Credit protection insurance sham

Credit protection insurance makes an easy dollar for lenders and insurers, but for consumers there are far smarter options.
 
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01 .Introduction

Toy house & car

In brief

  • Credit protection is a largely hidden insurance, which covers your debt and repayments if you die, become sick or lose your job.
  • CHOICE found credit protection insurance is disproportionately expensive compared with life insurance.

In this era of financial uncertainty, an insurance that at first glance seems cheap, convenient and promises to cover your loan repayments against potential disasters such as unemployment or sickness appears too good to be true. Unfortunately, CHOICE has found it really is. Our investigation concludes that credit protection insurance is a rip-off, as other options give you far better and cheaper cover.

Please note: this information was current as of March 2009 but is still a useful guide to today's market.


What is credit protection insurance?

Credit protection insurance (also called consumer credit insurance) covers your credit card, home loan or personal loan debt and repayments in the event of your death, terminal illness, disablement or unemployment. It is generally available with a mortgage, personal loan or credit card, is optional and in no way connected to mortgage insurance, which is usually compulsory if you have a home loan deposit of less than 20%.

It tends to be offered as a package, such as combined disablement and unemployment covers. If your claim is accepted, your debt is usually covered in the case of death or terminal illness and the repayments for disablement or unemployment. However, there are plenty of hidden catches and traps.

Why is credit protection a rort?

  • It’s very expensive: for a similar premium you can buy $500,000 life insurance or credit protection insurance worth only $2500. The life insurance policy would leave your family 200 times better off in the case of your death.
  • Only 1% of policyholders make a claim, compared with 13% of car insurance and 9% of sickness and accident insurance policyholders.
  • About 12 out of 100 claims are rejected, which is much higher than most other insurance options.
  • Only 15% of premiums income is returned in claims payouts to policyholders. This makes it very profitable for insurers and lenders who usually receive a 20% commission.
  • Other types of insurance on average use 74% of premiums for claim payouts to policyholders.

CHOICE verdict

There are about one million expensive and, in many cases, unsuitable credit protection policies. For most people, credit protection may not cover your needs and is usually more expensive than other insurance options. There are much smarter options to make sure you’re covered if something unexpected happens.

It is essential to have an emergency fund; if you have children or other dependants, think about how much money would be needed in the event of your death to cover their education and other needs. Usually the cheapest way to do this is to take out life insurance through your super fund. Also consider income protection insurance, trauma and total and permanent disability insurance, which cover you in the event of an illness, accident or disability.

 
 

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02.How much does it cost?

 

Credit card protection insurance: You usually pay a percentage of your credit card balance. ANZ CreditCover Plus charges 0.79%, which is about $237 per year if you spend $2500 per month on your card, for which you receive only very little cover.

Home loan insurance: The premium is calculated as a percentage of your loan balance, which varies depending on your age. With CBA, for a $500,000 home loan over 25 years, if you’re 49 years old and take cover for death, terminal illness, trauma, unemployment and disablement you pay $4680 per year for the life of the loan. This compares with an average premium amount of about $1090 through industry super funds for $500,000 life insurance (which usually includes terminal illness cover) combined with $75,000 income protection insurance ($3125 per month for up to two years).

Personal loan protection insurance: Premiums depend on variables, including loan term and amount. With Westpac, if you take out a $16,000 secured car loan over seven years you would pay $1542. The premium will be added to the loan itself, so you pay interest on it and your minimum loan repayments increase. At an interest rate of 8.49%, for example, you end up paying $2053.

Insurance table

Does it cover your needs?

In many cases, credit protection won’t cover your needs: depending on your card balance or loan amount, the cover amounts may be too small to make a difference, see the Credit Card Protection Insurance table, above. If you want to provide for your dependants, simply covering your debt is usually not enough as you would need to cover other expenses, such as your children’s education.

Only unemployment cover is exclusively available with credit protection – but it usually only covers repayments for a few months, not your living expenses.

Instead of taking out insurance at the start of the loan, make sure you don’t overcommit and talk to your lender if you become unemployed or sick. The Consumer Credit Code has hardship provisions and your lender should try to find a solution for you.

