Uninsured collateral? You’ve got options.
Hey, you booked an auto loan! That’s wonderful. I bet your financial institution requires insurance on this asset. And your loan agreement states it must be secured and maintained for the life of the loan, right? Why?
Because the car is also the collateral. So it needs to be protected.
Most borrowers purchase individual coverage. If everyone did that, this article would end here.
However, there are a small percentage of borrowers who either do not, cannot, or simply refuse to do so.
This leaves lenders like you at risk to loss. Fortunately, there are two popular solutions for the lending institution:
- Collateral Protection Insurance (CPI)
- Blanket Vendor’s Single Interest (VSI)
Full disclosure: We offer VSI as part of our Mission-Focused Toolkit. It might be a fit for your institution. We explain why it’s our choice in the VSI section below.
Today, our focus is on the first product, Collateral Protection Insurance (CPI).
So, what is it?
Collateral Protection Insurance is lender-placed coverage on unsecured collateral which has no personal insurance policy. It protects the lender’s loan balance in case of loss of collateral while uninsured.
CPI – A Brief History
During the 1980s, the banking industry had some high-profile problems. Maybe you’ve heard of the Savings and Loan Crisis? According to banking regulators, unsecured loans given by banks was one factor that contributed.
To deal with the challenge of unsecured lending, banking regulators suggested that borrowers applying for home or vehicle loans must carry insurance. The recommendations ensured protection on the value of the loan in case the collateral suffers any damage.
New loan agreements added a mandatory requirement to insure loans taken against all assets.
In 1996, The National Association of Insurance Commissioners (NAIC) released their Creditor-Placed Insurance Model Act. The Act standardized Collateral Protection Insurance programs across states where it was adopted.
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Borrower Must Maintain Insurance
Once a loan is disbursed, the responsibility for maintaining insurance coverage is on the borrower. So what happens if they suddenly fail to quality or allow it to lapse?
Lenders would then be responsible for obtaining insurance on their collateral. The cost of this insurance is passed on to the borrower. But how would the lender even know?
Interesting historical note: Technology made CPI possible.
The Need (and Challenges) Behind CPI’s Origin
How can a lender keep track of which loans had active insurance and which may have lapsed? What about accidentally duplicating coverage? Remember, we’re talking about the 1980s. It was hard enough getting rid of the flashing 12:00 on the VCR.
Their answer: Track it!
Agencies developed sophisticated, for the time, “tracking” systems. These connected borrowers and their insurance carriers to notify them when coverage lapsed. It’s the same concept in use today.
Speciality insurance companies built a coverage model to offer this as a protection product.
Institutions added this to their portfolio, and ensured loan agreements allowed them to add policies if needed. Thus, the practice known as “forced-placed collateral protection insurance” (CPI) was born. Not without some bumps along the way.
Take Every Reasonable Action
Following the introduction of CPI, borrowers complained about additional premium costs. Class action lawsuits found in favor of borrowers. Beyond settlements including financial awards, a new compliance process began.
Now, lenders (using their tracking providers) send notifications before any insurance is made effective. To ensure clarity, they must include a series of color-coded physical notices.
Lenders are required to take every reasonable action to give the borrower time and opportunity to secure and/or reinstate their personal insurance.
How Does CPI Work?
Once CPI becomes necessary, the premium is added to the loan automatically. It’s usually on an annual basis. This, of course, increases the outstanding balance. Lenders have two choices at this point: Raise monthly payment or extend the original term.
In case you had any lingering suspicions…yes, CPI is paid by the borrower, as they pay down their loan.
For the Borrower
CPI is almost always more expensive than individual policies. Typically, the premium is a percentage of the total amount of the loan. Depending on remaining loan balance, borrowers may find themselves paying a hefty sum for the CPI premium.
How much, exactly? CPI pricing is based on each individual auto loan and influenced by specific state policies and insurance providers. As a result, average premium price is not available.
What else affects the cost of CPI? Two major factors:
- Policies are not underwritten
- Issuance is guaranteed
Ironically, borrowers with a poor driving record, who fall into higher risk categories (and thus cost), may actually find coverage through CPI cheaper than an individual policy. Wild, right!
What if the borrower secures their own insurance? That’s fine and expected. The product is built to be pushed aside when no longer needed.
When the lender (or their CPI vendor) receives proof of insurance, the force-placed policy terminates on the effective date of the new personal insurance. The borrower is only responsible for CPI premiums while coverage was in force. The system credits any overpayment back to the borrower’s loan.
For the Lender
Generally, the lender has no costs with CPI. However, there are optional lender paid coverages (discussed in following section) if they so choose to add. The vendor is compensated through commissions with their CPI insurance carrier.
The largest “cost” for the lender is one of responsibility. Once a CPI program is implemented at your financial institution, the provider must guarantee the issuance of collateral protection policies.
