When Pandora King bought a new $5,430 Mustang from an Arlington automobile dealer last February, she paid an extra $900 for a short-term insurance policy that guaranteed repayment of her car loan if she died or became disabled.

The insurance she bought is called "credit insurance," and last year Americans paid $3 billion in premiums for it.

Many businesses, banks and retailers, particularly appliance and car dealers, require that potentially poor credit risks take out the credit insurance, though it is strictly voluntary under U.S. law.

According to Bob Hunter, deputy administrator of the Federal Insurance Administration, rates for the credit insurance are four to 10 times higher than rates for insurance sold by insurance agents.

The precentage of claims paid falls far below the national average for other types of insurance, according to federal and state officials.

In Maryland, for example, residents paid more than $17 million in credit insurance premiums last year. Yet, Maryland insurance companies paid out only $3.5 million because of loan defaults, leaving them with $13.5 million, much of it profit. Those ratios are typical nationwide, according to consumer interest groups, although few states keep track of the amount of claims paid out and national figures are unavailable.

Further, say the critics, few consumers realize that most dealers take a sizable commission on these policies, or that some local dealerships, including Dick Blanken Ford, have formed their own insurance company to increase their share of the profits.

Several area dealers, who privately acknowledge they require credit insurance of some customers before going through with a sale, are in open violation of such federal laws as the Truth in Lending Act, according to James B. McMahon, minority counsel for consumer affairs of the House Banking Committee.

Interview with U.S. and state officials and local businessmen showed that:

Area car dealerships get 55 percent to 60 percent of the premiums as a commission for selling credit insurance that guarantees their own loans. Blanken Ford's commissions on credit insurance last year totaled $123,481.

Dealers finance the cost of insurance at the same rate as the loan on the car, often at rates as high as 24 percent.

Blanken and 30 other Virginia dealerships found credit insurance so lucrative they set up their own insurance firm in Arizona, Commonwealth Dealer's Life Insurance Company (CDL). That is a typical "front operation" to skirt the more rigorous insurance licensing requirements of Virginia, according to Hunter.

CDL president Bruce Furr, a Virginia resident, aknowledges that CDL has no officers or employes in Arizona, has never written an insurance policy in that state, and received all of its $4 million in premiums last year from policies written by Virginia car dealerships.

Another consumer, Jeffery Grice, a 25-year-old custodian who lives in Suitland, paid $511 in credit insurance on a second-hand Ford he bought for $5,480 from Brown Lincoln-Mercury in Arlington. The $511 permium, like the car loan, was financed at a 24 percent interest rate.

Grice, who said he already had life and disability insurance as a federal employee, said he was pressured into buying the insurance to get financing.

A Brown Lincoln-Mercury spokesman, who asked not to be named, said it is "company policy" to require insurance of individuals with poor credit. He said Grice's credit insurance later was canceled at Grice's request and the premium credited against the cost of the car. Grice said he had received no such word from the dealership.

At Blanken Ford, a spokesman said he tells all customers that credit insurance is strictly voluntary. If the rates are exorbitant, he said, it is the fault of the insurance company, not the dealership.

But by forming its own Arizonabased firm, Blanken Ford in effect is the insurer. The arrangement gives Blanken "a little bigger piece of the action," said owner Dick Blanken.

According to Howard Clark, a former South Carolina insurance commmissioner who now is with the Federal Insurance Administration, creditor-owned insurance companies typically incorporate in Arizona. The state's cash requirement for establishing an insurance company is the lowest in the nation, only $37,500.

Two years ago Blanken Ford joined about 30 other Virginia dealerships, each hand-picked for its good "F & I operation" that is its finance and insurance business.

With a contribution of $1,250 from each dealer-giving them the requisite $37,500-they set up Commonwealth Dealer's Life Insurance Company (CDL) as an Arizona insurance company.

Arizona was selected, acknowledged Blanken, for its low cash requirements. Virginia requires insurance companies to have $2 million minimum to sell insurance in Virginia.

CDL is not licensed to sell insurance in Virginia and is not subject to Virginia's insurance laws. Instead, CDL contracted with Great Equity Life Insurance Company, a Chicago firm licensed in Virginia, and has them insure policies written by the Virginia dealerships.

CDL, according to Furr, "reinsures" those policies (repays Great Equity for any claims paid out). Great Equity receives 7.5 percent of the premium essentially for lending its name and its Virginia license to the operation.

An employe of the company that owns Great Equity said the reinsurance agreement with CDL is a legitimate business arrangement, one that is common throughout the industry.

"It's a ruse to get around the Virginia insurance law. The protection being sought for the Virginia insured is being thwarted," said Hunter, the Federal Insurance Administration deputy.

According to Blanken, "They (Great Equity) are an underwriter, not a front, but an underwriter." He points out that if CDL did not repay Great Equity for its claims, Great Equity would still have to make good on the dealer's policies.

Still, according to Furr, the Arizona company will return an additional 7 percent of the premium to dealers such as Blanken, giving them a total of between 61 and 62 percent of the commission.

A credit insurance industry spokesman, James Kielty of the Consumet Credit Insurance Association, says consumers are not overpaying for credit insurance. He also denies that there is coercion or pressure on consumers to purchase credit insurance and cities a 1978 study by the Federal Reserve Board which came to the same conclusion.

(A March, 1979 study conducted for the Independent Insurance Agents of America, Inc. disputed those findings and called the FRB study seriously flawed.)

Kielty says credit insurance rates, which nationally average about 60-65 cents per $100 of coverage, provide barely adequate profits. Lower tates, he says, would kill the industry, stripping consumers of insurance that protect them from reposession in difficult times.

"Any further reductions and we'll return to the old way of pounding at the door for the last two payments on the car when the breadwinner has died," warned Kielty.

But James Montgomery, acting superintendent of insurance for the District of Columbia says Kielty's warnings are not justified. Credit insurance rates in D.C. have been among the lowest in the nationa since 1962-49 cents per $100 of coverage-and there is no shortage of credit life insurance in the district of Columbia, he says.

Half a billion dollars in credit life insurance policies were written in D.C. last year, and that, says Montgomery, is proof that 39 cents per $100 coverage provides a "reasonable profit" to the credit insurance industry.

Virginia's regulations will lower the rate on credit life insurance from 78c cents per $100 coverage to 60 cents in July, but even that, said state insurance commissioner James W. Newman Sr., is still too high.

"The lobby on credit insurance is very, very strong-it's bankers, small loan companies, insurance companies, and car dealers," said Newman, who says Virginia's credit insurance laws "are very much weighted to the creditors.

"The consumer's voice is small. Big interest groups have exerted more influence than the average citizen can. Legislators," says Newman, "have not adquately responded to the consumer side of this particular issue."