Debt suspension: the latest dodge in the credit card issuers' corral

A sly twist on credit insurance that enables banks to skirt third-party underwriters and avoid a tangle of state laws is creeping into the card market.

Like credit insurance, "debt suspension" is sold as a credit card extra and is touted as a way to preserve your credit rating if a disability or job loss prevents you from being able to make your monthly payments.

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But while an insurance policy covers the payment, thereby paying down the balance while you are sick or unemployed, debt suspension only postpones the bill. The interest clock freezes, you cannot use the card, and the obligation is on hold until you are able to resume payments or the deferral period expires.

The greater of two evils
Consumer watchdogs say it's the greater of two evils.

"Credit insurance is generally a pretty poor deal for consumers, but compared to that, debt suspension is abominable," says Birny Birnbaum, an adviser with the Center for Economic Justice in Austin, Texas.

"It doesn't provide as much coverage and there is no regulation, so banks can charge a lot more."

The benefits of debt suspension to credit card issuers are significant. By cutting out the insurance industry, profits can go up exponentially. Phillips Business Information estimates credit insurance accounts for up to 40 percent of card issuers' fee income, and that by switching to debt suspension, profits could increase 50 percent to 60 percent.

And with no insurance regulations to follow, card companies can offer a one-size-fits-all product that is not subject to the price and marketing restrictions of the 50 states.

"Who's making the determination whether the fee is reasonable for the product being offered?" says William Burfeind, executive vice president of Consumer Credit Insurance Association, which represents about 170 companies and 80 percent of the industry's premium volume.

"It should be subject to regulation in terms of rates, forms and disclosure. But since nobody is monitoring it, the debt suspension product is trending upward."

Cost is similar
Currently, most credit insurance and debt suspension policies cost about the same -- 60 cents to 85 cents monthly for every $100 of the card's balance.

Citibank, which calls its debt suspension program "Credit Protector," charges 69 cents per $100, which means a customer with a $3,000 balance would pay $20.70 a month, or $248.40 a year. Its "Credit Shield" insurance policy is just 70 cents per $100.

Credit Protector defers monthly payments for up to 24 months if the customer is disabled or out of work, and up to three months for family leave. There is no payout if the customer dies. With the insurance policy, a disabled or jobless customer's bills are covered for up to a year, nine months for family leave. If the cardholder dies, the policy pays off the debt.

Some issuers, such as Providian Financial, are taking advantage of the no-rules playing field by charging a flat annual fee to customers with low card balances.

Bill Ramsay, a certified financial planner with Financial Balance Corp. in Cary, N.C., assisted a Providian customer who was paying $149 a year on a card with a $500 credit limit.

"An insurance premium would have been only about $3.60 a month," he said. "But Providian can charge a much higher rate because they don't have to follow the states' premium limits, and it doesn't have to actually pay any money out as a benefit.

"What a great deal for Providian, and what a total rip-off for their customers," Ramsay said.

Providian did not return phone calls requesting comment.

The insurance industry's argument is that debt suspension is a form of insurance and should be regulated by the states.

Debt suspension probe slated for this year
Tim Mullen, senior regulatory services manager for the National Association of Insurance Commissioners, says the group's legal team will be investigating that question this year.

"These products appear to be insurance to me," he says. "Our focus will be on whether states should retain that authority or will the (Comptroller of the Currency) override that.

"If we do find that it is insurance, I suspect it will spur further action by the NAIC."

Despite protests from the insurance industry and consumer groups, debt suspension has been upheld in courts and by federal regulators.

American Bankers Insurance Group Inc. of Miami, the largest underwriter of credit insurance, sued the Federal Reserve Board of Governors in 1998 over debt suspension, but was smacked down when the District Court of Washington ruled in favor of the Fed.

The legalities of the product have been bandied about for three decades under the umbrella of "debt cancellation agreements." Cancellation agreements, provided to debtors for a fee, allow lenders to forgive loans when debtors die.

Debt cancellation first got the blessing of the Comptroller of the Currency, the overseer of nationally chartered banks, in 1963, says Tim Wagner, director of the Department of Insurance for Nebraska, who has been tracking the issue.

Suspension instead of forgiveness
But because canceled debt is taxed and the lender might have to take a loss, the trend is for banks to suspend debts rather than forgive them, which means that, unlike a credit life insurance policy, most debt suspension programs make no provision should the customer die.

"Debt deferrals ... effectively reduce the value of the debt cancellation agreement feature to debtors, as no benefits are paid," Wagner says.

Citibank, the No. 1 credit card issuer, sought assurance from the OCC before instituting debt suspension about a year ago. Responding to the bank's query, the OCC in April 1998 wrote: "This type of contractual provision is no less a part of lending than any of the various other terms that are part of a loan agreement. The authority of a national bank to offer debt suspension agreements is an inherent part of its express authority to make loans."

Says Wagner, "The record is clear banking interests pressured the OCC to expand (debt cancellation agreements) to include disability and unemployment."

Issuers reluctant to follow suit
But even with the muscle of the Fed and the OCC behind them, credit card issuers have been slow to switch from credit insurance to debt suspension. Citibank still offers credit insurance, too. Fleet Financial started a program about three years ago.

One expert says it's because banks still can't believe they can boost profits so much by selling a product that is not regulated.

"Everybody thought it was too good to be true," says Bruce Johnson, president of Rodering Financial Services, a California-based consulting firm that helps card companies institute debt suspension programs.

"The lawyers kept telling the banks, 'You can't do this,' but we just kept insisting that there was a lot of money to be made here.

"Eventually, everybody is going to be doing it," Johnson says. "We just have to get by 'the sky-is-falling' folks in the legal departments."

Industry maverick Providian was first
Johnson said the fact that industry maverick Providian was the first to sell the product also made folks skeptical, even though the San Francisco-based company has been doing it for about 12 years.

"That probably slowed some people down," Johnson says.

Debt suspension and credit insurance solicitations are practically twins. It takes a hard look at the fine print to tell them apart.

"It's a mirror product. Chances are customers won't know the difference," says Johnson.

Birnbaum says consumers should steer clear of both. He and the Consumers Union did a study of credit insurance released in March 1999 and concluded it was "a massive rip-off," with customers being overcharged $2 billion in premiums.

Their survey looked at loss ratio -- the amount paid out in benefits vs. what consumers paid in premiums -- and found that the benefit to consumers has dropped steadily over the years. In 1995, consumers were paid 42.5 cents' worth of benefits for every premium dollar. In 1998, they were getting only 36 cents' worth. By comparison, actual loss ratios for group life insurance exceed 90 percent, the study noted, and 75 percent for group accident and health.

Birnbaum says the only people who might benefit from credit insurance are elderly folks in poor health who can't qualify for another policy, or those who live in states with low rates.

Even then, not all coverages will benefit them. For example, retirees don't need credit unemployment insurance. But card issuers frequently bundle several types of coverage together, forcing a customer who needs only life insurance to also pay for disability or property insurance.

"There is no meaningful opportunity to shop," warns Birnbaum. "You're presented with a package and it's a take-it-or-leave-it deal.

"Consumers should get a general purpose policy so that they are covered under any set of circumstances and can use the money as they need to."