Tomorrow is a mystery. It’s as much so for your institution as it is for your borrowers. A loan offered today with all the due diligence imaginable might be tomorrow’s write-off.
Sadly, one accident, health condition, or other malady can affect a person’s current employment, causing a cascade effect onto their credit score and future ability to repay. And this isn’t limited to the next sunrise. It’s each one between loan closing and maturity.
Possible Negative Life Events
We all look forward to the positive, while dreading the negative. The things we hope never occur, unfortunately, do happen. And they always seem to do so when it’s least expected.
All of these can place your loan at risk, while also putting the financial future of the borrower and/or their families in jeopardy.
Negative life events may include:
- Job lay-off
You’re all about reducing or managing risk. That’s why you have a range of insurance products. As a community financial institution, it is your role to educate and introduce such opportunities where they may do the most good.
One such tool is payment protection. As mentioned in our overview article, there are two main product categories that may accomplish your goal:
- Credit Insurance
- Debt Cancellation and Suspension Contracts
This article will assist you with a complete review of credit insurance:
- How it fits within today’s evolving banking industry
Our Transparency Pledge
We offer credit insurance. Of course, your needs vary from one institution to another, and our solution may not be a fit. Our goal is to make sure you have everything you need to review and make the right decision for your institution and borrowers.
- What is Credit Insurance?
- Types of Credit Insurance
- Underwriting & Exclusions
- Benefits for Borrowers
- Benefits for Lenders
- Cost of Credit Insurance
- Expand Your Knowledge
What Is Credit Insurance?
Credit insurance, as defined by Investopedia, is “a type of insurance policy purchased by a borrower that pays off one or more existing debts in the event of a death, disability, or in rare cases, unemployment.”
It is sold to help mitigate the risk to both borrower and lender. The insurance contract is between the policyholder and the insurance company. However, claims are paid to (and by) you, as the lender.
As an insurance product, it is regulated by each state’s insurance department. This may include oversight of:
- Rates & Commissions
How does that affect your offering? Let’s take a look.
It’s an insurance product. So, that means you need a license. Is that a big deal? I wish we had an easy answer for you. Unfortunately, it depends on your state (and states it will be offered). Some states require only a company license, which you can get with a simple application. Other states insist all staff complete an approved course and pass the exam.
Rates & Commissions
Insurance departments set what is known as prima facie rates. These rates are determined based on an actual history of claims. Each insurer must utilize these rates, which are filed with the state when charging for their coverage.
As a result, you may check these rates at any time with your state insurance regulator. Annually, rate adjustments are evaluated based on claim experience.
However, the Consumer Credit Insurance Model Regulation, adopted by most states, declares that insurers cannot request rate deviations unless their loss ratios exceed 60%.
“Loss ratio”: Incurred claims divided by the sum of earned premiums and imputed interest earned on unearned premiums.
Why operate in this way?
It keeps rates low for borrowers. Portfolio profitability also sees an impact, as well as commision limits paid to the lender.
Now you have a better feel of how regulations on licensing and rates/commissions affect the credit insurance products. It’s time to look at the range of solutions it can offer for your borrowers. At the top of the list is the most popular: Credit Life
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Types of Credit Insurance
Credit Life Insurance
Available as Single Life (Borrower) and Joint Life (Borrower or Spouse/Partner). It seeks to pay off a loan if the borrower (or partner, if joint) dies while holding the outstanding debt.
Credit Disability Insurance
Available only to the borrower. If they have a medical problem and cannot work, this coverage covers the monthly payments for a specific time. Of note: Benefits are subject to a waiting period, typically between 14 and 90 days, depending on the policy wording.
Credit Involuntary Unemployment Insurance
Applies to borrowers who lose their jobs through no fault of their own, typically through layoffs. Like credit disability, the insurance will take over the monthly loan payments for a specified time period. It may have a waiting period before benefits begin.
