Exposed: 'payment protection insurance' racket costing Britons £5.4bn

The Financial Services Authority will tomorrow lift the lid on a widespread scandal surrounding the sale of payment protection insurance by banks and finance companies.

An undercover shopping exercise by the watchdog is understood to have found evidence of the mis-selling of PPI, which is supposed to provide a safety net for customers.

PPI is sold with credit cards, loans and mortgages on the basis it will come to the rescue in times of crisis, such as illness or unemployment.

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It is supposed to offer peace of mind and will cover repayments on loans, cards and mortgages for a fixed period.

However, the vast majority of these policies are very expensive, generating a profits bonanza for the finance companies, while customers are being seriously misled about the cover.

The companies pay out only 20 per cent of the billions of pounds they collect each year in PPI premiums.

Scare tactics are used, such as playing up the threat to families from sickness and unemployment, in order to boost sales.

Bank staff give the impression that those applying for a loan will have a better chance of success if they also sign up for PPI.

PPI is sometimes wrapped into the cost of the loan, with interest added on top, without this being spelt out to a customer. Many of the companies rely on small print rules that mean those who make a claim are often rejected.

Common ailments that might mean people lose their income, such as mental health or back problems, are not routinely covered.

The Financial Ombudsman Service has received 2,145 complaints in the year to the end of July. This is up by half on the same period in 2006. Spokesman Emma Parker said: "The greatest number of complaints are about single premium PPI.

"This is where the cost of the policy is added to the loan and people are charged interest on it. This means that they are not only paying a high price for the insurance, but they are then paying interest, often at a high rate, on top."

The FSA has fined ten firms for mis-selling PPI over the past year or so. GE Capital Bank, which runs the store cards of some of Britain's biggest retailers, was fined £610,000 over errors in the sale of PPI.

The British Bankers Association insists PPI is useful to the public. It says extra safeguards have been introduced covering the sale of the policies.