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How Lending Works’ Insurance Against Losses Works
Prime personal loans P2P lending site Lending Works* is one of a smaller number of P2P lending sites that uses insurance to protect lenders from specific situations.
What the insurance does for lenders
Lending Works' insurance could pay out if and when a borrower is unable to meet loan repayments:
- It could do this when the borrower is unable to pay due to being made redundant.
- It could do so if the borrower can't pay due to sickness, accident, injury or death.
- It should pay 50% of the outstanding loan if a borrower gets an IVA (which is kind of similar to being made bankrupt) or enters into a debt management plan (the last stop before bankruptcy when lenders agree that the borrower can only afford significantly lower repayments).
- It could pay out in the event of borrower fraud or cybercrime.
A brief summary of how good this insurance is for lenders
Below you can read a lot more details, but for those of you with limited time, I'll just bullet list my key conclusions:
- The insurance is of some limited use and it will be more useful during a recession, when claims for unemployment and near-bankruptcy events will be higher.
- Since Lending Works will give few details, we should assume the impact will be modest.
- That an insurance company is willing to offer cover against fraud and cybercrime is additional reassurance that Lending Works has excellent processes in place to limit these risks.
- So long as the interest rates continue to be easily high enough for the risks, which I believe they are, we don't yet need to worry about the cost of the insurance policy, because Lending Works pays it on our behalf.
- Lending Works' insurance is not the main defence against losses: its excellent borrower selection is. And the insurance is also less important than Lending Works' reserve fund to pay for expected losses.
Now the details for those who are interested in a deeper look:
Sounds like PPI to me!
Insurance protecting against accident, illness and unemployment might remind many of you of payment protection insurance, or PPI. That's because it basically is PPI.
In case you never read the money pages of your favourite newspaper: over the past few years, banks have had to repay hundreds of thousands of people their PPI premiums. That's many billions of pounds altogether.
Now let me tell you something so controversial it might even sound evil to you: PPI isn't bad.
At least, it's not bad by itself. It's the company selling it that does the bad things.
What has been bad about it – what has earned it a very bad press – is that it has usually been sold at 10 times the price it should be sold at. Also, those buying the insurance were sold it when they didn't need it. Plus, they weren't properly informed about the most important parts of the small print that could lead to their claims being rejected – because they often are.
In other words, people buying the insurance hadn't been given enough information to decide whether it was worth the price and whether the insurance was right for them. Thus, far more people bought it than they should have.
1. Lending Works' unemployment cover
Let's return to Lending Works and its own PPI-like insurance, specifically the unemployment cover.
What matters is whether unemployment claims can easily be rejected and how much protection it really offers lenders.
Lending Works did not give me the detailed statistics of claims and rejected claims that I asked for. And it is not willing to give me a copy of the actual insurance contract, saying: “It has taken a significant amount of time and effort to negotiate the specific areas of cover and we believe this is still unique in the P2P industry.”
But here's what we do know.
“Well below” 1% of borrowers have claimed under the unemployment section
Whether someone is actually made redundant or whether an insurance policy counts it as redundancy are two very different things – as you may have had the misfortune to learn if you have tried to claim on a PPI policy yourself.
I learned of one substantial exclusion in the contract that gives a good example: if a borrower is made redundant and then gets a new job paying a lower income, the insurance claim will be rejected. That's even if the lower income means the borrower can't properly repay the loan.
Lending Works tells me that those claiming on the unemployment part of the insurance are “well below” 1% of all its borrowers. Unfortunately, it did not tell me what proportion of claims were rejected, even where the borrowers stated they were redundant or who Lending Works otherwise knew to be made redundant.
Lending Works said “unemployment cover has historically been the area of least claims”.
However, Lending Works, like those of us at 4thWay, believes this cover will be more important during a recession. Lending Works said it is expected to be “very valuable” then, where redundancies – and delays in re-employment – will happen a lot more.
Like a typical PPI policy, the insurance covers up to 12 months of repayments during a period of unemployment.
2. Accident, illness and death
In terms of accident and illness claims, Lending Works told me that claims here are “fairly low”. Most claims are based on the life insurance part, which means that the borrower has died.
While we don't know what exclusions there are, we should expect a raft of them. These might be based on such things as suicide if the borrower was being treated for depression at the time he or she started borrowing, those suffering from stress might not be covered at all, and pre-existing medical conditions certainly won't be covered.
3. Claiming for near-bankruptcy events
When a borrower can't pay due to accident, illness or unemployment, but insurance small print stops a claim, there are other areas of the insurance policy that might still pay lenders back.
Most notably, the insurance policy might cover 50% of the outstanding loan amount if a borrower enters into a “debt management programme” or an IVA. Borrowers do that when they can't afford to repay the full amount, which is often caused by being made unemployed or due to accident or illness, according to Lending Works.
Lending Works tells me that these claims have been more typical on the Lending Works insurance policy. The other half of the outstanding amount is then covered by Lending Works' substantial reserve fund, which is large enough to cover expected lender losses.
Without sight of the small print we can't know how valuable this is, but it will certainly be more significant during a recession.
4. Fraud and cybercrime
The insurance could also pay out in the event of borrower fraud or cybercrime.
Both of those events are likely to be rare, given Lending Works' proficiency both technologically and in assessing borrowers. Indeed, if Lending Works wasn't good at preventing those things then the insurance premiums would probably be too expensive.
This part of the insurance is therefore most likely more a marketing gimmick, although it is reassuring to know that an insurer also has faith in Lending Works' standards.
How much the insurance costs
Lending Works swallows the costs of the entire insurance policy so that lenders aren't charged directly. So, provided the interest rates we lenders earn continue to be good, this isn't an issue for us.
Lending Works currently has 4thWay PLUS Ratings on both its lending accounts. This means that, according to our strict tests of how Lending Works will perform in a severe recession, we expect that all or most Lending Works' lenders will still make money even after higher losses are taken into account.
Lenders might assume a small but noticeable benefit
I think it likely that the benefits of this insurance are going to be useful in containing losses further, but not the deciding factor.
Lending Works' insurance is not the main defence against losses. Excellent borrower selection is. And the insurance is less important than Lending Works' reserve fund to pay for expected losses.
Read the Lending Works Quick Expert Review.
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