The loan agreement is a separate contract from the insurance contract. Separate rules and separate authorisations are required for companies who are lenders and companies who are insurers.
The loan agreement is a contract between the customer and the lender under the Consumer Credit Act 1974. The capital borrowed may include the money needed to pay for the mortgage protection insurance policy if a single premium basis is used. This lending of the premium money is no different from any other part of the loan.
If the loan is settled early then there may be a rebate of interest because the capital has been repaid before the due date.
Loan costs are made up of the capital repayment plus the loan charges added on. Loan charges include interest charges over the whole period of the loan. If the loan is settled early then the settlement figure is based on the balance of loan still outstanding added to the interest rebate.
The mortgage protection policy is a contract between the insurer and the customer, no matter who sold the policy to them. If the policy is terminated early the premium refund should be paid to the customer, regardless of who sold the policy.
In practice the lender usually calculates the loan settlement figure, shows the premium refund as a separate amount, and then deducts the premium refund from the loan settlement figure. For ease this brings the two transactions together, but in fact they relate to separate contracts.
Rule 78 is sometimes used to calculate the premium refund and can sometimes also be used to calculate the interest rebate. When the revised Consumer Credit Act takes effect in 2005, it will replace rule 78 with a different method of calculation of the interest rebate. Lenders who calculate premium refunds for insurers may then need to use two different calculation methods as the Consumer Credit Act does not regulate General Insurance.