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Page 2: The basics of credit insurance: Do you really need it?

Alternatives to credit insurance

There are more cost-effective alternatives to credit insurance.

If you want insurance protection for your loan against disability, job loss and death, there are more cost-effective alternatives to credit insurance.

Term life insurance, especially "decreasing term life insurance," will provide money to your beneficiaries to pay off debt after your death. This choice also gives your family greater flexibility: The life insurance benefit can be used for any need, whereas a credit insurance will pay only the loan, within the terms of the policy.

The Ohio department of insurance points out, "As you get older, the cost of buying regular life insurance rises. However, in most cases, it is very expensive to buy a small credit life policy as a substitute for regular life insurance protection."

As with life insurance, disability insurance would also offer you greater financial flexibility than credit disability insurance in the event you need to make a claim. A group disability policy purchased through work, for example, can be an affordable means of guarding against financial catastrophe should you not be able to work.

Debt cancellation: Not insurance

Many lenders offer products called "debt cancellation" or "debt protection" that function much like credit insurance. However, these are banking products, not insurance, and therefore are not regulated by your state department of insurance.

These products are offered directly by the lender, not an insurer, and generally work like this: With a debt-cancellation product, the balance of your loan is reduced or cancelled upon a "triggering event" such as your death. With a "debt-suspension" product, you can skip payments without adding interest or fees, but your total debt is not reduced.

The process may look amazingly like credit insurance, though, because lenders often hire insurance companies to administer and market the programs.

The cost of debt-cancellation/suspension varies greatly by offer. Birny Birnbaum, executive director of the CEJ, has seen a range of 79 cents to two dollars per $100 of debt per month. Let's say you have $5,000 on a card and get a "debt protection" offer for the "low, low price" of $1 a month. That's $1 per $100 of debt, so you would pay $600 annually. Now think of that $600 better placed in term life insurance or an interest-bearing account.

A rising tide of debt-cancellation programs

Credit card companies in particular have replaced credit insurance with debt-cancellation products.

Credit card companies in particular have replaced credit insurance with debt-cancellation products, which are marketed to you with names like "credit protector."

Since 2000, according to the CEJ, "The majority of major credit card issuers, including Citicorp, Discover (Sears), Bank of America, Fleet Bank, Advanta, Bank One, Chase, MBNA, Providian and private label card issuers like Target, have replaced credit card credit insurance with credit card [debt-cancellation products]." Debt-cancellation products are also now being offered in conjunction with some installment loans, like mortgages through Bank of America.

There is no agency that requires banks to report debt-cancellation program sales, but Birnbaum estimates the market to be $2 billion to $4 billion and growing.

Burfeind of the CCIA observes that front-end expenses for banks to convert from selling credit insurance to selling debt cancellation are going down, and smaller lenders like community banks have been slow to convert.

However, for nationwide lenders like Bank of America, who have to file different regulatory forms in all 50 states to sell credit insurance, a conversion to debt-cancellation products will mean big administrative savings in the long run, although consumers shouldn't necessarily expect those savings passed on to them in lower premiums.

The CEJ, already suspicious of credit insurance, has been aghast at debt-cancellation products. It has found that lenders modify the triggering events and benefits much to the consumer's disadvantage. For example, what were once "death benefits" are now only "accidental death benefits," sharply reducing the number of qualifying claims; for other benefits to kick in, you may need to be unemployed for 90 days, or disabled for 90 days or on "employer-approved leave" for 90 days. Often, you may not even receive the contract terms until you have signed up, says Birnbaum.

"Federal banking regulators have developed regulations for debt-cancellation and debt-suspension products that do not even have the modest consumer protections that exist for credit insurance. There are no requirements for minimum benefit levels or reasonable rates and, consequently, debt-cancellation and debt-suspension products are a terrible deal for consumers," says the CEJ.

Debt-cancellation products are regulated by both state and federal agencies, depending on who is offering the product (such as a national bank vs. a state bank).

Important to note is that you likely lose the use of your credit card while you are receiving a benefit. Yet during a time of financial crisis, you likely need your credit line the most.

"Given that benefits are triggered by events that impair a borrower's income, it is during these times that the borrower is in greater need of borrowing capacity. When faced with the choice of a modest benefit or the loss of use of a credit card, we believe many consumers who paid for benefits and who are eligible for benefits will forego the benefits," speculates the CEJ.

Now, if you think that credit insurers are making out like gangbusters when they have a loss ratio of, say, 30 percent, consider this: The CEJ estimates that credit card issuers have a loss ratio of 1 to 3 percent on debt cancellation/suspension products. That means they pay out 1 to 3 cents for every dollar they take in.

"It's a monumental rip-off," concludes Birnbaum.

Because no one tracks these product sales, the true number is unknown, but Burfeind of the CCIA says he would be surprised if the actual loss ratio were that low.

Not in your best interests

When securing a loan, make sure credit insurance isn't added to your loan and financed along with your principal without your approval, a practice known as "packing." No lending institution can require you to take credit insurance or suggest that you're more likely to get loan approval if you buy it.

When securing a loan, make sure credit insurance isn't added to your loan and financed along with your principal without your approval.

Inducing consumers to pay for credit insurance they don't want is serious business. In 2002, the FTC made the largest consumer-protection settlement in its history when Citigroup agreed to pay $215 million because a subsidiary called The Associates had induced close to 2 million sub-prime mortgage borrowers to unknowingly take credit insurance. If borrowers noticed the credit insurance on statements and complained, The Associates discouraged them from removing the insurance.

"The Commission will not tolerate the fleecing of subprime borrowers through deceptive lending practices such as the packing of unwanted credit insurance on consumers' loans," said Timothy J. Muris, then chairman of the FTC, upon the settlement announcement.

State regulation does not uniformly addressed the concerns about credit insurance. According to Birnbaum, states regularly approve rates that will result in lucrative loss ratios of 30 to 40 percent.

Changing your mind

If you've recently purchased credit insurance and decide you don't want it, you may still be in a "free look" period. That's an initial period after buying insurance when you can change your mind and receive a full refund. "Free looks" usually last 10 to 30 days (check your policy terms) and some states mandate a free look.

Even if you've held the policy for longer than your "free look," you have the right to cancel it at any time.

If you discover that you've been paying for credit insurance that you never agreed to buy, you can lodge a complain with your state's department of insurance, which regulates credit insurance.

Credit insurance rides into the sunset

With lenders rapidly implementing debt-cancellation programs, credit insurance's years may be numbered. Burfeind of the CCIA predicts, "The more lenders that switch to debt cancellation, there's no need to have dual programs." Perhaps in 20 or so years, says Burfeind, credit insurance will be a product of the past.

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