Credit Property Insurance
Unlike the previous coverages, this option isn’t related to the borrower’s ability to repay their debt. Credit property insurance is generally “force-placed” when the borrower cannot or will not provide their own policy. It protects personal property used to secure the loan if destroyed by events like theft, accident or natural disasters during the term of coverage.
Get a lot more detail about this and similar coverages within our Collateral Protection articles.
Underwriting & Exclusions
Credit life insurance is not traditional life or disability insurance. What makes it different is that it is guaranteed issue. That means every person who applies will get the same coverage at the same rate. No medical records nor physical exams are required. Just completing a certificate.
Rates are based upon a per $100 of outstanding debt. To offset adverse selection, insurers will typically include a 6 month pre-existing exclusion. Coverage is underwritten at the time of a claim.
Beyond that first 6 month exclusion, pre-existing conditions (that existed at time of loan closing) resulting in a claim may still be a basis to deny the claim.
Credit Insurance Benefits For Borrowers
If a borrower can no longer repay a loan, they risk going into default. This causes a cascade effect of negative consequences.
Their credit score falls, making future loans more difficult to acquire (and more expensive if they do). Since many employers and landlords also check credit scores, default can even affect their ability to get a job or find a place to live.
It can get even worse. If the borrower dies before the loan is repaid, the obligation shifts to their survivors or loan cosigners. When that person was the primary income producer, it becomes even less likely the loan will see payments. Which means the collateral gets repossessed or foreclosed.
For a family already experiencing a challenging time, the loss of a car or their home may put them on a negative slide that’s nearly impossible to escape. Simply holding a credit insurance product lifts these burdens. The home stays. The car stays. Life can go on.
Credit Insurance Benefits For Lenders
As a community financial institution, the previous section may serve as benefit enough to offer said products. Yet there are advantages for the institution as well. Credit insurance:
- Reduces loan defaults & charge-offs
- Proceeds can pay off or pay down the outstanding balance
- Generates non-interest income
- Earn commissions on insurance policies sold
- Profit-sharing arrangements pay your institution from earned premium reserves, adding to your income
How Much Does Credit Insurance Cost?
The cost of credit insurance depends on a number of factors:
- Amount of the loan
- Type of policy borrower wants
- Type of credit being insured
As an example, the prima facie rate in the state of Washington for single and joint credit life is $.60 and $.96 respectively, per $1,000 of outstanding debt.
There are two ways to charge premiums, Single Premium Method or Monthly Outstanding Balance. Here’s what those mean:
Single Premium Method
In this option, the total cost of insurance is added to the total cost of the loan. As a result, the borrower pays interest on the insurance premium. If the insurance is canceled or loan is paid off early, they are generally entitled to a pro-rata refund.
Monthly Outstanding Balance
This is by far the more popular option. As the amount of risk decreases each month, the cost of insurance automatically recalculates to match the outstanding balance. Lenders may use this option for revolving home equity loans, credit cards, or even fixed loans such as car loans.
Monthly Outstanding Balance is divided into two categories:
The level of debt may vary month to month and can increase with time. Insurance companies charge the premium monthly, basing it on how much a borrower owes, either via an average daily balance or balance at the end of the month. Which is used depends on the type of policy offered to your borrower.
With this type of accounting, monthly insurance premiums will vary and are part of the minimum monthly payments.
The amount of debt that your borrower owes doesn’t change, and they pay the same amount each month. If your borrower fails to make the monthly payments on time, insurance premiums will continue to accrue, and the borrower may be required to pay an additional balance at the loan’s maturity date.
Expand Your Knowledge
Try as you might, you know it’s impossible to eliminate all risk of a loan going into default. However, you care about your borrowers, so you provide a range of protection products which can reduce those odds. Besides, what’s good for them is good for your institution! Everyone wins.
Since its introduction, credit insurance continues to be a major risk-management tool for lenders.
Is it the best option for your institution? That’s for your team to decide. We’ll be here answering your questions along the way.
If you haven’t already, make sure you look through our Payment Protection introduction piece. And subscribe to the Learning Library so you keep the insights coming to your inbox! You can expect 1-2 e-mails per week. Talk about manageable.
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