Credit protection is a service offered by U.S. banks in opening new credit card or other lending accounts. It provides for the customer's minimum payments to be deferred or made by the bank in the event of specified contingencies such as involuntary termination of employment.
Will our government, for instance the Consumer Financial Protection Bureau, soon move to protect consumers against banks that sell them such payment protection arrangements?
In the U.K., the financial regulator, FSA, and the high court recently prohibited continued marketing of similar "payment protection insurance" — including all sales made at the time of account opening. Furthermore, they will impose heavy liabilities for sales in prior years.
One U.K. bank has already acknowledged billion-dollar liabilities as a result of these decisions. The overall cost to U.K. banks in restitution and penalties is estimated at over $15 billion — excluding operating expenses and the loss of future revenues.
How could this happen? Products, pricing and marketing that appeared to enjoy regulatory and judicial tolerance for many years have now been found unacceptable — with retroactive effect. Could this also happen here? In the U.K., it is estimated that 3 million customers will be entitled to refunds. The figure for the U.S. could be much higher.
As the first person to develop this noninsurance bank product for credit cards and to market it in the U.S. through the bank holding company of which I was then chief executive, I find this situation of particular interest.
Before I introduced the product, credit and payment protection were underwritten by insurance companies, and centered on life insurance — which most bank customers didn't want. Such insurance delivered big profits to consumer finance companies and some other lenders, but was tightly regulated by most states.
The noninsurance credit protection that I introduced is not subject to such regulation. It is touched only by provisions of the Truth in Lending Act and federal laws and banking regulations that relate primarily to tying and to required disclosures. Credit protection quickly grew to be by far the most important add-on sold by banks to credit card customers, a major source of card-related income.
But credit protection products now sold by U.S. banks, particularly to credit card customers, may be subject to some of the same legal objections that hit their U.K. counterparts. These arise largely from findings of "unfairness."
One of the causes of action cited in the U.K. was that total benefits extended to customers were in some cases no more than a sixth of the total amounts paid for the protection, while marketing and operating costs were small.
In the U.S., typical fees for card credit protection, around 11% of balance per year, are more than half as much as the finance charges on the underlying credit — even though in a typical year only one in 20 card customers defaults and is charged off.
In the U.S. as in the U.K., the protection has tended to be offered on the same terms to all customers. U.K. regulators outlawed this as unfair to people such as those without employment, for instance, retired people and homemakers. But these people were not effectively warned about their limited eligibility for benefits, nor did product terms and pricing reflect it.
In a competitive market, why would millions of customers pay high premiums for payment protection — protection that was not suitable or useful for many of them?
The short answer is compelling. In the U.S., it is only the lender who can offer noninsurance credit protection on its own extensions of credit.
Any competitor proposing to protect payments on a lender's cards would be subject to insurance regulation — as well as having to pay for much less efficient marketing and much greater adverse selection.
No major institution has been willing to undertake this. Hence a bank offering credit protection to its borrowers effectively enjoys a monopoly position — and can price accordingly. If I don't like what my bank offers, my choice is either to do without credit protection, or to get the credit card itself from a different bank.
Given such imperfect competition, an allegation of "unfairness" is much more likely to be taken seriously by regulators and courts, particularly now, since Dodd-Frank has, at least arguably, subjected bank consumer services to a higher standard of fairness than was previously applied. Before, it may have been enough not to be overtly misleading and deceptive. That's no longer the case.
What if noninsurance credit protection were cut back in volume and price? Then banks would increase their APRs, just as they did when other card revenue elements such as over-line fees and default rates were constrained. But this "no brainer" solution won't pay the legal liabilities from past and current sales. If you're selling credit protection, face forward and take a good, hard look now.
Andrew Kahr is a principal in Credit Builders LLC, a financial product testing and development company. He was the founding chief executive of Providian Corp. and can be reached at
