PPI Inquiry_ Third Party Submission by jlhd32


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									11 May 2007                                                                              Non-Confidential Version



These are MBNA Bank Europe Limited's ("MBNA") initial thoughts on the points raised by the
Competition Commission in its Issues Statement published on 12 April 2007. MBNA will be
happy to discuss the issues in more detail at the hearing to be held on 26 June 2007.


1.        MBNA is a subsidiary of FIA Card Services NA, a national bank organised under the laws
          of the United States of America. MBNA's ultimate parent company is the Bank of America
          Corporation which acquired MBNA on 1 January 2006.

2.        The principal activity of MBNA is personal lending and ancillary activities in the United
          Kingdom, the Republic of Ireland and Spain. The group has its headquarters in Chester
          and operates through branches in the Republic of Ireland and Spain.

3.        MBNA entered the UK market in 1993. MBNA issues credit cards under the MasterCard,
          Visa and American Express brands. It offers both consumer and business credit cards.
          MBNA has traditionally focused on issuing affinity cards and now has over 850
          partnership programs with groups as diverse as Alliance & Leicester, Virgin, SONY, the
          National Trust, BMI and Breakthrough for Breast Cancer. MBNA is the only credit card
          issuer in the UK that has the organisational structure and technology platforms to support
          such a diverse set of partners.

4.        At present, MBNA also provides unsecured loans. However the company has decided
          recently that it will cease offering new unsecured loans and run down its existing
          unsecured loans business. 1

5.        MBNA offers PPI products associated with its credit card and unsecured loan products (ie
          PPI for unsecured loans and for outstanding credit card balances). It also offers other
          insurance products (for example: travel, car and home insurance), but this constitutes a
          relatively small part of its overall business. MBNA does not offer PPI as a stand-alone

          MBNA informed members of the Competition Commission at the site visit on 27 April 2007 that it had announced
          internally that it would cease offering unsecured loan business. It will continue to offer a loans broking service
          through its subsidiary, loans.co.uk, which it acquired in 2005.



6.        PPI is an insurance product that provides cover in connection with an underlying credit
          product. The purpose of PPI is to protect the borrower’s ability to maintain repayments
          and to help him avoid getting into debt should he be unable to keep up his repayments
          owing to accident, sickness, unemployment or death.

7.        Payment under a PPI product is made direct to the provider of the underlying credit
          product.     The insurer and the lender develop systems to ensure that the customer's
          specific loan account or credit card account is credited directly with any insurance
          proceeds. This is a considerable benefit to any customer who is concerned to ensure that
          his loan/credit card payments are protected. Moreover, the payments are not taken into
          account in calculating the customer's entitlement to any state benefits (in this respect PPI
          differs from certain other insurance products, including income protection).

Special features of MBNA

8.        In the document setting out its reasons for making a market investigation reference, the
          OFT identified four main PPI products:

          •        PPI on first-charge mortgages;

          •        PPI on second-charge mortgages and other secured loans;

          •        PPI on unsecured loans;

          •        PPI on credit card repayments.

9.        MBNA has traditionally focused on the provision of credit cards and unsecured loans. It
          does not offer first-charge mortgages, second-charge mortgages or other secured loans,
          nor does it offer PPI related to those products (and, as noted above, it will cease offering
          unsecured loans).

10.       Unlike many other providers of credit cards, unsecured loans and insurance products,
          MBNA does not have a high street presence, nor the type of established relationships
          with consumers, eg through the provision of current accounts, which many of its
          competitors enjoy. According to the OFT, in 2005/6, 90% of households had a personal
          current account. The OFT has commented that consumers may buy additional retail
          banking products from their current account provider, suggesting that current accounts
          can also act as a 'gateway' to the sale of other products. 2

11.       Instead MBNA has developed and continues to develop its customer relationships
          through innovative means, for example through its partnership programmes, affinity

          OFT918, Personal Current Accounts in the UK, April 2007.

2081284                                                                                         MBNA

          products and marketing initiatives. Since MBNA, lacking the advantages of cross-selling,
          has to invest heavily to attract customers, it is very much in its interests to retain those
          customers, which it aims to do by providing products that they want, backed up by
          excellent customer service.    Given the relatively limited range of products offered by
          MBNA, if a customer were to become dissatisfied with any MBNA product, MBNA risks
          losing the relationship entirely (whereas a financial institution offering a greater range of
          products might retain a customer relationship for at least some of their products even if a
          customer were dissatisfied with a particular aspect of a particular product).

12.       This is very much the case with the PPI products that MBNA offers. Since PPI products
          are so closely connected with the underlying credit card or unsecured loan, if a customer
          becomes dissatisfied with the PPI product, there is a serious risk that MBNA will lose the
          customer for both the PPI product and the main credit product.