For the Provider
The core of CPI is the detection of lapsed or added coverage, thus, their complex tracking software must be top-of-class. Profits from the program support the development and maintenance of their services.
Collateral Protection Insurance coverage is available in two forms:
- Single interest – Provides benefits and pays claims to one party (typically the lender)
- Dual interest – Provides benefits and pays claims to both parties (lender and borrower)
Today, most CPI programs are dual interest.
An important distinction for the borrower is that CPI covers only physical damage or theft to the collateral. Obviously, from a lender’s perspective, this makes sense, as those are the only direct risks to their collateral.
However, personal car insurance policies also provide liability protection. A driver with CPI is uncovered in the event of a liability claim. In many states, this means they would be operating the vehicle illegally.
Optional Lender Paid Coverage
As referenced above, the lender may opt for additional coverages, at their cost, within a CPI program:
- Loan Balance Protection: Provides coverage up to the loan balance when a Lender/Creditor Placed Insurance claim is paid based upon the Actual Cash Value (“ACV”).
- Broad Form Loss Payee: Eliminates deductibles on repossessions with Lender Placed coverage and provides coverage where limitation in the customers’ insurance prevents your financial institution from collecting on a loss.
- Premium Deficiency: Provides for 100% premium return, when a deficiency exists due to the premium, after repossession of the collateral.
- Repossession Expense & Mechanics Liens: Coverage for repossession expenses incurred in order to take legal or physical possession of the collateral, storage, and make payment to release a valid mechanics lien.
- Conversion & Confiscation (Skip Coverage): Provides coverage when the borrower has sold, traded, or disposed of the collateral, or the borrower and the collateral cannot be found.
- Repossessed Collateral: Provides physical damage coverage once the lender has possession of the collateral for up to sixty days.
- Instrument Filing Error & Omissions: Provides protection for an unintentional error or omission in the recording of a lien which bars the lender from repossessing the collateral.
CPI – The System (And Tracking)
As you’ve come to understand, CPI depends on the status of the borrower’s personal policy. It must be able to immediately respond if this coverage lapses. That takes technology and data.
Contrary to regular insurance, CPI providers offer high-level monitoring, services, and management. All the private insurance data of borrowers is obtained and kept updated to meet the requirements of CPI.
This constant and consistent tracking includes communication between the lender and borrowers. As described above, the system must provide clear notice to the borrowers when they no longer have adequate or any active insurance.
This helps ensure all collateralized loans are backed with an active insurance policy, thus protecting the lender.
When the borrower does not respond within a stated time frame, the system:
- Issues the insurance,
- Advises and bills the lender,
- Automatically adds it to the borrower’s loan balance.
If the borrower sends proof of insurance, this tracking ensures that the process happens in reverse and borrowers receive their refunds.
Alternatives to CPI
Collateral Protection Insurance is the most common form of force-placed coverage for vehicle loans. It is not the only option for a financial institution.
Below, we share two other ways lenders may protect their auto loans.
No matter the route you go, we want to ensure you have the best information available for your due diligence.
Vendors Single Interest (VSI)
Vendors Single Interest (VSI), also known as Lenders Blanket Single Interest (LBSI), is another type of insurance a lender may use to mitigate auto loan risk. Unlike CPI, it does not require a tracking system, as it is automatically added to every loan.
From a mission standpoint, we prefer this option, as it eliminates a punitive fee to the member. Plus, since everyone always has coverage, there’s no warning letters nor expensive protection to add. It’s easier and treats the members better. Essentially, mission-focused.
Hybrid CPI combines aspects of VSI and traditional CPI to serve the unique needs of the non-prime market. It is charged to the borrower monthly on a fully earned basis.
CPI For More Than Auto Loans!
While the majority of CPI programs are leveraged for auto loan portfolios, they are also used for:
- Real Estate (personal, commercial and farm)
- Protection for specific events including:
Thanks To Our Sources
We want to take a moment to thank our sources who helped provide much of the information in this article. Each offers CPI/VSI and had helpful guidance to share.
Of course, as part of our mission of honesty and transparency, we include “competitors” as well, since we understand our solution may not be the best fit for your institution. If interested, gather source material here:
Ending Our First CPI Journey
Collateral Protection Insurance (CPI) combines traditional insurance coverage with highly-connected tracking to help lenders manage and mitigate risks to their portfolios. VSI provides blanket coverage to achieve the same goal with no tracking nor member contact necessary.
We recognize that one of the programs are essential for your institution. Plus, helping avoid uninsured losses prevents delinquencies that hurt the credit union and member. No one wants to get involved in repossession.
CPI and VSI both prevent this loss and any possible negative effects on your portfolio. And, despite our reservations with sending aggressive letters to members, both can help keep members in their cars. That’s an important and mission-focused goal.
This is only the beginning of your CPI education and decision journey! We have other articles which compare Hybrid and Traditional CPI, discuss the advantages & disadvantages of a Vendors Single Interest (blanket) program, and more.
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