Debt protection and credit insurance are high-cost, low-value products that are poorly understood by consumers and inadequately monitored by regulators. The new Consumer Financial Protection Bureau created by the Dodd Frank Wall Street Reform and Consumer Protection Act should shed some light on these often shady products.
First off, what are debt protection and credit insurance products? Both types of product have a similar function in that they can cancel or suspend all or part of a consumer’s debt in the case of a life-changing event, such as death, involuntary unemployment, disability, or birth of a child. The products are regulated differently, however. Since credit insurance is an insurance product, it is regulated by the states. Debt protection products are bank products regulated by federal bank regulators. Credit card issuers have largely migrated from using credit insurance products to using debt protection products, since federal regulation currently offers several advantages to the lenders, including the opportunity for higher profits.
Debt protection products are often marketed to consumers as a way to achieve peace of mind and to protect a consumer’s credit rating in times of crisis. A recent Government Accountability Office (GAO) report points out, however, that the benefits of these products are often limited, especially compared to their relatively high costs. The report found that consumers received just 21 cents in financial benefits for every dollar spent on debt protection fees—and 55 cents went to profits. In contrast, group life insurance paid out an average of 83 cents for every dollar of premiums to consumers, while individual disability insurance paid out 51 cents of every dollar of premiums to consumers. Credit card consumers pay more than 10 percent of their average monthly balance in fees for debt protection products (about $200 annually).
There are a lot of reasons why consumers don’t get much bang for their buck with debt protection products. If the product simply cancels a monthly payment for a period of time, savings would be minimal. For example, monthly payments are typically only 1 to 2 percent of a consumer’s balance—so, on a $2,500 balance, the consumer would save only $25-50 per month. Some debt protection products cap the amount of benefits a consumer can receive, but do not similarly cap fees. If a consumer has a $20,000 balance, and the product has a limit of $10,000 of benefits, the consumer still pays fees for $20,000 even though only $10,000 of the debt would be cancelled in the event of his or her death. Debt protection products are typically bundled together for a variety of situations, such as coverage in the event of a consumer’s death, personal disability, and periods of unemployment. This bundling results in some consumers buying coverage for which they would receive little benefit. For example, in the event of the death of a consumer with no net assets, his or her heirs would not become responsible for his or her debt, so credit life coverage would be of little use. Consumers with certain preexisting health conditions would receive limited benefit from credit disability protection. In most cases, money spent on debt protection fees would be better spent on paying down debt or accumulating savings that would allow consumers to continue making monthly payments in the event of an emergency.
Additionally, regulatory attention to debt protection products has been relatively scarce. Debt protection products are largely regulated by the Truth in Lending Act (TILA), which governs disclosure of terms and conditions. However, fees for debt protection products do not have to be disclosed with credit card applications or opening documents. The Office of the Comptroller of the Currency, which regulates many providers of debt protection products, has additional regulations regarding misleading advertisements and disclosures. Nonetheless, it is still difficult for consumers to access information on terms and conditions before they purchase debt protection products, making it difficult to evaluate their appropriateness. The GAO contacted the nine largest credit card issuers and asked for the terms and conditions of their debt protection products. Seven out of the nine refused to provide the information without purchase of the product. A Federal Reserve study cited in the GAO report has found that consumers could not correctly calculate the amount of fees they would pay on debt protection products and did not understand certain limits on benefits.
The new Consumer Financial Protection Bureau will take over regulation of debt protection products in July 2011. Clearly, there is much work to be done to disclose the disproportionate costs of these products and improve public understanding. We encourage the CFPB to also closely evaluate the appropriateness of the pricing of debt protection products and determine whether current disclosures and fees are abusive, unfair or deceptive. The CFPB should also launch a campaign to improve public understanding of debt protection products by requiring issuers to disclose terms and conditions in advance of the product’s purchase, disclose the maximum possible fees a borrower could pay, and clearly explain eligibility limitations and exclusions.