13.       MBNA is therefore very focussed on delivering excellent customer service and avoiding
          any situation in which customers, having purchased a product, feel that they are not
          obtaining value for money. In relation to PPI products, this means that MBNA:

          •      provides customers with information about PPI products at an early stage;

          •      always provides quotes for unsecured loan products and credit card products both
                 with and without PPI without being prompted;

          •      makes clear that PPI is optional;

          •      explains the eligibility criteria, policy cover, exclusions and price;

          •      provides hospitalisation cover and life cover for customers aged 65 to 70;

          •      encourages customers who are struggling to make repayments to claim on their
                 PPI where the relevant claim criteria are met (for example, if payments are
                 outstanding for more than 30 days, MBNA will write to customers who have a PPI
                 policy, asking them whether they have considered making a claim); MBNA also
                 reimburses the cost of medical certificates (up to £15 per certificate) since it
                 considers that this cost might otherwise discourage certain customers from
                 submitting a claim;

          •      excludes customers who have made a claim from any interest rate increases that
                 would otherwise apply to the underlying credit product for the time during which
                 payments are being made under the claim.

14.       MBNA also adopts a judgemental lending approach for a large proportion of applications.

2081284                                                                                          MBNA

          •       Cards: credit risk is assessed through the use of credit risk scores and
                  judgemental lending. MBNA uses generic bureau scores for every application in
                  addition to using a custom developed applicant risk model. Niche scorecards are
                  used at the margins of MBNA's lending spectrum to refer higher risk applications
                  for judgemental review. Manual underwriting is undertaken in XX% of cases.

          •       Loans: credit risk is assessed through the use of credit risk scores and
                  judgemental lending. MBNA uses generic bureau scores for every application in
                  addition to using a custom developed applicant risk model. Manual underwriting
                  is undertaken in XX% of cases.

          In general terms, MBNA considers a range of factors, rather than relying on a mechanistic
          scoring process.    Thus MBNA will take into account an applicant's stability (time at
          address/time in employment, etc); ability (income, disposable monthly income); and
          willingness (credit references, credit card and bank statements submitted by the applicant
          and information provided by MBNA's strategic partners).

Relevant geographic market

15.       MBNA considers that the geographic market is likely to be national in scope, both for
          credit card PPI and unsecured loans PPI.

Relevant product market

16.       MBNA considers that PPI is generally not regarded as a stand-alone product by suppliers
          or by customers.

17.       It is MBNA’s view that PPI and the underlying credit product are closely related, in terms
          of both their design and the customer’s perception. For example, in the case of credit
          card PPI, the PPI product should ideally reflect any minimum repayment provisions in
          effect with regard to outstanding balances. MBNA was recently required by the US Office
          of Comptroller of Currency to increase the minimum monthly repayment on its credit card
          products to £25 to avoid negative amortisation. As a result, MBNA's minimum PPI claim
          payment is in the process of being increased to 5% or £25, whichever is the higher (it
          currently stands at 5% or £10 to reflect the existing approach).

18.       MBNA believes that customers purchase PPI as an add-on to the credit product, rather
          than as a self-standing product. More specifically PPI is only purchased if:

          •       the customer also obtains (in the case of MBNA) a credit card or an unsecured
                  loan which gives rise to an obligation to make regular payments to pay off the
                  debt; and

2081284                                                                                        MBNA

          •         the customer wants the comfort of knowing that he will be able to meet those
                    payments even where there are unexpected changes in his circumstances (to the
                    extent that this ability is not already safeguarded through some other form of
                    insurance, such as income protection or critical illness cover). 3

19.       A customer will therefore tend to consider whether he wishes to obtain PPI when he is
          thinking about obtaining the primary product, ie a credit card or an unsecured loan (and
          sometimes only after the primary product has been purchased).

20.       Thus, even though there are cases in which PPI and the underlying credit product could
          be provided and purchased separately, it is MBNA’s view that there are strong
          complementarities on the demand side and that therefore the so-called "point-of-sale
          advantage" enjoyed by the provider of the primary credit product – a point of concern
          raised by the OFT and reflected in the Issues Statement – should not be regarded as a
          potential indicator of a restriction or distortion of competition, but rather as the inevitable
          consequence of customers’ preferences for purchasing both the credit and the PPI
          product together. The fact that the customer is able to buy PPI cover at the same time as
          the underlying credit product is extremely convenient for the customer. If customers were
          unable to buy the two products at the same time, there is a real risk that some customers
          might not obtain the cover that they need.

