Until a few years ago, collateral protection insurance was an obscure byproduct of the auto lending business. Banks routinely carry this form of protection for vehicles whose owners fail to keep up payments on their own car insurance policies.

It's not obscure any longer.

Nearly 40 suits concerning collateral protection insurance, or CPI, as it is popularly known, have been filed against banks and insurance companies since 1989. Consumers, angry that the banks charge them more for the collateral policies than they would have paid if they hadn't let their own policies lapse, are suing their lenders.

None of the cases has yet gone to trial because the companies hit by litigation have concluded it is cheaper to settle. But the settlements are costly: $19 million for Jacksonville, Fla.-based Barnett Banks Inc. in October; another $16 million for First Interstate Bancorp, Los Angeles, in 1992; and $6 million for Pittsburgh-based Mellon Bank Corp. in 1990.

|Going to Be an Explosion'

In the biggest bloodbath yet, the California arm of Ford Motor Credit Co. settled for $58.3 million in September.

"There's going to be an explosion of this kind of litigation across the country," warns Mark A. Chavez, a Walnut Creek, Calif.-based attorney who has spearheaded most of the class actions directed against banks. "If banks haven't cleaned up their program by now, they're taking some really serious risk going forward."

Like a two-by-four brandished in anger, the suits have certainly gotten the industry's attention. Many banks began modifying their collateral protection policies after the Mellon settlement, so most of the current litigation focuses on pre-1990 practices. Banks can't afford to drop the practice completely because they need to be sure the cars they have made loans on are always adequately covered, regardless of whether the owner has been remiss. But it's clear banks must do something about the issue.

Trying to Cut Liability

Virtually all large auto lenders are now working to reduce their potential liability. "I spend about 30% of my time now just on legal conversations about CPI," says John Anthony Munaretto, national manager/financial institutions for the Dallas office of interstate National Corp., a subsidiary of Fireman's Fund Insurance Co.

"It used to be a product that maybe the senior vice president of installment loans got involved with; now there's a board decision being made on the product."

Collateral protection insurance, sometimes called "vendor single interest insurance," is a stopgap measure for banks.

Average Life of 90 Days

The average life of Interstate National's collateral protection policies is 90 days, according to Mr. Munaretto, who says just 16% go to a full year.

The bank's collateral is protected during that period but only up to the amount of the loan balance. Thus, if a $20,000 car with a $3,000 balance gets totaled, the bank recovers just the $3,000 still owed it.

The problem is that some customers don't read or don't understand the notices they receive from the bank saying collateral protection has been applied - "force-placed," in industry jargon.

Another problem: Some policies contain hidden riders or endorsements that go beyond the usual comprehensive and collision coverage, such as coverage for premium reimbursement or repossession expenses. Plaintiffs' attorneys say such charges should not be put on the borrower, who has no say in the matter.

A final bone of contention involves premium "rebates" - kickbacks" in the view of plantiffs' attorneys - made by the insurance companies to the banks to win accounts.

Banks say such rebates represent valid "account servicing" charges necessary to defray the high costs of administering a collateral protection program. But critics say there's not enough disclosure to the consumer about these fees.

"There's nothing wrong with the collateral protection product," Mr. Munaretto says. "What's wrong is how the insurance companies were selling it to the banks and how the banks got a little greedy."

Mr. Munaretto, who has been selling the product for about 10 years, says competitive pressures spurred insurance companies to tack on additional features to their policies.

Higher Premiums a Problem

These features provide greater protection for the banks but also increase premiums for the consumer. Higher premiums, perversely, make it more likely that borrowers will default.

"We found it best that the premiums be as low as possible because then they become collectible," says Mike Perrone, president of Fields Financial Services Inc., a Bryan, Tex.-based data processor for bank collateral protection programs.

Consider Dorcas Mitchell Inmon, a Barnett customer in St. Petersburg, Fla., who ended up with a $1,500 insurance bill five years after paying off a $4,000 loan in 1988. (Her bill was so high partly because it included accumulated interest). "They were unfair to me," she complains, referring to the bank.

|Glad When It's Over'

The car Ms. Inmon purchased in 1985, a 1980 Chevrolet Caprice, now sits in her front yard with a blown engine. Ms. Inmon had wanted to trade the Caprice in before it reached that state of disrepair, but she could never obtain title from the bank because of the insurance claim.

