Press release
Full report
 

What is Credit Insurance?
Credit insurance is big business. From 1995 to 1997, more than $17 billion of credit insurance was sold in the United States. Credit insurance refers to a group of insurance products sold in conjunction with a loan or credit agreement. The products may be sold by credit card companies, auto dealers, finance companies, department stores, furniture stores or wherever loans are made and credit extended for the purchase of personal property. The major types of credit insurance that are the subject of this report are:

• Credit Life pays off the consumer’s remaining debt on a specific loan or credit card account if the borrower dies during the term of the coverage.
  
• Credit Accident and Health, also known as Credit Disability, pays a limited number of monthly payments on a specific loan or credit card account if the borrower becomes disabled during the term of coverage.
  
• Credit Involuntary Unemployment pays a limited number of monthly payments on a specific loan or credit card account if the borrower becomes involuntarily unemployed during the term of coverage.
  
• Credit Property pays to repair or replace personal property purchased with the loan or credit proceeds and/or serving as collateral for the credit if the property is lost, damaged or stolen. Unlike the first three credit insurance products, credit property insurance is not directly related to an event affecting a consumer’s ability to pay his or her debt.
  

This report reviews the performance of state insurance regulators in protecting the consumers of credit insurance. Our analysis shows that ineffective regulation has caused consumers to overpay for credit insurance by $2 billion dollars a year and has failed to protect consumers from unfair sales and market practices. Additional problems exist for credit property insurance.

Credit Insurance Consumers Overcharged by $ 2 Billion a Year
The loss ratio – the ratio of benefits paid on behalf of consumers to premiums paid by consumers – is the single most important measure of the value of credit insurance to consumers. Insurance regulators have determined that a 60% is the minimum loss ratio for credit life and credit disability insurance to provide reasonable benefits to consumers in relation to premium costs. The 60% loss ratio standard for credit life and disability insurance is a modest one. Actual historical loss ratios for group life insurance and group accident and health insurance exceed 90% and 75%, respectively. Historical loss ratios for private passenger automobile insurance are just under 70%.

Our review of actual credit insurance loss ratios shows that state legislatures and/or state insurance regulators, with only a very few exceptions, have failed to protect credit insurance consumers. Actual historical credit insurance loss ratios are far below even the NAIC model’s modest 60% loss ratio standard.

Table 1 shows 1997 countrywide credit insurance premiums, loss ratios and commissions by coverage. The 1997 credit insurance loss ratios ranged from 12% to 49%, depending upon the coverage. Overall, less than 39 cents on the premium dollar was paid out in claims on behalf of consumers.

These loss ratios are unconscionably low – far below any reasonable measure of benefit in relation to the premium charged to consumers. The actual loss ratios fall far below even the NAIC minimum standards. The credit involuntary unemployment and credit property loss ratios are particularly egregious.

If credit insurance had been priced to provide even minimum reasonable benefits to consumers in relation to premiums paid, consumers would have paid $2 billion less in premium for credit insurance in 1997. Overall credit insurance overcharges were almost 37% of total premium charged. For credit unemployment and credit property (other), premiums were excessive by more than 80% of premium.

While a few states do a good overall job of regulating credit insurance and protecting consumers – New York, Maine and Pennsylvania – the vast majority of states fail miserably in protecting credit insurance consumers. Table 2 shows the 1995-97 combined loss ratio for credit life, disability, unemployment and property and the amount of premium overcharges by state. The worst states for credit insurance consumers include Louisiana, North Dakota, Mississippi, Alaska, Nebraska and Minnesota where overall loss ratios were less than 32% and consumer overcharges were around 50% or more of total premium. Forty-five states and the District of Columbia had three-year overall credit insurance loss ratios of less than 50%. Three-year overcharges exceed $100 million in 14 states.

Reverse Competition and Ineffective Regulation Lead to Massive Overcharges
The dominant characteristic of credit insurance markets throughout the country is reverse competition. The credit insurance policy is a group policy sold to a lender who then issues certificates to individual borrowers. Because the lender purchases the policy, credit insurers market the product to the lenders and not to the borrower -- the ultimate consumer who pays for the product. This market structure leads insurers to bid for the lender’s business by providing higher commissions and other compensation to the lender. Greater competition for the lender’s business leads to higher prices of credit insurance to the borrower.

