Credit-insurance come-ons raise capital concerns

Credit insurance, a product that's supposed to bring peace of mind to the people who buy it, has come under scrutiny by consumer advocates and some legislators who say it's overpriced at best and, at worst, illegally forced on people.

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Whether complaints will bring about any changes remains to be seen. When it comes to credit insurance, it's still very much consumer beware.

Credit insurance is often offered to consumers when they finance a purchase either through a loan or a credit card. Most credit-insurance policies make the minimum payment on a specific loan or credit card if the consumer becomes disabled or unemployed, or pay off the debt if the consumer dies.

There are four main types of credit insurance:

• Credit life pays the remaining debt if the borrower dies.
• Credit disability usually pays the minimum amount due for a specific number of months.
• Credit involuntary unemployment pays the minimum amount due for a specific number of months.
• Credit property pays to repair or replace property purchased with a loan or credit card if the property is lost, damaged or stolen.

Credit life has the bad-boy reputation of the group. Consumer activists accuse some lenders of coercing borrowers into buying credit life by strongly suggesting that they may not get the loan or credit card if they don't accept the insurance.

Some major purchases may have "single premium" credit life -- a product that's been targeted by consumer advocates so much that some lenders, such as Citigroup, have stopped selling it. Freddie Mac and Fannie Mae have banned the purchase of mortgages that have single premium credit insurance.

The single premium is supposed to be paid in a lump sum, so it's often added on to the price of the loan with the consumer paying interest on the loan and the insurance. In some cases, the insurance coverage may, for example, last only five years while the loan may take longer to repay. That means the consumer continues paying for insurance even though the purchase is no longer covered.

Irrational loss ratios
But consumer groups have also blasted two other forms of credit insurance: unemployment and property. The problem is low loss ratios.

The Center for Economic Justice calls the loss ratio the single most important measure in determining whether the cost of credit insurance is justified in comparison to the benefits.

A study done by the Center and the Consumer Federation of America shows that the loss ratio for all major forms of credit insurance in 2000 was 34.2 percent. That means for every dollar paid in premiums, consumers received just over 34 cents in benefits.

But the national Association of Insurance Commissioners recommends a minimum loss ratio of 60 percent. If that 60 percent figure had been enforced, consumers would have paid 75 percent less in premiums.

According to the study, the loss ratio for credit property was 14.7 percent and for credit unemployment it was even worse, 5.8 percent.

"Most people think the most likely thing they'll collect on is credit unemployment; they think it will benefit them," says Birny Birnbaum of the Center for Economic Justice. "Very few people get a chance to use it. There are so few payouts it's hard to see it as a good deal. Credit-unemployment loss ratios are in the single digits; they don't do a damn thing."

Jim Sykes of Assurant Group, the country's largest underwriter of credit insurance, says they're still accumulating data that could help determine how to price credit unemployment.

"When it was first introduced, we underestimated the economy in our pricing. The economy was strong and we didn't get the claims. Now the economy has turned and unemployment has grown but we're still not seeing the up tick in claims that we expected.

"One guess is many of the people enrolled in the program have forgotten they have it. Credit unemployment is hardly ever bought on a stand-alone basis, it's usually bundled. They bought it for the life and disability, but aren't making claims because they forgot they have it."

Where are the regulators?
Credit insurance is regulated by the individual states. Critics say state insurance regulators have failed to do their job.

"The states should take seriously their responsibility to protect insurance consumers. It's that simple. I don't understand any excuse or rationale as to why regulators have done such a poor job," says Birnbaum.

Mike Kreidler, insurance commissioner of Washington state and co-chair of the National Association of Insurance Commissioner's credit insurance working group, says commissioners often don't have the power to make changes that would benefit consumers.

In addition, some may also be more concerned about protecting their jobs than protecting consumers.

"Most regulators don't have the authority to enforce standards such as the 60-percent loss ratio. They'd need to go to their state legislatures to do it. The other side of the problem is the retailers and lenders are a very large, politically-connected, aggressive group. Credit insurance is a significant profit center for them. You go after it and you unleash the dogs of war.

"Thirty-eight of the 50 insurance commissioners are appointed," says Kreidler. "A lot of times the people who wind up on the governor's staff as insurance regulator keep the job by keeping a low profile. If you kick all the retailers because of credit insurance, the governor may wonder what you're doing."

If state insurance regulators are the first line of defense against predatory credit-insurance practices, consumers may be up a creek without a paddle.

Frank Torres of Consumers Union says Congress may intervene.

"There is going to be discussion in Congress, maybe this year, to create a federal insurance charter. That might be the appropriate place to regulate this."

Sykes, of Assurant Group, likes the idea of federal regulation.

"Nobody's business is regulated more than ours. We deal with 50 states," Sykes says. "There have been conversations about how fast Congress will move to create an agency to regulate insurance. For an industry not to have a regulatory agency like the OCC (Office of the Comptroller of the Currency) or the FDIC is a disadvantage, and we'd welcome a federal agency if it meant we wouldn't have to deal with 50 states."

Kreidler says federal regulation would be worse for consumers than state regulation.

"I can tell you the people pushing for federal involvement in insurance want to follow the model of the OCC where disclosure is all that's required and, 'We don't worry about the details.' If you follow that model, you're not doing anything for the consumer. Consumers, by and large, don't want federal involvement because of that concern. That doesn't mean they're happy with the role state regulators have taken."

Sykes says he is concerned about over-regulation caused by the actions of some bad apples.

"Predatory lending is a practice. We sell a product. The fact that someone might have misused our product doesn't make it a bad product," Sykes says.

"Credit insurance isn't designed for everyone. If you have a steady paycheck, good health, life insurance and money in the bank, it's probably not for you. But if you live paycheck to paycheck, can't qualify or afford traditional insurance, it can serve as an important safety net."

Birnbaum, of the Center for Economic Justice, agrees that credit insurance, if priced properly, can be a worthwhile product for some people. But Torres of Consumers Union strongly disagrees.

"Typically, the people that it gets sold to are the ones who can least afford it. You tack on credit insurance and instead of using that money to pay off the debt, it's drained out of their pocketbook to pay for services and products that are essentially shams."

Credit insurance incognito
Debt-cancellation contracts and debt-suspension contracts are, essentially, credit insurance substitutes sold as a bank product, and therefore not regulated by state insurance commissions. Debt cancellation eliminates the debt, while debt suspension simply postpones payment of the debt -- no benefits are paid.

Because of the criticism of credit insurance, more debt-cancellation contracts and debt-suspension contracts are being sold.

Kreidler calls that a problem.

"Debt cancellation is overseen by the OCC, but calling it regulated in the context of state regulation is a misnomer. They're much more in the vein of just making sure there's disclosure. That's a lot less oversight."

According to Kreidler, debt cancellation is one reason state regulators don't push too hard for reform of credit insurance. Regulators fear retailers and lenders will switch to lightly-regulated debt-cancellation and debt-suspension contracts, and then consumers will have even less protection.

Most people shouldn't buy credit insurance or a debt-cancellation/debt-suspension contract. But if you do buy a policy or a contract, make sure it's because you want it. Don't let a salesperson scare you into buying it.

If a salesperson tells you the loan is contingent upon the purchase of insurance, report them to your state attorney general, state insurance commissioner or consumer protection office.