Default insurance may be one key to increasing lending, according to one person.
Credit unions, nearly all of which are seeking to make more loans, have an opportunity in underserved markets, but often are leery due to associated risks, said Rob Rusch, VP-associate general counsel with CUNA Mutual Group. The answer, he told NASCUS' annual meting, lies in mitigating that risk through default insurance.
"Moving into non-prime lending is one way credit unions can reach their growth goals and in the process keep many members from falling prey to alternative 'high-rate' lenders," Rusch said. "Default insurance is an effective tool in helping credit unions obtain better bottom-line results, while at the same time addressing a credit union's safety and soundness concerns."
Rusch, along with co-presenter Steve Martin, VP-lenders protection insurance with CUNA Mutual, identified the benefits of default insurance to credit unions and members, examined the problems regulators and credit unions had with past default insurance programs, and discussed new business models to effectively address those problems.
"The number of non-prime vehicle loans turned down by credit unions each year is estimated at $40 billion to $50 billion," said Rusch. "When a member is denied by their credit union, they look for alternatives and usually find the non-traditional lenders that charge anywhere from 2% to 5% above what they could receive from their credit union. With default insurance, a credit union can increase the number of loans it makes to near- and non-prime borrowers while greatly reducing the risk."
Rusch cited a number of benefits default insurance brings to credit unions, and members:
For credit unions:
* Serving underserved members.
* Increased loan approvals.
* More booked approvals.
* Increased loan applications.
* Enhanced lending profitability.
* Managed risk on non-prime loans.
For members, they said the benefits include:
* Loan approval for more "borderline" members.
* Lower interest rates.
* More favorable loan terms;
* Lower cost for voluntary coverages.
Martin acknowledged that previous default insurance business models have failed, for which he cited a variety of reasons.
"One problem was the instability of the insurance carrier. A credit union needs to be assured their insurer is stable and will be around for at least the length of the loan," said Martin.
Another problem with older default insurance models was the insurer being too far away from the transaction, he suggested, adding that they eventually lost control of the program. "They didn't make decisions on individual loans and instead were looking at entire portfolios," said Martin. "Additionally, there were some unrealistic yield projections and underwriting was left to people lacking proper skill sets."
If a credit union considers utilizing default insurance, due diligence is crucial, said Martin. "Know the stability of the insurer, the product, the pricing, and what ongoing support the insurer will provide. Will they be close to the experience? How quickly will you get underwriter information?"
Martin said a default insurance model that works is one that makes decisions at the point of sale, and one that has risk shared between the insurer and the financial institution.
"A credit union needs to turn a default insurance proposal inside out and apply their own evaluations and assumptions to determine the risk involved, and what kind of yield they can expect," said Martin. "You also need to continually monitor the program's results to determine if adjustments are necessary.
"Over time, credit unions will gain experience and realize that lending to higher-risk members is manageable. With that experience they may find approvals on some of these loans can be given without the use of default insurance."
