PPI Inquiry post emerging thinking oral evidence HSBC

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					                                   PPI MARKET INQUIRY


      Summary of Emerging Thinking hearing with HSBC on 28 February 2008

Underwriting

1.      HSBC told the Competition Commission (CC) that it had agreed an extension of the
        existing underwriting arrangements with Aviva for home, credit and travel insurance,
        and that it had completed the sale of the Hamilton insurance companies to Aviva.

Withdrawal of PPI and sales of LifeChoices

2.      HSBC said that it had decided at least temporarily, to stop selling PPI under its
        HSBC, First Direct and Marks & Spencer brands. [ ]. HSBC was now offering
        customers the chance to discuss their protection needs with one option being the
        LifeChoices income protection product to enable customers to meet all their financial
        insurance needs.

3.      The LifeChoices income protection product was constructed of four component parts:
        life insurance; trauma; sickness; and unemployment cover. Once one of the core
        elements had been purchased—life or sickness—the other components could be
        added. LifeChoices was a regular premium product. The customer chose the level of
        benefit they wished to purchase. [ ].

4.      The key difference between the LifeChoices income protection product and PPI
        products was the linkage between the credit and the protection product. LifeChoices
        was sold to protect the customer’s lifestyle with no linkage to a credit product, so if a
        credit product held by the customer was terminated early, there was no reason to
        terminate Life Choices. LifeChoices was about offering protection for all expenditure,
        including rent, school fees, maintenance payments or any other outgoings a
        customer wished to protect. LifeChoices was a free-standing short-term income
        protection product which HSBC did not regard as a substitute for PPI as part of the
        protected credit market. [ ].

5.      [   ].

PPI

6.      Although it had, at least temporarily, stopped selling PPI, HSBC described its under-
        standing of the PPI sale process. Customers sought either protected credit or
        unprotected credit. HSBC believed that customers within the protected credit market
        were interested in purchasing a loan with protection. It believed that it was very easy
        for customers to access quotes for lending with or without protection and that there
        were a sizable number of customers who, when researching which lender to go to,
        would look at the total cost of the protected loan if that was what they were interested
        in purchasing—though it did note that credit and PPI would be sold as separate
        products [ ].

7.      On the Internet, HSBC’s customers would get a personalised quote with and without
        PPI [ ]. [ ], customers would have to go through the full application process,
        although the marketing material would have advertised the typical APR, and this was


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      explained in the marketing material. Customers would not necessarily know the cost
      of the credit until their application had been approved. What they could see from the
      marketing material was the differential between protected and unprotected credit.

8.    HSBC believed that credit markets were competitive, with a lot of searching and
      sufficient information available to customers. Only a small number of marginal
      customers were needed to search on the PPI element to make a PPI market
      competitive. It was very clear that, wherever a customer shopped for credit, it was
      straightforward to obtain the price of protected and unprotected credit.

9.    HSBC said that of its protected loan customers, [ ] per cent had purchased
      protected loans from it before and were therefore repeat, and necessarily informed,
      purchasers. There were a number of pieces of consumer research which showed
      that there were a substantial number of customers who looked at the total cost of
      protected credit before deciding which institution to approach. Although taking PPI
      did not affect approval of the applications for credit, the customers were very
      conscious of the monthly repayment, which would include PPI.

10.   HSBC believed that a customer who shopped around for credit would show the same
      behaviour for protected and unprotected credit. Therefore, there was a high
      proportion of customers saying that they had looked at the cost from more than one
      company, and a high proportion of those were saying that they took into account the
      total cost of the package. HSBC believed that they would have looked at the cost of
      unprotected and protected credit because the information was available and easy to
      access.

11.   HSBC Bank plc did not currently offer personal loans to those who were not existing
      customers of HSBC Bank plc. However, it was in the market for offering personal
      loans to, and for searching for offers by, its existing customers. HSBC noted that it
      did not have an ‘exclusive’ relationship with its existing customers, who also
      purchased financial products from, and therefore had ‘relationships’, with, other
      providers. HSBC believed that its existing customers searched HSBC’s own
      products, but also read the press, used the Internet accessed aggregator websites,
      and searched for products of other providers, with whom they may also have an
      existing relationship.

