Borrowing money is not much fun. Not only do you have to jump through hoops to get the loan, but once you have it, you face months or years of cash drain to pay it back.
And during that time there is the chance that something will happen to you. You might become ill or disabled and unable to work; or, you might die. If that happens, how does the loan get repaid?
One way, of course, is through insurance. Prudent people carry enough life and disability insurance to see them (or their heirs) through these kinds of spots -- to pay their debts and taxes and to provide for their spouses and offspring if need be.
Such insurance can be purchased individually or through group plans run by employers. In addition, there are all sorts of terms and plans one can buy.
But there is one sort of insurance you should think twice about before buying. It's called credit insurance, and it is sold by auto dealers, banks and other lenders, many of whom get fat commissions off it. People who have adequate life and disability coverage don't need credit insurance at all, and insurance regulators across the country are worried that those who do need it have to pay excessive premiums to obtain it.
North Dakota Insurance Commissioner Earl D. Pomeroy said an investigation by his department "found premiums to be disgracefully overpriced" and that payouts by policies to cover consumers' claims were "wholly inadequate."
Pomeroy told a recent hearing of the National Association of Insurance Commissioners (NAIC) that he believes "that our experience is quite representative of the situation in most of the states in this country."
The NAIC released figures showing that "loss ratios" -- the amount paid out in claims compared with the amount collected in premiums -- are far lower for credit insurance than most other insurance. Credit life insurance, for example, has an average loss ratio of 37.6 percent last year, meaning that for every $1 in premiums, only 37.6 cents went back to consumers in claims. The rest was retained by the insurers for overhead and profit.
Credit insurance can be subdivided into several categories -- credit life, credit disability (or accident and health, often dubbed "A&H"), credit unemployment and credit property. Credit life pays off the loan if you die, credit disability and credit unemployment make payments for you if you are out of work, and credit property covers the item that the loan is secured against.
Credit life and disability are by far the most common.
In addition to the price, the marketing of these products raises other issues that trouble regulators. Among them:
There is no competition at the consumer level. The salesman is often the lending officer, and the only policy a consumer is offered is the one the lender is selling. Indeed there is what is called "reverse competition" in the industry -- a situation where insurers vie for the business of lenders, not by offering a better deal for the consumer but by offering bigger commissions for the lender.
Despite tougher laws, lenders often leave borrowers with the impression that the insurance is required, or they conceal the sale in other documents so that borrowers sign up for coverage without realizing they are doing so, according to consumer advocates. Industry representatives dispute these charges, noting that consumers must sign a document acknowledging that they understand the coverage is not required and that they wish to purchase it. However, two insurance commissioners at the hearing recalled being billed for credit insurance on credit card accounts when they had not signed up for it.
In many states, credit life insurance pays both the principal and the interest due on a loan, rather than simply the outstanding loan balance. Normally, if you pay off a loan, you pay only the remaining principal, but credit life policies often compute their benefit by taking the amount of each loan payment and multiplying by the number of payments remaining. The policy beneficiary gets to keep the excess, but the consumer has purchased more insurance -- and paid higher premiums -- than he or she needed. Since the premium for credit life insurance is almost always a one-time charge that becomes part of the loan, it boosts interest costs to the borrower. Thus, any overcharge for the coverage is magnified by the financing costs.
The industry witnesses at the NAIC hearing defended their practices as necessary to doing business.
While the price per $1,000 of coverage may seem excessive when compared with ordinary term life insurance, said William F. Burfeind, executive vice president of the Chicago-based Consumer Credit Insurance Association, credit life policies are usually for smaller amounts and are relatively more costly to administer.
Burfeind drew an analogy to buying milk -- it's more expensive by the quart than by the gallon.
So if states set arbitrary minimum loss ratios or maximum prices per $100 of insurance, as the NAIC is considering, companies may find it impossible to sell the coverage at all.
In addition, if commissions are cut, insurers will lose market share or the market will shrink, industry representatives said. Car dealers, for example, "will sell Scotchgard instead" of insurance to car buyers, said Dennis DiMaggio of American Bankers Insurance Group.
Burfeind emphasized, and consumer advocates agreed, that credit insurance does have a place. It makes sense for people who have families to protect and who cannot afford term life insurance, where policies typically must be at least $50,000. And since there are no medical criteria to meet, it is available to people who are otherwise uninsurable.
At the current price, however, credit insurance is of questionable value to those who can get other coverage. Some states, notably Maine, New York, Vermont and a few others concentrated in the Northeast, have tightened the premium limits, but in others insurers can charge dramatically higher premiums.
A study by the National Insurance Consumer Organization found that costs on credit life coverage for a four-year, 12 percent $10,000 loan varied from 28.1 cents per $100 of coverage in Maine to $1 per $100 in Alabama and Louisiana. The cost was 49 cents in the District, 51.6 cents in Virginia and 56 cents in Maryland.
But even in the tough states, the cost of normal term insurance is substantially less, so the bottom line for most people is this: Analyze your insurance needs, including your debts, and buy a comprehensive package to cover them. Not only will your coverage be more comprehensive and your family better protected, but you'll save money as well.
To help you figure out how much insurance you ought to have, in the next two weeks this column will provide work sheets for calculating disability and life insurance coverage.