When states establish prima facie rates for credit life and credit disability insurance, credit insurers are generally allowed to charge lower rates if they want. Few credit insurers do. Because of reverse competition, a credit insurer who wants to offer the ultimate consumer a lower rate will simply not be able to get a lender to select the product. The lender will select another credit insurer who, by charging a higher rate to the ultimate consumer, can offer a higher commission to the lender.

When presumptive rates are set too high, competition does not force credit insurers to offer lower rates in the market. In the case of credit life and credit disability, presumptive rates have clearly been too high to achieve the 60% target loss ratio. For credit unemployment and credit property insurance, there are typically no presumptive rates and state regulators have shown dismal performance in protecting consumers from excessive rates caused by reverse competition.

In the cases of credit property and credit unemployment coverages, commissions to lenders are as much as four times greater than claim payments on behalf of consumers. For all credit insurance coverages, reverse competition has caused excessive commissions to lenders – commission amounts that far exceed any reasonable costs incurred by the lenders in selling the credit insurance on behalf of the credit insurer. In many cases, the lender owns the credit insurer and realizes additional profits from very low loss ratios.

Unfair Sales and Trade Practices
In our view, the tremendous profit to producers from the sale of credit insurance has led to numerous instances of unfair and deceptive sales practices by credit insurers and producers over the years. Over the past several years, there have been numerous enforcement actions and lawsuits against credit insurers and lenders for unfair and deceptive sales practices. Credit insurers and lenders have used coercive tactics to force consumers to purchase credit insurance against their will and have deceived consumers into purchasing credit insurance without their knowledge. In addition, many states allow credit insurers to charge credit insurance premiums for amounts greater than the amount borrowed by the consumer, causing consumers to pay excessive premiums.

Another problem found is post-claims underwriting, when the credit insurance is sold to who are ineligible for benefits. The lender sells the credit insurance policy, either knowing the consumer is ineligible for benefits or not bothering to check. The credit insurer is happy to take the premium from consumers ineligible for benefits, but when the consumer files a claim, the credit insurer denies the claim based on eligibility. The result of this arrangement is that creditors and insurance companies keep the premiums paid by ineligible debtors who never file an insurance claim, while refusing to pay on the same policies if claims are ever filed.

General Recommendations for Reform
To address the overpricing and unfair and deceptive practices that plague credit insurance, we recommend that state legislators and insurance regulators:

• Establish minimum loss ratios for credit insurance and enforce those standards. Although higher standards are reasonable, the rock-bottom minimum loss ratios of 60% for credit life and disability and 75% for credit unemployment and credit property insurance should be enforced. Further, credit insurers who substantially fail to meet these standard should be required to rebate excessive premiums to consumers.
  
• Prohibit gross indebtedness premium calculations. Consumers should not be required, at the lender’s choice, of paying credit insurance premium for coverage beyond that necessary to protect the lender’s interest.
  
• Enact effective consumer disclosure requirements. Consumers must be given meaningful and effective disclosures about the terms and conditions of the insurance and the fact that it is optional, along with price information, so they can determine whether it’s a good value. They should also be informed that they may have other insurance that covers the risk.
  
• Enact additional prohibitions and stronger penalties against credit insurers for unfair and coercive sales practices. For example, credit insurers should be prohibited from selling credit insurance until after the underlying loan has been made.
  
• Prohibit post-claims underwriting. Credit insurers should be prohibited from denying coverage after a reasonable period of time in which they can verify representations made by the consumer. Post-claims underwriting should be declared an unfair trade practice.
  
• Provide consumer choice. Credit insurers and lenders should be required to offer consumers a choice of purchasing individual coverages instead of only a complete package of coverages.
  