Mortgages

12.   Compared with other credit products, HSBC said that it was more common in the
      mortgage market for customers to purchase a mortgage and a stand-alone product,
      and hence customers in the protected mortgage market would meet their needs by
      sourcing products from different providers, By contrast, in the protected loan and
      cards markets, customers were more likely to meet their need for protected credit by
      sourcing products from one provider.

Credit cards

13.   HSBC said that it was more difficult to look at the bundled price for a credit card
      because it depended on the customer’s credit card spending behaviour. For a loan,
      the total price was much clearer because it was a structured repayment, whereas the
      balance on and the repayments under a credit card would vary and thus it was less
      clear what the combined price would be. However, it was not hard to use the prices
      to rank suppliers, and it was a relatively straightforward calculation for customers to
      combine APR and PPI cost in order to determine the overall cost of protected credit
      cards.


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Point of sale

14.   HSBC said that, as customers carried out more research and became more informed
      and with the expansion of the Internet, the point-of-sale advantage would diminish.
      HSBC believed that there would be an increase in customers seeking stand-alone
      protection. [ ]. HSBC agreed that if the sale of protection and the credit were de-
      linked throughout the industry, there would be a reduction in the total sales of
      protection as a whole.

15.   When HSBC was selling PPI it did not notice any impact of the stand-alone products
      sold by other providers on the sales of PPI. The volume of stand-alone sales was not
      high enough for HSBC to note or understand the impact. If a customer did not
      purchase a loan from HSBC and purchased protection elsewhere, HSBC would not
      necessarily know that. Therefore HSBC would not understand that it had lost sales
      from the protected market to the unprotected market. The market was, however,
      moving with the launch of stand-alone products by other large providers. One reason
      stand-alone providers had been unsuccessful in the past was because of a degree of
      anti-selection where a customer was purchasing a stand-alone product. HSBC
      believed that the offerings being made by major providers might overcome this anti-
      selection problem because they would know more about the customers to whom they
      were selling the product. In the same way, HSBC said that it had some knowledge of
      the customers purchasing its LifeChoices income protection product. If there was a
      large demand for stand-alone protection then the impact of anti-selection would
      diminish. It had always been true of PPI that with a level of penetration above [ ]
      per cent there was less need to be worried about anti-selection.

Penetration rates

16.   HSBC said that the ICOB regulations introduced in 2005 [ ]. Firms that took training
      seriously saw an increase in their penetration rates because staff were more
      confident in the product. Over time, that advantage was lost: adverse media
      coverage undermined a lot of that confidence both in customers and the sales force.
      Consequently, the sales force perhaps felt less confident about selling the product,
      which had an impact on overall penetration rates. The sales process had since
      become more complex and time consuming and a number of customers did not want
      to spend the time to be taken through a fully-compliant, best practice sales process.

17.   The penetration rate for PPI increased closer to the loan score cut-off, as those
      customers understood that they had a higher probability of an adverse change in
      their financial circumstances and would be more inclined to purchase PPI. HSBC
      added that the bad debt experience of PPI customers was considerably worse than
      that of non–PPI customers in a way that would not necessarily be picked up from the
      scorecard.

18.   HSBC said that the sale of its LifeChoices income protection product required either
      [ ].

19.   [   ].

Market definition

20.   HSBC considered that there were two relevant markets: for protected credit (demand
      for the credit product and for the protection of repayments on it) and for unprotected
      credit.



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21.    In practice, because the sales process involved a customer requesting to take out the
       credit product before any discussion of the customer’s PPI needs, HSBC would not
       at that point know whether the customer’s demand was for protected or unprotected
       credit, [ ]. HSBC believed that if it put up the price of PPI, so that protected credit
       would become more expensive, that would cause some customers to take
       unprotected credit elsewhere and others to take unprotected credit rather than
       protected credit. If the price of PPI went up across the market as a whole, there
       would be customers who were interested in protected credit but felt that it was too
       expensive and would not borrow at all.

