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The basics of credit insurance: Do you really need it?
If you've just taken out a loan, or are in the process of borrowing money or signing up for a credit card, your lender may offer you credit insurance. The policies promise to pay your loan if you die, go on disability or lose your job. You might wonder if you really need credit insurance.
Credit insurance is optional. However, before taking out a policy, weigh its advantages and disadvantages. Studies by consumer groups suggest that credit insurance may not be a good value for your money. Do your homework before you buy.
Here are some of the basics of credit insurance:
- You are not required to buy credit insurance as a condition of any loan or financing.
- You must purchase credit insurance at the institution where you obtain your loan.
- Credit insurance is most commonly offered as a group policy through a bank, credit union or vendor such as an auto dealer or furniture store, although you may be able to buy a policy individually.
- Credit insurance benefits are first paid to the lender, not to you, in the event you make a claim. Any excess benefit will be paid to you.
- The credit insurance benefit decreases as your loan balance decreases.
- There are two primary ways to pay for credit insurance: monthly premiums or a single premium. Some "single-premium credit insurance" gets added to your principal and financed with your loan when you buy new furniture or a new car. That means you don't have to write a check for the credit insurance but you're paying interest on those premiums.
- Credit insurance is often sold in a package, which typically includes credit life insurance, disability insurance and unemployment or property coverage. In some cases, your only choice is to buy the whole package or none, even if you are ineligible for benefits under some of the policy types. Some states mandate that you must be offered individual coverage.
- Credit insurance can be purchased without a medical exam and the premium does not vary according to your age, unlike life insurance.
- Credit insurance may not pay if you have a pre-existing health condition.
- A credit insurance application may ask for your medical history. You may not be eligible for credit insurance if you have had a serious medical condition like cancer or heart disease.
- Some credit insurance will not cover the full amount of your outstanding loan or the full term. For example, in New York the maximum allowable coverage for credit life insurance is $220,000 and you may have a higher mortgage; some policies may cap the amount at less. The maximum amount for all other debts is $55,000.
- The lender or insurance company can cancel your credit insurance with advance notice if you pay your premiums in monthly installments. If you've paid with a single premium, your credit insurance cannot be cancelled.
The average premium in 2006 for credit life was 50 cents per $100 of debt annually, according to the Consumer Credit Industry Association (CCIA) in Chicago, an industry trade group. That means if you carry credit life on a credit card where you have a $6,000 debt, you'll pay $30 a year. Figures for credit disability, credit property and credit unemployment are not available from the CCIA.
The business of credit insurance
William Burfeind, executive vice president of the CCIA, says the target customer for credit insurance is "the uninsured or underinsured with little or no liquid assets who's assuming a financial obligation they could not honor in the event of death, disability or unemployment or, in the case of credit property insurance, could not repair or replace the item financed (TV, etc.), but would still have the repayment obligation."
According to the CCIA, consumer credit insurance totalled $5.56 billion in net written premium in 2006. Of this total, credit life was $1.28 billion, credit disability was $1.43 billion, credit property $2.44 billion and credit unemployment was $41 million.
Types of credit insurance
Credit life insurance: Pays your debt on a specific loan or line of credit if you die before the loan is paid off.
Credit disability insurance (also called credit accident and health insurance): If you are unable to work because of a disability, this coverage makes your monthly minimum loan payments for a limited time period. The policy may require that you be working a certain number of hours a week before the disability. You must be disabled for a certain number of days before the credit insurance will kick in, typically 14 to 30 days.
Credit involuntary unemployment insurance: If you become unemployed because of a lay-off or strike, this coverage pays your minimum loan payment for a limited time period. The policy may require that you be working a certain number of hours a week before the job loss. You must be unemployed for a certain number of days, typically 30, before a benefit is paid.
Credit property insurance: There are two types of credit property insurance. Credit personal property insurance covers repair or replacement of a financed item, such as a washer. If you have homeowners or renters insurance, this insurance is unnecessary.
Credit leave of absence insurance: This policy makes a limited number of monthly payments on a specific loan or credit card if you take an unpaid family leave from work for specific reasons, including care for a newborn or care for a seriously ill family member.
Credit insurance can be a lucrative business for those selling it.
The market for credit insurance is often described as "reverse competition," meaning you can be subject to overcharging because you don't get the opportunity to shop around for the best rates. The lender picks your coverage type, premium and insurer making you a "captive market" without choices. Therefore, it becomes up to state regulators to police the market to make sure borrowers aren't getting socked with whopping rates.
And in states where credit insurance is loosely regulated, insurers decide on rates based on how much profit they want to make, not on reasonable cost, according to the New York department of insurance (DOI).
"Such 'reverse competition,' unless properly controlled, results in insurance charges to debtors that are unreasonably high in relation to the benefits provided to them," says the New York DOI.
