Agency reveals that over seven out of 10 claims for means tested benefits fail, so ISMI is often a very weak safety net.
As for using savings to replace income ,according to a recent survey by the Institute for Fiscal Studies, the majority of households have savings of £750 or less.
All these factors mean that being off work for more than three months often leaves homeowners in acute financial difficulty.
Arguably, given that events such as redundancy or illness are usually unpredictable, all 28 million UK workers need some form of accident, sickness and unemployment cover. Realistically, homeowners need to understand the risks they face, revealed by the fact that mortgage payment protection insurance providers receive thousands of new claims every month.
Although there are no hard and fast rules to determine who needs mortgage payment protection insurance, research suggests that the most important influences are the mortgage borrower’s attitude to risk and insurance, and budgetary constraints. Broadly, the mortgage borrowers most likely to value mortgage payment protection insurance are those who:
• Are risk-averse and are attracted to the peace of mind that mortgage payment protection insurance provides.
• Are working in insecure occupations or have low job security.
• Have few or no savings.
• Have a small deposit or none whatsoever.
• Rely on a single income to pay the mortgage.
• Have limited employee benefits (less than six months’ sickness benefits).
• Have no other means of income replacement.
It is not unknown for 70 per cent of first-time buyers to buy mortgage payment protection insurance, reflecting the fact that they usually fall into several of the above categories. Research conducted by accident, sickness and unemployment product provider St Andrew’s last year showed that families with children were also keen buyers of mortgage payment protection insurance.
Conversely, borrowers in secure employment with generous benefits and redundancy terms are mostly untroubled by the risks of accident, sickness and unemployment. Others taking a similar view are those who:
• Have considerable savings and/or few debts.
• Have significant equity in their property, that is a low loan-to-value ratio.
• Have a working partner whose income can meet the repayments.
• Have a low income-to-value multiple.
• Have tight budgets and can’t afford it.
• View themselves as financially sophisticated or risk-takers.
These factors perhaps explain why mortgage payment protection insurance sales are higher in the North of England than in the more affluent South-East corner. Ironically, these well-off borrowers are exactly the sort who will not qualify for ISMI.
Unlike motor or household insurance, mortgage payment protection insurance is rarely individually underwritten. All customers pay the same rate, regardless of occupation, age or health problems. This “one size fits all” approach means that there is no cherry picking of the better risks. In this respect, mortgage payment protection insurance is inclusive not exclusive, and applicants otherwise considered poor risks are not discriminated against.
Monthly premiums for mortgage payment protection insurance plans range from under £4 to over £6 per £100 of benefit, with an average rate of £5.50. Sales by intermediaries are improving and more standalone policies are appearing, with Marks & Spencer recently launching their own version.
It is worth comparing the typical monthly premium of £22 for £400 of benefit with the £4,800 in benefits that this policyholder would receive if they were unlucky enough to be off work for a year or more. With claims normally lasting around six months, most sick or unemployed claimants receive between £2,000 and £3,000 – a substantial sum to protect their homes and credit ratings.
Most insurers now credit benefits directly into the policyholder’s mortgage account, ensuring that his/her entitlement to means tested benefits is not affected.
In any event, the Benefits Agency will ignore any benefits that go towards paying the mortgage and other associated expenses, such as endowment and buildings insurance premiums.
Although sales continue to improve, fewer than three out of 10 new mortgages include accident, sickness and unemployment cover. The Government has agreed with lenders and insurers that 55 per cent of all borrowers should have mortgage payment protection insurance cover by 2004, so current take-up will need to double to meet this goal.
Alongside growing sales is an encouraging trend towards improved persistency, with cancellations falling in recent years.
Although lenders arrange up to 85 per cent of all mortgage payment protection insurance policies, I estimate that the proportion sold by intermediaries has risen from 10 per cent in 1998 to 15 per cent in 1999.
With up to 1.8 million mortgages being arrange in 2000 – almost half by intermediaries – they have a vital role to play in stimulating sales and a huge opportunity to protect their clients and earn useful commissions.
The launch of the Sustainable Home Ownership (SHO) initiative by lenders, insurers and the Government in July 1999 created a baseline specification for all new accident, sickness and unemployment policies. SHO has lead to standardisation and consumer guarantees for the first time, which must have helped to stimulates sales over the last year. Mortgage payment protection insurance policies must:
• Cover the employed, self-employed, contract and part-time workers.
• Have an excess period of no more than 60 days.
• Include a benefit that accrues daily and is paid monthly.
• Pay benefits for at least 12 months.
St Andrew’s most recent survey indicate that around half of polices have a 60-day excess, with the remainder offer a 30-day excess or back to day one cover.
In recent years, borrowers have increasingly chosen to buy unemployment only policies but, given that around half of mortgage payment protection insurance claims are for accident and sickness, it is uncertain whether this unbundling of accident, sickness and unemployment plans is a desirable trend.
Increasingly, policies now include back to work assistance, whereby unemployed policyholders receive help with CV drafting, job-finding and interview techniques. This adds a valuable service to the financial benefits the borrower receives and helps to improve the claim experience.
Another positive market trend is to combine short-term accident, sickness and unemployment cover with the long-term disability cover afforded by income protection.
Most mortgage payment protection insurance policies start paying benefits after a 30 or 60 day waiting period, which fits well with income protection policies, the majority of which have a waiting period of between 13 and 52 weeks. Another initiative is to add an unemployment rider to income protection contracts.
An unmistakable development is mounting media and Government recognition of the need for mortgage payment protection insurance cover, with the recent Housing Green Paper including a section on the role of mortgage payment protection insurance and public/private insurance provision.
In recommendations released at the end of July 2000, the social security select committee proposed that mortgage lenders ensure all borrowers have mortgage payment protection insurance. Opinion on this issue is divided but there will always be a proportion of borrowers for whom mortgage payment protection insurance is unnecessary or unwanted.
Perhaps compulsion has its merits, as St Andrew’s research reveals that half of homeowners would struggle to pay three mortgage repayments while unemployed.
With the average house price now exceeding £100,000, rising mortgage rates and the withdrawal of mortgage interest relief at source, homeowners are facing escalating housing costs. This leads me to believe that lenders and intermediaries have a duty to ensure all borrowers are given the opportunity to protect themselves with mortgage payment protection insurance.
IFAs marketing accident, sickness and unemployment cover should seek out reasonably priced cover and check that the policy is baseline-compliant, contains no unusual exclusions and has a reasonable cooling-off period.
Pre-existing medical conditions occurring in the 12 months prior to the policy are usually excluded, as is unemployment in close proximity to the start of cover, usually 60 days.
Remember that a policy costing £5 with a 60-day excess period is not necessarily better value than one costing £5.50 offering back to day one cover. Mortgage payment protection insurance is bought not sold and, ultimately, the client will decide whether the cover is appropriate.
However, as trusted professionals, IFAs are in an ideal position to explain the risks and help clients to make an informed decision.