21.       Given the relationship between the primary credit product and the PPI product described
          above, MBNA considers that - at least in relation to the products it offers - the relevant
          market is likely to comprise both the underlying credit product and the PPI product. This
          is the case even though customers may choose not to buy the PPI product, or to buy it
          later.    In considering how to position its own offering, MBNA researches what its
          competitors are doing in relation to both the underlying credit product and the associated
          PPI product.

22.       In relation to the services it offers, MBNA considers that the relevant market is therefore
          likely to comprise competing packages of credit products and PPI products, eg credit
          cards with associated PPI ("credit card/PPI packages") and unsecured loans with
          associated PPI ("unsecured loan/PPI packages").

23.       In MBNA’s view, many customers are able and willing to substitute between different
          forms of credit (repayment of which they may then wish to protect through taking out PPI).
          For example, an agreed overdraft on a current account (in combination with a debit card)
          may be considered to be a substitute for a credit card; rather than taking out an
          unsecured loan in order to finance a particular purchase, customers may take the
          decision to re-mortgage their property in order to obtain a cash sum to make the

          Note, however, that an advantage of PPI is that it is in addition to other cover and does not affect the amount of State
          benefits that might be payable.

2081284                                                                                                                    MBNA

          purchase. A customer obtaining a loan may reduce the level of outstanding balances on
          a credit card, and so forth.

24.       However, regardless of how strong these competitive constraints between different forms
          of credit (and their associated PPI product) are, MBNA believes that even if the
          Competition Commission were to consider narrow markets for different types of credit
          there is very strong competition between providers of (i) credit card/PPI packages and (ii)
          unsecured loan/PPI packages.

25.       First, there are a large number of providers of credit card/PPI packages and unsecured
          loan/PPI packages in the UK who offer a diverse array of products. Second, it is an
          innovative sector which has seen new entry over the years, MBNA being a good example
          of a later entrant which gained market share by offering a different product offering.
          Consumers therefore have a wide range of choice, and are, in MBNA’s experience,
          prepared to and can switch easily between credit providers.

26.       Notwithstanding the fact that PPI in the majority of cases is purchased together with --
          and from the same provider as -- the underlying credit product, standalone providers of
          PPI also provide a competitive constraint (even though there are relatively few standalone
          providers at present).

27.       Furthermore, MBNA considers that other insurance products also provide a competitive
          constraint. Income protection and critical illness, while not entirely substitutable for PPI,
          provide an alternative for consumers who wish to protect themselves from the financial
          consequences of events such as accidents, sickness or unemployment and ensure an
          income stream or lump sum payment which they can then use to cover their ongoing
          expenses, including repaying loans.       MBNA has been piloting an income protection
          product which it has offered as an alternative to PPI with its unsecured loans.

Competitive indicators

28.       The Competition Commission has set out a number of indicators of competition, including
          pricing, profitability, and customer behaviour.

29.       As noted above, PPI is a secondary product which MBNA provides, and its customers
          purchase, as part of an overall bundle. All aspects of MBNA's business are involved in
          the provision of that bundle, including product design and sourcing; business
          development; marketing; sales; fulfilment; portfolio risk management; claims and
          administration; and the control environment.         Allocation of costs and measuring
          profitability of PPI on a standalone basis is therefore extremely difficult and not very

2081284                                                                                          MBNA

30.       The close relationship between the primary credit and the secondary PPI product
          suggests that it may be difficult, if not impossible, to establish any meaningful comparison
          of prices and costs for PPI in isolation. For example, to the extent that customers tend to
          purchase credit and PPI from the same provider, customer acquisition costs are incurred
          by the provider in order to generate revenues from both the credit and the PPI product.

31.       Similarly, attempts to establish the profitability of PPI on a stand-alone basis may not
          produce meaningful results, given that PPI is closely interwoven with the primary product.
          Indeed there is no separate and fully costed profit-and-loss account for PPI services
          within MBNA.

32.       In purely practical terms, the fact that PPI and the underlying credit product are offered
          together may also have implications for the analysis of data provided by the various
          respondents to the Competition Commission’s questionnaire. There would seem to be a
          considerable amount of discretion with regard to allocating costs against the provision of
          the PPI product, and it may therefore be difficult to obtain returns from the various
          providers on a consistent basis, in particular where institutions differ in the range of
          products they offer or where credit providers and insurers are vertically integrated.

33.       The Competition Commission considers that the presence of cyclical effects may impact
          on the choice of an appropriate period over which profitability should be assessed. MBNA
          would point out that the appropriate period over which profitability (at an appropriate level
          of aggregation) is assessed should not just be sufficient to take into account cyclical
          fluctuations, but should also cover periods of considerable investment in establishing
          reputation and goodwill.    Too short a period may only provide a snapshot picture of
          profitability, failing to take into account the fact that considerable investments had to be
          undertaken by financial institutions to establish their market presence.