In every state, credit insurance forms must be approved by its department of insurance. Some states have also established minimum "loss ratios," meaning how much an insurer must pay out in claims compared to how much in premiums it charges. Washington state, for example, enacted a law in 2005 that requires a 60 percent loss ratio; that means credit insurers must pay out at least 60 cents for every dollar in premium they take in.
Loss ratios vary not only by state but also by the type of credit insurance. For example, the Center for Economic Justice, a consumer advocacy group in Texas, reports that between 2004 and 2008, credit life loss ratios varied from under 35 percent in Louisiana, Nevada, Nebraska and South Dakota to over 55 percent in Oregon, Maine, New York, Vermont and Virginia.
The most highly lucrative types of credit insurance are credit family leave and credit personal property. The CEJ puts the loss ratio for credit family leave at 0 — it is only a fraction of 1 percent. That means insurers are paying out less than one penny for every dollar in premium they take in, by CEJ estimates. The nationwide loss ratio for credit personal property insurance was 7.8 percent in 2008, according to the CEJ.
Burfeind of the CCIA says, "CCIA does not subscribe to the loss ratio standard for determining rate reasonableness. The pure loss ratio test falsely assumes that all business costs associated with credit insurance are directly and proportionately related to claims, i.e., if claims go down by 10 percent the so do all expenses components. Premium rates should not be excessive to consumers, but they also need to be adequate for insurers. The appropriate methodology, in layman's terms, is component rating. Under this approach, the various expense components, including claims, are valued for reasonableness and added together to get the rate."
Regardless of loss ratio, one of the worst deals going may be financed premium credit insurance. That's where your premiums are financed along with your loan principal, so the lender collects not only the profit on the insurance contract but also the interest.
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 also gives your family more flexibility: The life insurance benefit can be used for any need, whereas credit insurance will only pay for 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 also offers you greater financial flexibility than credit disability insurance. A group disability policy purchased through work, for example, may be a more affordable alternative.
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 that 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 payment protection (debt cancellation and debt suspension) varies greatly among lenders. Birny Birnbaum, executive director of the CEJ, says that most credit card debt cancellation contracts range between 79 to 99 cents per $100 of outstanding balance. Let's say you have $5,000 on a card and get a "debt protection" offer for the "low, low price" of 99 cents a month. That's 99 cents per $100 of debt, so you would pay almost $50 a month or $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, which are also marketed as a "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.
No state or federal bank regulators require lenders to report debt cancellation program sales or benefit payouts, but Birnbaum estimates the market to have grown to more than $5 billion The product, initially sold only with credit cards, is now sold by banks and credit unions with other types of loans, including auto loans.
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.
Studies conducted by CEJ and other consumer groups found that credit insurance products — regulated by state insurance regulators — were poor values for consumers because they typically return only 30 to 40 percent of premium paid by consumers in benefits, depending on the state. Debt cancellation products and suspension agreements are even a worse value for consumers, says Birnbaum. The fees paid by consumers often outweigh the benefits. Also, rates and benefits are unregulated and lenders have been known to modify triggering events and benefits to the consumer's disadvantage. For example, says Birnbaum, lenders changed the death benefit of credit insurance to an accidental death benefit in debt cancellation, a change that reduces the benefits paid by 95 percent. Disclosure is generally poor, and consumers typically do not get the complete terms and conditions and eligibility until after they purchase the product.
According to the CEJ, "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.”
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).
You’re also likely to lose your credit card while you are receiving a benefit. Yet during a time of financial crisis, you likely need your credit 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.
10 questions to ask when considering credit insurance
1. Do I have other insurance or other assets, such as savings, that would cover my debts in the event of my death, disability or unemployment?
2. How much is the premium for credit insurance? Would it be less expensive and better suit my needs to buy a life insurance policy or a disability insurance policy? Credit insurance may cost more than a traditional life insurance policy or a disability policy.
3. If I purchase single premium coverage, will the premium be financed as part of the loan? If so, how much will my loan payment increase due to the cost of the credit insurance?
4. Will the credit insurance cover the full term of the loan and the entire balance?
5. How long do I have to wait before my monthly benefit is paid if I become disabled or lose my job?
6. What conditions are not covered by the policy?
7. Can I cancel the insurance?
8. Can the insurance company or lender cancel the insurance?
9. Can the terms of the policy be changed without my consent? Can the premium rate be increased?
10. Is there a choice of products and rates?
|Source: New York Insurance Department|
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 3 to 5 percent on debt cancellation/suspension products. That means they pay out 3 to 5 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 you 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 address the concerns about credit insurance. According to Birnbaum, states regularly approve rates that will result in lucrative loss ratios of 30 to 40 percent, or even less. From 2004 to 2008, the loss ratio for credit family leave insurance was 20 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 complaint 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.