Consumer group Choice has called for lenders’ mortgage insurance (LMI) to be abolished in response to the Productivity Commission’s draft report on competition in the financial system.

In a submission to the commission, Choice says LMI “masquerades” as a consumer-facing product while protecting only the lender, and calls it a “moral hazard”.

Choice also queries the ability to create competitive pricing in a concentrated market. It says there are so few providers of LMI that there are no competitive drivers pushing down prices.

The commission’s draft report says LMI price competition appears constrained by factors that can be alleviated by regulation. Only four companies, two of them banks, provide LMI.

The report suggests requiring lenders to provide refunds for LMI costs when customers pay out or refinance their loan.

Choice criticises the “opaque” nature of the LMI pricing structure, saying it is unclear on what basis LMI premiums are determined, or whether banks are earning an added profit on top of the insurance they negotiate with an internal or external provider.

Banks should instead price the risk of default into the value of the loan, Choice says.

Those that engage with LMI providers may be encouraged to lend to borrowers without serious consideration of their repayment ability, which Choice labels a moral hazard.

There are also serious disclosure issues with LMI, the consumer advocate warns.

Banks should not be allowed to disguise an insurance policy against a borrower as a consumer-facing product, it says.

Commonwealth Bank’s response to the commission’s draft report says it takes care to ensure LMI rates and accompanying offerings are competitive. It passes the cost of the premium to customers and does not charge a margin or fees above that.

About 23% of owner-occupier home loans are supported by LMI.