Ms. Inmon now hopes to benefit from the recent Barnett settlement, but the most she or any other Barnett borrower can receive credit for is $500.

"I'll be glad when it's over with. I sure to God will," she says wearily.

Bank attorneys are reluctant to speak for attribution. But off the record, they acknowledge that one reason they have been settling these cases is a fear of hostile juries.

One attorney illustrates the bank's dilemma with a hypothetical example: "So they bring in Mr. Jones, who had a 1985 Corolla and for four years didn't have insurance on it, and the bill comes to 10 grand between the principal and the interest. So you stand there in front of the six fine jurors who have bought their own insurance and have an idea what it costs and you explain to them why there's a $10,000 premium on that car that only covers the bank's interest.

"And who is it you're fighting with during this three-year period?" the attorney adds. "Who is it you're deposing and aggravating? Your customers. If you can come up with a reasonable settlement and a reasonable way to work it out after a cost-benefit analysis, I think you're going to find damn near every bank settling it."

A Good Living

Such reasoning is music to the ears of Mr. Chavez, who earns a very good living suing banks over collateral protection insurance. Since 1992, he and his co-counsel have settled some of the industry's biggest cases: Barnett; First Interstate; BankAmerica Corp. ($9 million); Bank of the West ($3.7 million); Wells Fargo & Co. ($1.1 million); and Nissan Motor Acceptance Co. ($3.5 million)

His biggest victory came in the $58.3 million Ford Motor Credit case, settled in September after 21/2 years of litigation. A press release by Ford Motor Credit states clearly the company's concern about "the risk of a runaway jury verdict."

Mr. Chavez, a partner in the firm Farrow, Bramson, Chavez & Baskin, declines to discuss his compensation. But attorney fees are a matter of public record. In the Barnett case, they amounted to $3 million, shared by Mr. Chavez's firm and his Miami-based co-counsel, Gerald F. Richman.

Cleaning Up

Mr. Chavez doesn't think attorney fees are an issue. "The reality of it is there were some victims out there and it wasn't the banks," he says. "What we've done through this litigation is clean up the industry. We've dramatically altered the types of practices that occur."

Mr. Chavez says he became interested in collateral protection insurance in 1990, when a man who had been painting the house of one of his partners came into the office with a story about how his vehicle had been repossessed.

During the course of his research, Mr. Chavez learned about the 1990 Mellon case, which had first signaled to banks that they may have a serious problem with the product. Building on the lessons learned from that litigation, Mr. Chavez began suing banks in California, Arizona, and Florida, working through co-counsel in the latter two states.

Other attorneys have filed unrelated collateral protection suits against auto lenders in Ohio, Pennsylvania, Georgia, and Alabama.

Focus May Change

Mr. Chavez's list of pending suits reads like a Who's Who of Banking: in California, Security Pacific Corp. (a BankAmerica predecessor company); General Motors Acceptance Corp., Tokai Credit Corp., Ford Motor Credit Co., and Toyota Motor Credit Co.; in Arizona, Security Pacific and Ford Motor Credit again; in Florida, NationsBank Corp., First Union Corp., Chase Manhattan Corp., SunTrust Banks Inc., General Motors Acceptance, and Ford Motor Credit.

Up to now, Mr. Chavez has focused on subsidiary banks chartered in specific states, because it was the easiest way to research the cases. But he says the next development is likely to be settlements with large holding companies that cover their entire franchise nationwide.

Angry Customers

However well the banks and finance companies defend themselves, they aren't likely to escape cheaply. And in the meantime, they've got some angry customers to contend with.

Cheryln Storace of Largo, Fla., bought a 1987 Hyundai Excel with a $14,000 Barnett loan cosigned by her father. When she paid off the loan in 1992, Barnett presented her with a $4,166 bill for collateral protection insurance that had been force-placed by the bank after she let her collision insurance lapse twice.

This became a problem for Ms. Storace's father when he tried to refinance his house and found the Barnett loan listed as a problem credit. Ms. Storace finally settled the insurance claim for $2,500, but remains miffed at Barnett. "Everybody goes through hard financial times in their lives. They weren't willing to work with you in any way," she says.

Ms. Storace knows that the maximum she can recover from the $19 million settlement is $500, but she doesn't care. "If I don't get anything back, it will be okay," she says. "It would be nice just to see Barnett suffer a little bit."

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