Understanding Credit Insurance

Credit insurance is insurance that guarantees or secures payment of an outstanding obligation in a credit transaction in the event that the borrower is unable to pay. For instance, a consumer purchases a car. The dealer arranges for the consumer to obtain a loan for the purchase, perhaps seller financing. During the transaction, the dealer encourages the consumer to purchase credit insurance as security, in case something should happen rendering the consumer unable to make the required payments on the loan. Not wanting to risk losing the family car should he or she become disabled or die, the consumer agrees to purchase credit insurance. The same pattern is often repeated in other credit transactions as well, including sales of consumer goods, mobile home sales, and residential mortgages.

Creditors have an incentive to sell credit insurance for several reasons. There is incentive not only because the creditor is the primary beneficiary under a credit insurance policy, but also because the creditor receives significant compensation from the sale of insurance from the insurer whose product it sells, and because interest is charged when the creditor finances the insurance premium.

Older Americans may be more susceptible than other consumers to credit insurance sales pitches. This is because they are more aware of their own mortality or risk of becoming disabled than younger people, and may perceive their overall risk of loss of income more keenly. Creditors are not unaware of this state of mind and in some circumstances might try to take advantage it.

Types of Credit Insurance

There are four basic types of credit insurance. They are credit property, credit life, credit disability (a.k.a. accident and health insurance), and involuntary loss of income insurance. Except for credit property insurance, which protects against loss of the collateral through some casualty, all other forms of credit insurance protect against some casualty befalling the borrower. As with other kinds of insurance, the borrower ordinarily will have to meet eligibility requirements under the particular policy in order for the insurance to have effect.

Credit Property Insurance

Insures against damage or loss to the collateral securing the loan. This type of insurance is commonly required in credit transactions such as home mortgages or car purchases. This is because a creditor has little recourse for recovering its investment once the collateral is damaged or destroyed and the benefit of foreclosure or repossession is lost along with the collateral itself. Even if property insurance is required, however, under most states' insurance laws the creditor cannot require the borrower to purchase it through the creditor.

Credit Life Insurance

Insures that if the consumer dies, the outstanding loan balance will be paid. Eligibility for credit life usually includes limitations on pre-existing health conditions. The policy will often state that coverage is not provided for losses due to conditions commencing or treated prior to application for insurance or within a specified period of time following the effective date of the policy. Other policies state that there is no coverage unless the applicant is in "sound" or good" health when the insurance becomes effective. In addition, most policies state that an applicant beyond a certain age cannot obtain coverage, or that coverage expires when an insured person reaches that age.

Credit Disability/Accident and Health Insurance

Insures the consumer against varying disabilities resulting from accident or ill health (other than pre-existing conditions). These policies only cover the periodic payments that come due during a disability, and usually require that the consumer be incapacitated for a minimum period of time before any payments begin. The consumer usually must be a full-time worker to be eligible for benefits. The sooner payments begin, the more expensive the premiums will be.

Involuntary loss of income insurance

Insures against layoff or other causes of involuntary loss of income, as the policy may specify. Like disability coverage, policies for involuntary loss of income typically state that coverage does not become effective unless the applicant is, for example, actively at work," "regularly performing the duties of his/her occupation," or "gainfully employed" on the policy's effective date. In addition, no coverage is ordinarily provided when the loss of income results from the consumer's voluntary actions (e.g., resignation).

Common Credit Insurance Abuses

There are four common credit insurance abuses. They include involuntary or pressured sales techniques, price overcharges in sales to eligible borrowers, sale of incomplete coverage, and post-claim ineligibility determination by the insurance company.

Involuntary or Pressured Sales Techniques
Creditors may not require credit insurance, except for property insurance in some circumstances, as a condition of the loan. Where credit insurance is an option, consumers may be misled by creditors into thinking that it is required. When it is required, in only a very few cases can lenders explicitly require borrowers to purchase insurance from the lender; state law usually prohibits such a requirement, and the federal Truth in Lending Act (15 U.S.C. §1601 et seq.) also imposes certain restrictions on this practice.

Price Overcharges
There are at least three ways in which a creditor can overcharge for credit insurance. One is to charge a premium rate higher than that permitted by premium finance law or regulation. Another is to recommend the purchase of insurance coverage in excess of that allowable under law or necessary to protect the loan. Finally, a level life policy may be sold where a decreasing life policy is called for.

Sale of Incomplete Coverage
As consumer loan amounts grow larger and terms grow longer (especially in mortgage transactions), the cost of long-term credit insurance can be prohibitive. Therefore, it is becoming more common for creditors to sell credit insurance which does not completely insure the loan. For example, a 10-year, $10,000 policy may be sold in connection with a 15-year, $15,000 loan, but the policy may be misrepresented to the consumer as covering the full term and amount of the loan. Thus, when an event occurs requiring payoff of the loan under the policy, the consumer (or her survivors) may be left obligated personally for an outstanding balance.

Post-Claim Ineligibility Determination
This scenario usually arises because of some conduct or omission by the creditor who sold the insurance, even though he knew or have known that the borrower was ineligible (ineligibility factors may include the consumer's age or health or employment status, depending on the type of coverage purchased and the specific policy requirements).

Common situations include:
- the creditor has knowledge of a policy condition that would disqualify the consumer, but does not share the information with the insurer;

- the creditor fails to make any inquiry about the consumer's age, health or other relevant facts;

-the creditor deliberately misstates information on the insurance application;

-the creditor fails to process the application properly.

Is Credit Insurance Necessary

Generally speaking, insurance is nice to have. However, it is not a necessity. Whether or not to purchase credit insurance ultimately is a matter of personal choice and one's assessment of individual risk versus the cost of premiums. If having credit insurance is your personal choice, you could probably minimize the cost by shopping for alternative types of insurance which would serve the purpose.

Credit insurance offered through the lender is usually not a good bargain for the money, given the narrow benefits. A better deal for the money is likely to be adequate insurance of a more general type. For example, disability insurance not tied to the debt offers the possibility of replacing income, as well. The difference is the insured can direct the monthly benefits to wherever he or she thinks is most important. For example, the consumer may prefer to use it to make the mortgage payment, even if it means defaulting on a car loan. Similarly, a general life insurance policy in an amount adequate to meet the borrower's needs gives the insured the freedom to set priorities for debt repayment.Older consumers may sometimes feel that credit insurance is desirable because underwriting requirements make it difficult for them to obtain these other types of insurance.

If that is the case, credit insurance is worth exploring, but do it wisely:

- Ask what limitations and exclusions there are on paying the benefits. Tell them you want the answer in writing. If they won't do that, be wary.

-Ask for a clear explanation of the benefits.

-Check carefully the premium price -- which can run into thousands of dollars. Ask the creditor to give you a comparison of your monthly payment amount and the total debt, both with and without the insurance. If the price of the insurance makes the monthly payments uncomfortably high given your income, it may make default more likely. If it is an unsecured loan for a car, you may decide to take that risk. If it is a mortgage on your home, you may weigh the risk of death or disability differently against the relative risk of default.

If you already have credit insurance in connection with a prior transaction and feel like you were misled or abused in a manner described above, contact an attorney immediately.

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Understanding Credit Insurance

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