22.    HSBC believed that a price rise of 5 per cent on its protected credit product would
       cause a reduction in sales, because it was relatively easy for customers to find out
       the cost of protected credit across the market. It had shown in its response to the
       CC’s Emerging Thinking that a 5 per cent increase in the price of its protected credit
       offer would make its offer less attractive relative to some of its competitors. That
       reduction in sales would make its activity unprofitable. HSBC had exited from the
       protected credit market and it believed that it had lost protected credit customers.
       Some would have switched from protected to unprotected credit; some would have
       met their wider protection needs by purchasing LifeChoices; and some would have
       gone elsewhere to purchase protected credit from another provider. [ ].

Profitability

23.    HSBC disagreed with the CC’s findings that PPI distribution was highly profitable. It
       believed that the returns were normal and consistent with effective competition in the
       market for protected and unprotected credit products. While there were some
       differences in the relative contribution of sales to protected and unprotected credit
       customers, these differences were not that great due to the significantly higher levels
       of bad debt incurred in extending credit to protected credit customers.

24.    HSBC did not think that the CC should look at PPI as an add-on product. It was not
       an add-on product.

25.    HSBC did not accept the CC’s market economic model; nor, it did not agree with the
       operational cost and the cost of capital allocated. However, it had undertaken further
       analysis, using the market economics model used by the CC, which had shown a
       materially different conclusion to that drawn by the CC.

26.    HSBC had carried out the analysis which had sought to explore how much additional
       bad debt was being taken on by making credit available to PPI customers. It was
       highly concerned that, in assessing the profitability of PPI distribution, the CC’s
       published paper on Profitability had not taken into account some very significant
       costs, most notably that there was an additional bad debt charge introduced by
       selling loans to customers who chose to take out PPI that was not captured by the
       credit scoring.

27.    In terms of costs, HSBC said that the way in which the business was managed was
       not to allocate costs by product—[ ]. It saw no reason why the cost income ratio for
       PPI would be much less than the cost income ratio for the whole of the bank’s
       operation. On capital, HSBC noted that the CC was drawing conclusions about the
       return on capital being high, but it said that the capital assumed in the CC’s model
       was only regulatory capital and not economic capital.

28.    HSBC said that when it was selling PPI, it set the prices of credit, and of bundled
       credit and PPI, with reference to [ ]. In terms of profitability levels for protected and


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      unprotected credit, both of those markets made a positive contribution to HSBC and
      both made a contribution that it would regard as a normal level.

Customer search

29.   From customer research carried out by HSBC, other parties and the Office of Fair
      Trading (OFT), there was clear evidence indicating that customers had prior
      knowledge of, and shopped around for, protected credit. Such customers
      approached a number of providers of protected and unprotected credit and presented
      themselves as customers shopping in the protected or unprotected credit markets.
      The FSA comparison tables would add a further layer of information that would help
      in shopping around and searching. These would be useful not only in terms of
      providing customers with price information, but also in terms of providing customers
      with comparative data on the terms and conditions and coverage of the products
      available.

30.   HSBC said that the Defaqto rating system introduced a competitive impetus into the
      market. The five star methodology was gaining credibility across the general insur-
      ance market and a number of competitors were starting to use it a method of
      communicating to their customers the quality of the product.

Innovation

31.   HSBC had seen improved coverage within the product and changes that had been in
      response to competitor activity. Examples given included its carer cover and its back-
      to-work assistance. The launch and roll out of its LifeChoices income protection
      product was an example of a response to competition; [ ]. In terms of product
      development, HSBC stated that it had spoken to customers about their needs and
      then looked at what type of propositions it could offer to meet those needs. In
      addition, HSBC looked what other products were on the market attempting to meet
      those needs, for example the Post Office Lifestyle Protection product. Another
      example where HSBC moved for competitive reasons was pre-existing exclusions,
      where it saw a general movement within the industry to soften the severity of the
      exclusion of a pre-existing condition.




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