Where does the money go?

I was asked recently to say what would happen with the hundreds of millions (billions?) of pounds being refunded for mis-sold insurance policies.


A twenty minute conversation became (as these things do) a single line in the Financial Mail on Sunday, to the effect that I thought people would use the money to prop up their lifestyle.


There was also a quote from another “expert” who said everybody would save it, or use it to pay off existing debt.


A simple – people will spend it – doesn’t really reflect what I said and I’m sure that the comment that people would all save their money doesn’t encompass the other argument either.


But then typically, journalism is about headlines, and it wants simple answers.  The desire is for black and white absolutes, people are all the same, all act together, will all spend or all save.


So what’s going on, and where will the money go?


Firstly, this  money is in respect of payment protection cover, which is not really a mainstream need.  Like pet insurance, critical illness cover, boiler and heating cover etc. it’s  something that (if I was still a financial advisor), I’d usually suggest you not take. 


As a coach and psychologist, I tend to ask what you want to get from an insurance (or an investment such as a pension plan, come to that).  If you want value for money, you probably won’t get it from something like PPI. 


The chance of actually claiming on the PPI, boiler cover, pet insurance is quite small.  If you multiply the amount of premium you pay by the amount you’ll get if you claim and do the calculation for the duration of the policy you’ll get less than you pay in premiums.  


That’s true of most insurance (if the odds were in your favour, the company would have to put the premiums up, or they’d go broke).  I’ve explained that in more detail in the book, [amazon-product region=”uk” text=”Taming the Pound” type=”text”]1848767528[/amazon-product]


 The point is that a car, a house, your life etc. are usually more money than you can afford, so you can’t “self-insure”.  With PPI, pet insurance etc. you’re unlikely to go bankrupt from paying a claim out of savings, and if you invest the money that would have been the premium you end up with more money at the end of the day, even if you have to dig into that saving at some point to pay a claim yourself.

If people actually think what they want, most of them will not want PPI – the exceptions will be if the claim would be an absolute disaster, and they don’t mind paying over the odds for peace of mind.


The same thing applies to critical illness and many insurances that are heavily marketed.  If most people needed them, they wouldn’t need to be marketed so heavily.


So a lot of the people who are going to get compensation are people who took out cover they didn’t need.  Theoretically, all of them were over-sold it (or they wouldn’t get a refund) but I imagine that quite a lot actually did want it because they thought they needed it, so in fact the sales people are getting a bit of a beating on those cases – how sad!


The reason people got the cover was, often, that they didn’t understand it, they thought they had to have it, they wanted to do what most people did, they wanted to look financially responsible etc.


Very few of them, however will have made a calculation about whether they really needed it, or they wouldn’t have taken it out, or would have voiced objections at the time.


It therefore seems likely that they are not going to be very “calculation” minded, or prepared to make a lot of individualised decisions about their money.  They’ll probably follow what most people do.


One school of thought (the “savings” school) is that people getting this refund will have learned a lesson.  So they will mostly save the money.


The argument is that, having been conned once, they will be careful, save their money, pay off existing debts etc.  That assumes people learn collectively, not individually.


The idea to which I subscribe is that very few people indeed really behave logically with money.  Human beings don’t really think logically at all – logic not being a survival characteristic throughout most of human history, when we were evolving our advanced brains.  And we learn from our own experience, not collective experience.


Most people, given some money will think of it like money won gambling, found in the street or (very commonly) on credit card.  It will be seen as a form of monopoly money.


Add that to the fact that people have been tightening their belts already, and that these particular people don’t really like doing careful calculations of need.

Bear in mind that status is pretty important to most people and if you can’t afford a new car or holiday and your friends, relatives and neighbours can (or can stick it on credit so that they appear to be better off than you), you have a recipe for a show of conspicuous consumption.


I’m not saying that everybody, including you, if it applies to you, will spend the money.  That’s the problem with the papers, they assume it is always one thing or the other.


Each person is an individual, so there will be a mix of behaviour. But I think the majority will carry on trying to live the life they lead before.


I could be wrong – and if this does include you, spending it and not reducing debt will almost certainly be a big mistake.


But if you think that debt will decrease, savings increase and retail sales spiral downwards, as people act “sensibly”, I think you’ll be wrong. 


It seems more likely to me that, while some “behave responsibly”, the money will run through the majority of hands and never be used to reduce borrowing.


It will be interesting to see whether, however many millions are paid in compensation, personal debt drops by a commensurate amount.


 I don’t think it will, but I hope it does for you.



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