Clamp down on credit insurance abuse

2014-09-28 15:00

Despite laws to protect consumers from unscrupulous lenders, very little of this protection is experienced in reality, writes Maya Fisher-French

If you have borrowed money, whether through a furniture retailer, microlender or a bank, you will most likely have credit insurance because the National Credit Act stipulates mandatory credit insurance when taking out a loan. This insurance money would be used to settle the debt should the borrower die or become ill.

Unfortunately, unscrupulous lenders are using it to circumvent the limit on fees and interest rates placed on them by the National Credit Act by charging excessive rates for credit insurance.

In 2012 alone, premiums of about R16?billion were paid by borrowers for credit insurance.

In its technical review of the consumer credit insurance market in South Africa, the Treasury found that, in general, the rates charged for credit life insurance were about 10 times higher than for stand-alone life cover such as funeral cover, with commissions as high as 40% of the total premium paid to sales consultants.

The furniture retailers were by far the most expensive in terms of cover, with credit insurance costs on average making up 15.6% of the total cost of loans compared with 4% for personal loans.

They also found that although customers are theoretically entitled to shop around for cover or cede existing cover, this was not always easy to do and the lender would often place restrictions on the type of cover they would accept, thereby limiting the customer’s options, forcing them to take the insurance through the credit provider.

The Treasury also found that claims made on credit life policies were less than half that experienced in stand-alone life insurance products (20% versus 45%), which suggests that few people actually understand that they have taken out credit insurance or how to claim

on it.

Reshma Sheoraj, the director of the insurance, tax and financial sector policy at the Treasury and who is heading the consultation process on credit insurance, says these findings suggest that “credit insurance serves the credit provider rather than the customer”.

In 2013, FinMark Trust commissioned research on credit insurance through research house Cenfri.

The research was conducted through mystery shopping, which analysed quotations from credit providers offering credit insurance as well as comparing advertising in printed media.

Interviews with customers who had taken out loans with credit insurance were also conducted.

The research found that credit providers encouraged people to buy up to the maximum their credit rating would allow and that 89% of people interviewed said credit was easy to obtain.

The researchers also found that basic requirements under the National Credit Act were not met, with 26% of furniture retailers and 15% of microlenders not asking for bank statements.

Furthermore, nearly 30% of furniture retailers and 48% of microlenders did not undertake an affordability assessment. The researchers also found a lack of transparency when it came to providing the total cost of credit, with the full costs only disclosed after the customer had accepted the quote.

Of the mystery shoppers, only 21 out of the 35 (60%) were given details of the credit insurance they were required to take out and only five were told they could shop around or use exiting cover.

Interviews with people who had taken out loans found that they had little awareness around credit insurance and saw it simply as “just another finance charge”. Researchers found most consumers were focused on buying the item they wanted and finding out whether their loan would be approved, rather than asking questions about the total cost.

FinMark’s researchers found that credit insurance costs typically made up 50% of the initial credit value (see graphic) and 20% of the total repayable amount.

The details of the policy were not properly disclosed, with only 32% of customers told about how to lodge a claim. Only 15% of customers were told about commission or fees.

FinMark’s findings suggest that despite laws to protect consumers, very little of this protection is experienced in reality.

The findings suggest more information will not necessarily lead to better decisions because people suffer from decision fatigue – what is required is a simpler, more regulated environment where less financially literate consumers can trust the products they are offered and make easier comparisons.

Solutions

The Treasury is looking at several options to curb the abuses in this market:

.?Capped rates: This would be in the form of a cap on the maximum an insurer can charge for specific cover or through a cap on the total cost of a loan versus the current model, where there is only a cap on interest rates and services fees.

.?Self-insure: There is also a proposal for credit providers to insure the risk themselves. This would be a cost borne by the provider, which they would then build into the cost of the loan, possibly through higher rates. The benefit of this is it would be easier for a customer to compare quotes because cover would be standardised. However, this would require a lifting of the interest rate cap on short-term loans.

.?Better advice: Consultants selling credit life would have to be Financial Advisory and Intermediary Services compliant and be held responsible for the product they sold. They would have to produce proper records of advice and could be penalised if they did not comply.

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