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Consumer Credit Regulation: 6.2.2 How Debt Protection Products Work

Both credit insurance and debt cancellation agreements eliminate some or all of the consumer’s indebtedness. Credit insurance, however, usually involves a third-party insurer, whereas debt protection products are sold by the lender directly to the consumer. The absence of a third-party insurer is part of the reason these products are more profitable for lenders.17 (Even so, an insurance company may issue a contractual liability policy to the lender to insure against losses under the debt protection products.

Consumer Credit Regulation: 6.2.4.2 OCC Regulation

The OCC debt protection regulations—applicable to national banks and federal savings associations—provide only minimal substantive consumer protections, predominately in the mortgage context.55 Unlike state insurance regulators’ oversight of credit insurance, the OCC and other federal banking regulators do not address the reasonableness of the pricing of debt protection products.56 The OCC primarily relies on disclosure of the terms of the agreement to protect consumers.

Consumer Credit Regulation: 6.2.4.3 TILA and CFPB Regulation

The Truth in Lending Act contains provisions regarding the disclosure of debt suspension, debt cancellation, and credit insurance products, all three of which are treated the same for purposes of disclosure requirements.63 Under these rules, mandatory debt protection or credit insurance fees are treated as finance charges, whereas voluntary products are not.64 In order for the products to qualify as voluntary, lenders must make certain disclosures.65

Consumer Credit Regulation: 6.2.5.1 Nature of Abusive or Deceptive Sales Practices

In addition to concerns over the pricing and benefits of debt protection products, there have been allegations of abusive or deceptive practices in the sale of these products to consumers. These include allegations that cardholders were involuntarily enrolled into these programs, and that they were enrolled using deceptive or misleading representations.

Consumer Credit Regulation: 6.2.5.3 State Attorney General Enforcement

A number of state regulators have taken enforcement action against credit card lenders over deceptive or abusive practices in the sale of debt protection products. The Minnesota attorney general filed a lawsuit against Discover Bank, alleging that telemarketers for Discover Bank used deception to sell debt protection to credit card customers.

Consumer Credit Regulation: 6.2.5.4 Private Litigation over Unfair and Deceptive Sales Practices

A number of private lawsuits have also been filed alleging deception and unfair practices in the sale of debt protection products, although the courts in these cases are split as to whether the claims were preempted by the OCC regulations.94 Several lawsuits alleging that consumers were involuntarily enrolled in debt protection products have survived preemption and other challenges.95 A California lawsuit alleging deceptive practices in the handling of claims when consumers tried to use the benefits

Consumer Credit Regulation: 6.3.1 Overview

Credit insurance is sold as an add-on product by banks, credit unions, auto dealers, finance companies, and retailers, including department, furniture, jewelry, and home improvement stores. The credit insurance policy pays claims on a covered loan if designated events occur, such as the borrower’s death, illness, or unemployment, or loss or damage to the collateral.

Consumer Credit Regulation: 6.3.2.3 Creditor Receives Interest on the Premium

Creditors often finance the consumer’s credit insurance premium and gain additional interest revenue on such financing. If the purchase of the credit life or credit accident and health insurance is voluntary, or if the borrower has a choice of providers on required property insurance on collateral, the Truth in Lending Act and most state credit laws108 permit the cost of the premium to be included in the principal or amount financed.

Consumer Credit Regulation: 6.3.3.1 Low Loss Ratios Demonstrate Excessive Cost

That credit insurance is overpriced can be demonstrated by reviewing credit insurance “loss ratios,” the percentage of incurred insurance claims to net premium dollars. In other words, if an insurer has a 35% loss ratio, then 35% of each premium dollar is paid out to insureds for claims. The other 65% is retained for the insurer’s expenses and profit and the creditor’s compensation.

Consumer Credit Regulation: 6.3.3.2 Reverse Competition; Market Failures

The extremely low loss ratios for lines of credit insurance without price regulation, and even the low loss ratios for insurance lines where the price is regulated can be explained by the phenomenon of reverse competition. The National Association of Insurance Commissioners Credit Personal Property Model Law provides a definition and description of reverse-competitive markets:117

Consumer Credit Regulation: 6.3.4.2.1 Decreasing term credit life insurance

Credit life pays off an outstanding obligation in the event of the borrower’s death. The most commonly sold type of credit life is decreasing or declining term credit life insurance. “Decreasing term” means that the amount of coverage decreases as the balance on the loan declines because of the installment payments. Theoretically, the benefits payable in the event of death will cover only the outstanding balance on the loan at the time the death occurs.123

Consumer Credit Regulation: 6.3.4.2.2 Level term credit life insurance

The second type of credit life insurance is level term credit life insurance, where the amount of coverage or benefits payable does not decrease despite the fact that the installment payments reduce the account balance. The benefits payable remain level over the entire term of the policy.

Consumer Credit Regulation: 6.3.4.2.3 Joint and single credit life insurance and term limits

Single credit life protects only one named debtor. Joint life protects two debtors who are obligated on an account. Most often, joint life is sold where two spouses are both obligated on an account. Joint coverage, however, means only that the policy will pay if either borrower dies. If both borrowers die, there are no additional benefits. The premium rate for joint life is more expensive than single life.

Consumer Credit Regulation: 6.3.4.3 Credit Disability/Accident and Health

Credit disability insurance developed later than credit life insurance, but in much the same manner and for the same purpose. Creditors were looking to borrowers’ wages to repay debt; death and disability are two major unforeseen circumstances that could interrupt wages. The purpose of credit disability insurance is to ensure that payments on a loan or credit sale will still be made should sickness or accident cause a significant unanticipated interruption in income.

Consumer Credit Regulation: 6.3.4.4 Involuntary Unemployment Insurance

Loss-of-income or involuntary unemployment insurance is aimed primarily at loss of income caused by layoffs, though some policies will also make monthly payments on a credit account if, in certain circumstances, the borrower goes out on strike or is fired. Unemployment insurance may be sold separately, or in combination with credit disability coverage. This combination coverage may raise special cost and voluntariness questions which should be explored.131

Consumer Credit Regulation: 6.3.4.5 Credit Personal Property

Credit personal property insurance insures against loss of the collateral on a loan, either property purchased with the loan or property pledged to repay a loan. However, it is not unknown for credit personal property insurance to be written on property unrelated to the loan, or for coverage to be written in amounts greater than the loan, despite the fact that this practice may be illegal in many states.137 Other times, the coverage may be very limited, such as loss caused by fire or lightning after repossession.

Consumer Credit Regulation: 6.3.4.6 Non-Credit Insurance Distinguished

Creditors may offer to sell ancillary insurance, unrelated to the debt itself. This insurance does not protect the creditor against any risk relating to the account, unlike credit insurance, where the beneficiary is the creditor or the debtor’s account. However, the creditor will finance the premium for this “separately” purchased product. The creditor may sell cancer insurance, accidental death and dismemberment insurance,140 or level term non-credit life insurance (in addition to the credit life).

Consumer Credit Regulation: 6.4.1 Introduction

State insurance departments regulate the conduct of insurers in selling credit insurance. State banking agencies or other state regulators have authority concerning a creditor’s offer of credit insurance. Federal regulators, primarily the Consumer Financial Protection Bureau, may also regulate creditor actions involving credit insurance.

Consumer Credit Regulation: 6.4.2.1 General Restrictions

State credit statutes—such as small loan acts, consumer loan acts, industrial loan acts, second mortgage laws, or general credit statutes, including retail installment sales acts—may contain important limitations on the creditor’s sale of credit insurance.143 Unlike most credit insurance codes, credit and licensing statutes often provide viable consumer remedies for violations.