34.       The Competition Commission also raises the issue whether profits from the sale of PPI
          are being used to subsidise the primary credit products. MBNA would make the following
          two preliminary observations.

          •       First, since many suppliers – like MBNA – provide the primary credit product and
                  PPI very much as a package, a significant proportion of costs may most
                  appropriately be regarded as common across the primary and the secondary
                  products. Both the revenue from the primary credit product and the revenue from
                  the related PPI product contribute towards the recovery of these costs.           Of
                  course, the relative magnitude of these contributions may differ, but such a
                  situation should not be described as "cross-subsidisation". Put differently, even
                  though one product may appear to be making losses, and the other product may
                  appear to be very profitable, this may only be because of an arbitrary allocation of

2081284                                                                                           MBNA

                   fixed and common costs incurred in the provision of both products and should
                   therefore not be regarded as cross-subsidisation.

          •        Second, any analysis of the relative contribution towards the recovery of fixed and
                   common costs coming from the primary and the secondary product – and in the
                   extreme case even cross-subsidies flowing between these 4 - would have to take
                   into consideration the fact that with regard to both the underlying credit product
                   and the PPI product customers tend to be better informed about various factors
                   that have an impact on the risk they pose to the lender, and the likelihood that
                   they will make a claim under their policy. Higher PPI premiums will not only
                   reduce the number of customers who take out that type of insurance, but also
                   affect the average risk across the pool of PPI customers; similarly (and despite
                   MBNA’s efforts to assess as accurately as possible the credit risk posed by
                   individual customers through its judgemental lending approach), increasing APRs
                   will not only reduce demand for the credit product, but also affect the average
                   credit risk across the pool of borrowers. These effects mean that great care is
                   required in order to establish the impact that changing the structure of prices (eg
                   lowering PPI premiums and increasing APRs) would have, not only on take-up
                   volumes, but also on the characteristics of those who decide to take out the
                   product, and thus on the lender’s costs.                   In other words, the implications of
                   customer self-selection in response to particular pricing structures need to be
                   considered carefully in order to establish the competitiveness (or otherwise) of
                   specific pricing models.

          Wholesale market

35.       MBNA considers that the wholesale market is competitive.                              MBNA carries out a
          competitive tendering process before appointing an insurer.                         Until 1 January 2005,
          MBNA's PPI products were underwritten by Norwich Union.                            In late 2003/early 2004
          MBNA went out to tender for a new contract, approaching ten insurers, six of whom
          responded. The contract was ultimately awarded to St Andrew's Group (part of HBOS).
          The decision to appoint St Andrew's was based on a whole range of factors, including
          product range; clarity of policy wording, claims advice and guidance; customer
          satisfaction/service levels, particularly for claims handling; financials; proven track record;
          and ability to support European growth.

          Relevance of the Competition Commission's store card inquiry

36.       The OFT's terms of reference exclude store card PPI, on the grounds that it would be
          disproportionate to include store card PPI in another reference when it was considered so

          A cross-subsidy would exist where the revenues from the provision of one of the products were insufficient to cover
          the incremental costs that are incurred in providing this product.

2081284                                                                                                               MBNA

          recently in the store card inquiry and the remedies following that inquiry only took effect
          on 1 May 2007.

37.       Credit card PPI (in particular) bears many similarities to store card PPI, both of which are
          based on the protection of payments on monthly outstanding balances on the cards.

38.       MBNA considers that there is no obvious reason why credit card PPI should raise
          manifestly different issues to store card PPI or why credit card PPI should be treated
          significantly differently to the way in which the Competition Commission treated store card
          PPI in its store card inquiry.

          Impact of other regulation

39.       The Competition Commission is of course required to focus on competition issues rather
          than wider issues such as mis-selling. However, the FSA will continue to investigate PPI
          during the Competition Commission's inquiry. In particular, the FSA has indicated that it
          is considering the introduction of additional rules for PPI in its Insurance Conduct of
          Business (ICOB) sourcebook at the end of this year. 5

40.       MBNA considers that the Competition Commission will need to take into account
          developments in response to the FSA's investigation, as well as other industry
          developments as its inquiry proceeds.

41.       MBNA is subject to very considerable regulatory oversight, not only in the UK but also
          from the US Office of Comptroller of Currency. This not only impacts on the way in which
          MBNA conducts its business, but also takes up a considerable amount of management
          time and imposes significant compliance costs.

                                       *        *        *       *        *

          FSA: "ICOB Review: Interim Report: Consumer Experience and Outcomes in General Insurance Markets", March

2081284                                                                                                     MBNA

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