When you took out your mortgage, personal loan or applied for your credit card, did you pay extra for payment protection insurance? Because if you did, there's a chance that this expensive form of protection could be worthless if you ever need to make a claim under the policy.

The idea behind payment protection insurance (PPI) (also known as unemployment insurance) is simple. It's mean to pay out in order to cover the payments on your loans if you experience a sudden drop in income, such as losing your job.

Great!

Except in practice it doesn't work like that. The Office of Fair Trading (OFT) has launched an investigation into payment protection insurance after the Citizens advice bureau discovered that 85% of their clients' PPI claims had been refused by the provider.

In the UK alone, PPI premiums amount to 5.4billion a year. And from that figure, the insurers only pay out just over 1billion. That leaves them with over 4billion pure profit. No wonder they're so keen to make sure that you're "protected".

The main problem is the greed of insurance companies. They're so keen to squeeze every drop of profit out of their customers that payment protection insurance is sold to anyone who can be persuaded to pay for it. Even if it's unsuitable for their circumstances.

In many cases, lenders will sell this insurance to any borrower, without checking to see if their customer is eligible for the cover. And when their customer has reason to make a claim, the majority will be rejected because their circumstances are specifically excluded in the small print.

For example, contract workers, part time workers, the self-employed and those who stop work voluntarily are likely to be excluded.

It's also common for policies to exclude certain age limits, people who had pre-existing medical conditions when the policy began, people who cause their own injuries, stress, depression, bad back and complications from cosmetic surgery.

PPI policies are also likely to be cancelled if the insurance company decides that you knew you were ill or likely to lose your job when you applied for the insurance cover.

And if all that doesn't make it hard enough to make a claim, some policies have to be in force for a certain number of months before a claim can be made. And even if you are successful with your claim, it may take months for the money to arrive and it won't reduce your original debt, just the interest on it. And then, just when you thought it couldn't get any worse, most policies will only cover your monthly repayments for 12 months.

1) Know the score

Payment protection insurance is not compulsory, although many lenders hint that it is by automatically adding PPI to the quote they give you. But you don't have to take PPI to get the loan. And if your lender puts pressure on you to take the cover, look elsewhere for your loan.

2) Avoid PPI

If your circumstances don't meet the terms of the policy, or you can't find a good quote, it might be better to avoid PPI and use the money that it would otherwise have cost you to build up a safety net of cash for emergencies. If you build up the equivalent of six months' loan repayments, it should be enough to give you some breathing space in the event that your income drops suddenly. And, if that doesn't happen, the money is still under your control instead of swelling the profits of the insurance companies.

3) Go Independent

PPI can be a useful form of protection in certain circumstances, but it's vital that you check the terms and conditions closely. Read the small print of your loan agreement to make sure that you aren't paying extra for it. If necessary, look for an independent company to provide you with PPI because your lender will charge you much, much more.

For example, if you wanted a PPI policy to cover a personal loan repaid over 5 years, the premiums charged by your lender could cost you 20-40% of the amount borrowed. So in order to cover 20000 of debt, PPI could cost you anything between 4000 (66 per month extra) and 8000 (133 per month extra) over the life of the loan. In fact, one of the worst cases reported was someone who had a loan for 72000 and 44000 of that was for PPI.

So if you still want PPI try an independent insurance company such as British Protection, Free Insurance or Paymentcare. Typical costs should be approximately 4-6% of the amount covered.