Additional Problems with Credit Property Insurance
In addition to the problems generally for credit insurance, credit property suffers from some specific problems, due to the fact that the coverage is related to "property" and there is little regulation of the product:

• Loan packing refers to the practice of lenders of adding to, or "packing," the amount financed by a consumer through the sale of expensive, unnecessary and often unwanted products, such as credit insurance. Lenders have great incentive to pack credit insurance because of the large commissions and lack of adequate regulation. Adding credit insurance allows insurers to increase the amount financed, in some cases allowing them to surpass statutory thresholds that allow the lender to take a security interest in the home.
  
• Phantom coverage refers to premium calculations based on amounts in excess to the amount of coverage provided. One example occurs with credit card credit property insurance because the premium calculation is based on the monthly outstanding balance. However, the outstanding balance typically includes any number of items that are not covered property under the credit property insurance coverage, such as meals, finance charges, and services. Consumers pay for phantom coverage – they pay the premium but get no coverage in return.
  
• Overvalued Collateral: Lenders may overvalue the property used as collateral or take an interest in collateral solely to sell credit property insurance on the property. The collateral may be worth very little relative to the loan amount, but the lender may sell credit property based on overvalued collateral, or an amount higher than the loan amount.
  

Excessive Premiums and Commissions and Very Low Loss Ratios

While excessive commissions to producers are a problem for all credit insurance coverages, as described above, the higher commission levels for credit unemployment and credit property insurance are particularly egregious. Commissions in 1997 exceeded 52% of premium for credit unemployment and exceeded 45% for credit property insurance sold in conjunction with credit cards. Commissions for credit unemployment and credit property should be less than commissions for credit life and disability.

In addition, minimum loss ratios credit property and credit unemployment should be higher than the 60% target loss ratios for credit life and credit disability. For example, if 60% is the minimum target loss ratio for credit life and credit disability and that loss ratio reflects a 20% to 25% average commission, then a reduction in commission levels for credit property and credit unemployment to a 5% to 10% average commission will alone increase the minimum loss ratio target for credit unemployment and credit property to 75%.

Recommendations for Credit Property Insurance

There is a great deal of disparity in how the states regulate credit property. While the NAIC has developed a model law and regulation for credit life and disability, it has failed to adopt models for credit property insurance. The states and the NAIC must step up to the plate and enact effective regulation that protects consumers from excessive overcharging, such as:

• Provide Effective Consumer Disclosure, Not a Shield for Unfair Practices. Most consumer disclosures are worse than inadequate. Effective consumer disclosures must include monthly statements to the consumer, printed on the credit card or other billing notice, regarding the voluntary nature of the coverage, the cost of the coverage and the average expected loss ratio for the coverage.
  
• Prohibit the Sale of Duplicative Insurance. Consumers should not only be informed that coverage is not needed if they carry other insurance, but creditors should not be permitted to sell duplicative insurance if the consumer already has the relevant coverage.
  
• Limit Credit Property Sales to Purchases over A Minimum Amount. Prohibiting the sale of credit insurance on loans for purchases under a minimum amount, such as $1,000, will discourage insurance packing and eliminate unnecessary sales of credit insurance for very small loan amounts.
  
• Establish a 75% Minimum Loss Ratio. By establishing maximum premium rates based upon minimum loss ratio standards of at 75% for credit property insurance, credit property insurance consumers will be assured of reasonable benefits in relation to premium charges.
  
• Limit Premium Calculation to Durable Personal Property. Phantom coverage must be eliminated by requiring that credit insurance premium calculations be based only on the cost of items actually covered by the insurance. One approach is to define durable personal property and require that premium calculations be based only on purchases of durable personal property.
  
• Limit Premium Calculations to the Lesser of Purchase Price or Loan Principal Amount. Premium calculations should be based on the lesser of the purchase price or the original debt amount which is the remaining principal at the time of policy issuance. This will help ensure that the basis for premium calculations is related to the coverage provided and protect consumers from overcharges and phantom coverages.
  

Conclusion
State legislatures and state insurance regulators, with the assistance of the NAIC, must do a far better job protecting credit insurance consumers than they have done to date. The situation has worsened for credit insurance consumers as credit insurance loss ratios have fallen and overcharges have grown. State regulation has generally not protected credit insurance consumers for the traditional coverages, even as new coverages are introduced that raise new consumer concerns.