It's high-cost cover, but will it keep the rain out?

Esther Shaw hears a warning on payment protection insurance for loans

These policies take the form of bolt-on cover for unsecured personal loans, credit cards and mortgages. The idea is that borrowers will be able to maintain their debt repayments in the event of their income disappearing due to illness, accident or unemployment.

An estimated 20 million of these policies are in force today - generating £5bn a year for lenders. But such success has taken place against a backdrop of years of criticism for being overpriced, worthless and riddled with exclusions that can prevent payouts on customers' claims.

And last week, the Citizens Advice consumer organisation declared that this poor deal has gone on for too long. It lodged a "supercomplaint" with the Office of Fair Trading (OFT) about the mis-selling of PPI policies, dubbing it a "protection racket".

Taking evidence from 270 of its bureaux around the country, Citizens Advice says the cover is more a lucrative source of profit for the finance industry than an offer of protection for consumers.

Extra premiums paid for PPI, says the Citizens Advice complaint, can add up to 25 per cent to the cost of the original loan that the insurance policy is taken out to protect.

According to separate research from the price-comparison website moneyexpert.com, PPI can add more than £900 over four years to the cost of a £5,000 loan.

Put PPI into the equation, moneyexpert.com has found, and the companies heading its own "best buy" lists for loans no longer rank among the top five for value.

The supercomplaint voices the concern that these costly policies can be mis-sold by the lender's staff, often using high-pressure tactics, to "inappropriate" customers such as the self-employed and contract workers, whose claims would probably not be met by the insurer.

Common ailments that stop people working - a bad back, stress and mental health problems - are often excluded, while many policies prevent claims by imposing arbitrary age limits and excluding pre-existing medi- cal conditions.

Often, buyers aren't aware of all this, either because the policy hasn't been properly explained, or they've missed the details in the small print.

Despite industry claims that just 15 per cent of claims are turned down, Citizens Advice found that 85 per cent of its clients who had claimed on one of these policies had been unsuccessful.

Recent figures from the Department of Trade and Industry revealed that just 4 per cent of people with PPI actually make a claim on it - of which a quarter are turned down.

With personal loans, sales staff often add the insurance automatically to a quote requested by a consumer - irrespective of whether it is asked for - and make it difficult for people to see what they are paying for.

Even when claims are successful, there can often be a waiting period of up to a month before the payments kick in. And then the insurer might pay out for only 12 or 24 months.

"At best, the excessive cost for minimal benefits makes PPI bad value for many people," says David Harker, chief executive of Citizens Advice. "At worst, mis-selling means the most vulnerable people are parted from large amounts of money under false pretences and left exposed to more debt."

He says it is "a scandal" that so little has been done to remedy the problems that were first reported 10 years ago.

The Citizens Advice supercomplaint to the OFT focuses on the cost of PPI and the way it is sold. The watchdog must respond in 90 days, and the complaint could trigger a formal inquiry.

If the industry is found guilty, it could face caps on the size of future premiums and the number of policy exclusions.

Citizens Advice is also calling on the Financial Services Authority (FSA), the City watchdog, to develop a PPI code, setting out minimum standards for lenders. "We badly need an official investigation into how this market is operating," says Mr Harker. "This needs to lead to effective regulation that ensures a fair deal for all consumers."

PPI came within the FSA's remit only in January this year. But the regulator has already been busy with its own inquiry, although this has been limited to the way the cover is sold rather than an analysis of the policies themselves.

The supercomplaint also has the support of consumer body Which?.

"We are concerned about the aggressive sales tactics employed and unhappy that, in many cases when applying for a loan, PPI is automatically included in the quote," says Which? spokesman Laurence Baxter.

The cover "should not be bought and sold glibly like loaves of bread".

Borrowers should find out just how much the whole cost will be before signing up, he says, and should check whether they actually need it. Many people may already have adequate income protection policies, employer sick pay arrangements or enough in savings not to need the cover.

PPI has been a money- spinner for banks, credit card firms and other lenders. According to recent estimates from investment bank Morgan Stanley, it makes up a sizeable chunk of pre-tax profits at a number of high-street lenders.

Many providers refuse to publish their profit figures for PPI, preferring instead to argue that the cover represents good value for money.