Collateral protection insurance

Collateral Protection Insurance, or CPI, insures property (primarily vehicles) held as collateral for loans made by lending institutions. CPI may be classified as single-interest insurance if it protects the interest of the lender, a single party, or as dual-interest insurance coverage if it protects the interest of both the lender and the borrower.

Upon signing a loan agreement, the borrower typically agrees to purchase and maintain insurance that must include comprehensive and collision coverage and list the lending institution as the lienholder. If the borrower fails to purchase such coverage, the lender is left vulnerable to losses, and the lender turns to a CPI provider to protect its interests against loss. There is a need for CPI in the market because in the United States nearly 15 percent of all drivers are uninsured.^[1]

Lenders purchase CPI in order to manage their risk of loss by transferring the risk to an insurance company. By doing so, lenders also protect the interests of their customers, borrowers, and investors. Unlike other forms of insurance available to lenders, such as blanket insurance that impacts borrowers that have already purchased insurance, CPI affects only uninsured borrowers. CPI is therefore designed to be equitable to the lender and insured borrowers.

Additionally, depending upon the structure of the CPI policy chosen by the lender, the uninsured borrower may also be protected in several ways. For instance, a policy may provide that if collateral is damaged, it can be repaired and retained by the borrower. If the collateral is damaged beyond repair, CPI insurance can pay off the loan.

How CPI Works

When a borrower takes out a loan for a vehicle at a lending institution, he or she signs an agreement to maintain dual-interest insurance, protecting both the borrower and the lender with comprehensive and collision coverage on the vehicle throughout the life of the loan. The borrower provides proof of insurance to the lender, which is verified by the CPI provider or a tracking company.

If proof of insurance is not received, notices are sent to borrowers prompting them to obtain required coverage. If responses to notices are not received, the lending institution may choose to have CPI coverage “force-placed” on the borrower’s loan to protect its interest from damage or loss.

The lending institution passes the premium charge on to the borrower by adding the premium to the loan principal and increasing the loan payments. If the borrower subsequently provides proof of insurance, a refund is issued.

Throughout the life of a loan, the CPI provider monitors proof of insurance to ensure that policies remain in force. If policies lapse, notices are sent in accordance with the procedure outlined above.

Past Problems

Interest in collateral protection insurance increased in the late 1980s when, in response to a bank crisis, regulators recommended that assets securing loans be insured and, if borrowers did not obtain insurance, that lenders obtain CPI. The rise in CPI activity generated by this recommendation also coincided with a number of consumer complaints, including suits from borrowers.^[2]

Borrower lawsuits were often prompted by lenders’ providing inadequate disclosure regarding the right to force-place CPI policies, force-placing policies with unnecessary coverages, and not disclosing they might be making a commission on the transaction. Additionally, some CPI providers had administrative problems with their programs, including the inability to receive and process insurance documents in a timely manner and ineffective tracking technology. These problems resulted in sending unnecessary letters to borrowers, issuing policies to borrowers who were in fact insured, and delays in processing premium refunds when proof of insurance was received, all of which served to exacerbate borrower complaints.

Title 4. Regulation of Interest, Loans, and Financed Transactions Subtitle A. Interest Chapter 307.Collateral Protection Insurance CREDITOR LIABILITY. (a) A creditor, its insurer, or the insurer's agent that places collateral protection insurance in substantial compliance with the terms of this chapter is not directly or indirectly liable to a debtor, cosigner, or guarantor or any other person in connection with the placement of the collateral protection insurance.

(b) This chapter does not impose a fiduciary relationship between the creditor and debtor. Placement of collateral protection insurance is for the principal purpose of protecting the interest of the creditor if the debtor fails to insure collateral as required by the credit agreement.

(c) A creditor is not required under this chapter to purchase collateral protection insurance or to otherwise insure collateral. A creditor is not liable to a debtor or any other person for failing to purchase collateral protection insurance, failing to purchase a certain amount or level of coverage of collateral protection insurance, or purchasing collateral protection insurance that protects only the interests of the creditor or less than all the interest of a debtor. This chapter does not create a cause of action for damages on behalf of a debtor or any other person in connection with the placement of collateral protection insurance.

Market Response and Current State

Lenders improved their contract language to address the disclosure problems that existed in the past. Additionally, the practices and supporting technologies of the CPI market have evolved since the 1980s. Today, leading CPI providers provide online tracking systems that are updated in real time and are used by providers, borrowers, and lenders to communicate and coordinate on insurance-related issues.

CPI providers have also implemented electronic data interchange (EDI) with borrowers’ private insurance carriers in order to maintain current information on required insurance. This has enabled CPI providers to more accurately place insurance only on noncompliant borrowers and to process adjustments and refunds quickly when proof of insurance is subsequently received.

Because of the improvements made in CPI administration, interest in CPI insurance again increased through the early 2000s to the present day. Additionally, a driving factor behind the growth in the CPI marketplace has been in the longer duration of loans. For instance, by mid-2003, the average length of an auto loan at credit unions exceeded 62 months.^[3] The longer the term of a loan, the more likely it is that a borrower will be in a negative-equity, or “upside-down,” situation. Borrowers who are upside down are also more likely to default on loan payments, resulting in more repossessions for lenders who then must deal with uninsured damage to repossessed vehicles.

Notes

1. ^ Insurance Research Council, “Uninsured Motorists—2006 Edition,” June 2006.
2. ^ Class Action Dilemmas: Pursuing Public Goals for Private Gain, Deborah R. Hensler, Nicholas M. Pace, Institute for Civil Justice (U.S.), Beth Giddens, Erik Moller, Jennifer Gross. Published 2000 by Rand Corporation.
3. ^ Credit Union National Association, “Auto-loan terms hit record, CU has 96-month term,” November 26 2003.