Credit Insurance: It’s a Good Policy to Be Wary
No sooner do our lenders sell loans now than they’re pushing insurance--credit life insurance, mortgage accident insurance, credit disability, credit unemployment. “We’ll take care of your Citibank credit card bills when you can’t due to unemployment, sickness, accident, or death,” one bank says. Another emphasizes the “modest cost” for such “piece of mind.”
Credit insurance covers payment of a particular loan, typically consumer loans for autos, home mortgages, even revolving credit accounts. If the consumer dies, “credit life” pays off the balance--a boon to both his heirs and his creditors, who needn’t stand in line with their claim on the estate. Another form of credit insurance takes over in the event of disability or “involuntary unemployment,” making monthly payments to save the consumer from default or delinquency.
Not surprisingly, there are qualifications. Credit life may be limited to accidents, excluding any that involve illness, declared or undeclared war, even military service. Disability policies may exclude any conditions diagnosed or treated in the six months before signing up, may not start coverage for 31 days or more, and there may be no protection from foreclosure or late fees while the claim is being processed. Furthermore, creditors may “take care of your bills when you can’t,” but they may only take care of the minimum amount due--sometimes only 4% or 5% of the total outstanding--and only for 9, 12, or 24 months.
Cost Is Confusing
The cost of this insurance is also confusing, with both rates and application so variable that few consumers could judge or compare products. Credit insurance on bank cards is generally priced per $100 of a month’s average daily balance, with the bank-card issuer offering only life coverage, combinations of life and disability or unemployment, or all three. In any case, it seems low-cost, just 2 cents a day per $100 for all three in most states, says Citibank. But as life insurance actuary James Hunt, former Vermont insurance commissioner, says, “If your balance is $200 or $300 a month, it doesn’t matter a lot, but if it’s $2,000 or $3,000, you begin to notice it.”
Mortgage credit insurance premiums are usually calculated on the loan principal--13 1/2 cents, say, per $1,000 for accidental death coverage, or $13.50 a month on a $100,000 mortgage. “The premium will not go up because you grow older,” says Shearson/American Express Mortgage, but the benefit goes down with the loan balance, because insurance covers whatever is outstanding at the time of death.
The knottier calculations come on consumer loans--autos, furniture, mobile homes--where the insurance premium might be calculated on the total amount due, including finance charges, and then tacked onto the loan. On a $10,000 auto loan at 12.5% for four years, credit life insurance priced at 30 cents per $100 per year would be calculated on the $13,519.68 repayable; then that $40.56 a year, or $162.24 for the four years would be tacked onto the loan, yielding a monthly cost--including its finance charges--of $4.29 a month or $205.92 in all.
Rates Vary Widely
These rates also vary widely among states, ranging from less than 30 cents per $100 per year for credit life to $1 per $100. On a $6,000, four-year loan, calculates Hunt, the credit life charge before financing might be $76 in New York, $131 in California, and $339 in Alabama. This variation, says Robert Hunter, head of the National Insurance Consumer Organization in Virginia, isn’t “because California’s mortality is twice New York’s,” but because some states regulate the rates more closely than others.
Without regulation, as almost everyone admits, credit insurance has been a field that invites abuse. It’s sold by lenders, or through lenders, with their endorsement: this creates a “reverse competition.” “The real competition among insurers,” explains Hunter, “is to sell the seller by offering him the biggest commission. The higher the commission, the higher the premium, so while normal competition drives prices down, reverse competition drives them up.”
Even in closely regulated states, the nature of this competition makes it difficult for consumers to evaluate the products. Not quite salesmen, lenders clearly “recommend” the purchase: “you’ll find it well worth your while,” writes Shearson. Moreover, the consumer can’t shop brands: “You’re dependent on your lender,” says State Farm Life Insurance actuary Terry Huff, “to offer you a good deal.”
But endorsers have a financial interest, taking not just finance charges, but a commission, “dividend” or “administrative allowance” that in some states is half the premium. They also do their part vigorously, even urging the insurance as they write a loan; up to 60% of their customers may take this “over-the-desk” insurance, while 5% would be a good response to a mailing.
They also know their best market-- the insurance ingenue, a relative newcomer to questions of family security. Says Ray LuBien, senior vice president of Security Pacific Insurance Services in San Diego, “It’s going to appeal most to someone who doesn’t have a lot of other basic coverage”--most commonly, life insurance.
It might not appeal to that customer either if he considers the alternatives, rarely mentioned by lenders. Credit insurance is tied to specific loans, paying off that obligation alone. The money even goes directly to the creditor: “It doesn’t even give your heirs the right to decide what to do with the money,” says Hunter, “though they might prefer to keep a $50,000 loan at 8% and do something else with the insurance money.”
What’s more, covering each insurance need separately, says Hunter, is “like buying toothpaste in individual portions squeezed from the tube. You should figure out your family’s total needs--not just paying off loans, but food, clothes, housing for X number of years, and buy insurance in aggregate amounts.” Indeed, since life insurance gets cheaper, the higher its limits, “you might buy more efficiently if you’re covering more,” says Huff.
But nothing’s sure: the basic rate isn’t the only consideration. Nothing’s simple either: if it’s hard to evaluate such specialized credit insurance all by itself, it’s even harder to compare it methodically to other, more general coverages--the subject of the next column.