03.Alternative strategies

 

Alternative strategies recommended by CHOICE

The first thing to do is have an emergency fund that you can draw on if something unexpected happens. If you have a mortgage with a redraw facility, use this to store some emergency funds. Otherwise, use a high-interest online savings account. Then consider taking out insurance to cover yourself and/or your dependants. Both life insurance and income protection insurance are usually cheaper to take out with superannuation.

Life insurance is the best choice for covering dependants. As a rule of thumb, the sum insured should be 10 times your salary. However, you may need more depending on your individual circumstances – consider how much you owe, how many children you have and their age, for some example premiums see the table below. You’ll also need cover if you have a loan in joint names or someone else is guarantor for the loan. If you’re single and don’t have any dependants, however, you usually don’t need life insurance cover even if you’re in debt. As AMP’s Ken Lockery says: “What can they do? It’s up to the lender to see if they can recover the debt from your estate.”

Income protection insurance pays up to 75% of your salary if you cannot work because of illness. Premiums vary depending on your risk factors, the waiting period until the benefit kicks in and the duration of cover, which ranges from two years up to age 65, see the table above.

Insurance premiums table

Trauma insurance If you’re not employed because you’re looking after children, you usually can’t take out income protection insurance. Consider trauma insurance instead, which pays a lump sum in case you suffer one of a number of conditions, such as cancer, stroke or heart disease.

Total and permanent disability insurance pays a lump sum if you become permanently disabled because of an accident or an illness such as a stroke. You can be insured against either not being able to do your specific type of work or any work generally. One advantage credit protection has over other insurance options is that premiums for normal life insurance and income protection vary depending on risk factors such as age, type of employment and health.

With credit protection, you generally don’t need a health assessment so it may therefore be more convenient and easy to take out. Be aware, however, that credit protection may not cover pre-existing conditions. Make sure you read the product disclosure statement and be clear about the cover it provides.

04.Victims of credit protection

 

Improper selling of credit insurance is rife. Some lenders promote it heavily and it can be difficult to get out of.

Katherine Lane, Principal Solicitor at the Consumer Credit Legal Centre NSW, has seen people who have been sold credit protection insurance with unemployment cover while being unemployed at the time. This cover only applies if you have been employed for a period of time before you become unemployed, so the cover was worthless for them.

In 2005, GE Money was investigated by the Australian Securities & Investments Commission (ASIC), which found it had:

  • Advised customers to take out credit protection covering their death in addition to a normal life insurance policy.
  • Routinely advised singles without dependants to take out life insurance.

Subsequently, GE Money gave ASIC an enforceable undertaking to change the sales practices employed by its Hallmark insurance businesses. However, in May 2008 ASIC took action when Hallmark failed to comply.

We have received further reports about problems with GE Money. Alison from Queensland took out an interest–free deal to buy a combination microwave. On her first statement she found a charge for credit protection insurance, even though at no time during the sale was this cover explained or even mentioned to her. Alison was forced to ring GE Money and cancel the cover.

Hard sell

When George called his bank to activate his new credit card it took much longer than usual. The consumer service officer used the time to try to sell him credit protection, which he declined.

However, a week later, George received a letter from his bank congratulating him for taking out cover. He soon discovered how difficult it was to get out of a contract to which he’d never agreed. He immediately called the bank to cancel but was told he had to send a letter including the certificate of insurance. The bank cancelled the contract after he sent the letter. CHOICE has since lodged a complaint with ASIC about George’s experience.

Problems with claims

Scott from Adelaide took out credit protection for a $10,000 personal loan to buy a motorbike and consolidate some debt. He paid a premium of about $1000.

When he lost his job, he rang his lender to make a claim but was only able to talk to the insurer after two further calls. He had to fill out a number of forms and needed a statement from his former employer, but was uncomfortable asking for it. He was told it would take two weeks to process the claim but his lender refused to suspend his repayments until the claim was processed. Scott gave up and asked his father for a loan instead.

Only about 1% of credit protection policyholders made a claim in the 12 months to June 2006 – far fewer than with other types of insurance. In the same period, about 12 out of every 100 credit protection claims were rejected, much more than most other types of insurance. The reason for this is very tight exclusions in the contract. “In general, the benefits of consumer credit insurance are weighted in favour of the lender,” says Ken Lockery, AMP Director Personal Wealth Protection.