Debt Cancellation Product Poised for Takeoff

Credit insurance may be soon replaced by debt cancellation agreements on a variety of consumer loans. The Office of Comptroller of the Currency (OCC) is finalizing new rules governing such agreements for release in early 2002. The rules are expected to encourage more banks to offer the product in conjunction with loans.

From the consumer's standpoint, a debt cancellation agreement functions much like traditional credit insurance. For a fee, the lender agrees to cancel or suspend payment on the borrower's loan in the event of death, serious injury, unemployment, or other life events. Some large banks offer such agreements now, but most banks have been reluctant to offer the product because they lack standardized guidelines for consumer protections and liability. Jim McIntyre, general counsel for the American Bankers Insurance Association said that banks are hoping that regulators will provide some assurance that debt cancellation contracts are safe and relatively risk-free.

Gary Fagg, the president of CreditRe, an accounting, actuarial and management consulting firm, told the American Banker, "I anticipate a strong upswing when the (OCC) regulation comes out." According to the OCC, about 5% of the roughly 2,200 national banks currently offer debt cancellation contracts, and just 23 offer debt suspension. Mr. Fagg says "I think credit insurance will drop from a $6 billion industry to a $2 billion industry by 2005. Eventually, the debt protection concept will fundamentally replace credit insurance at most institutions."

Both credit insurance and debt cancellation agreements remove the borrower's loan obligations. However, the former requires premium payments to and claim payouts from a third party institution, the insurance company. In contrast, a debt cancellation agreement is a loan product instead of an insurance product, and eliminates the need for the insurance company. Moreover, it is regulated by the OCC and state banking agencies, while credit insurance is regulated by state insurance commissioners. Because a debt cancellation agreement is not governed by state insurance laws, banks have more freedom to adjust the application and pricing to fit customer needs.

Currently, for the right to cancel debt in case of death, borrowers pay anywhere from 30 to 80 cents per $100 of a loan's remaining balance per month. Most banks limit the product to loans under $10,000. Banks are also letting customers suspend their loans upon disability, involuntary unemployment or other types of life events that typically fall outside the scope of insurance products. CrediRe recently designed debt suspension products for divorce, military relocation and even the incarceration of a spouse.

Interestingly, in spite of the potentially greater flexibility of the debt cancellation agreements, the Consumer Federation of America views both debt cancellation agreements and credit insurance as unnecessary. Bob Hunter, the CFA's insurance director, told the American Banker, "Debt cancellation and credit insurance are technically the same thing—it's like butter and margarine. But, most consumers have no need to buy either."

Banks that have been offering debt cancellation contracts for some time seem pleased with the product. First National Bank of Eastern Arkansas in Forrest City has sold the contracts on about 15% of its loans over the past 10 years. BankAtlantic Bancorp (Ft. Lauderdale, FL) began offering the contracts about 9 months ago, primarily to boost their non-interest income. About 19% of loan customers since then have taken the product.