The high cost of insuring your loan

2015-03-03 06:00

Despite an investigation into the rates charged by credit providers for insurance, borrowers are still paying high rates for credit insurance. writes Maya Fisher-French

If you were stuck for cash and needed to borrow R5?000 – which you would pay back over only four months – how much do you think you would pay for that loan?

Well, if you are a high-risk client (a low-income earner with a bad credit history, employed in a sector with high retrenchment rates), that loan could cost you more than 50% in insurance, fees and interest.

Concerned debt counsellors and legal aid lawyers have shown City Press examples of the kind of loans their indebted clients are struggling to repay. Much of the cost is due to high rates charged for credit life – the insurance you pay when you borrow money.

In the case of a R5?000 loan repayable over four months, between interest, credit life and service fees, the client would pay a massive R2?840 in costs – more than half of what was borrowed – in just four months.

Of those costs, the highest by far is the credit life insurance at a massive R1?155 – payable as a R288-per-month premium. That represents about 40% of the cost of the loan.

In another example, a customer borrowed R6?000 to be repaid over four months with a total repayment of R9?383. Again, the R3?383 paid in costs represents more than 50% of the value of the loan and the credit life insurance made up more than 40% of the costs – R1?386 payable as a premium of R346 a month.

Research conducted by Treasury last year found that, in general, the rates charged for credit life were around 10 times higher than for stand-alone life cover, such as funeral cover. It also found that commissions paid to sales consultants were as high as 40% of the total premium paid.

Kobus Jordaan, managing executive at insurance company Guardrisk, which underwrites many credit-insurance policies, says one cannot compare a long-term insurance contract such as funeral cover with a short-term policy of a few months.

“The cost of issuing and administering this type of policy is only recovered over three to four months, as opposed to much longer periods in the traditional life insurance space,” he says.

However, in its paper, Technical Review of the Consumer Credit Insurance Market in South Africa, Treasury and the Financial Services Board recommended that credit life should be capped at a premium of about R4 a month for every R1?000 borrowed. Some credit providers are charging rates as high as R56/R1?000 – more than 10 times the recommended rate.

What are you paying for?

Willie van Aardt, CEO of Finbond Mutual Bank, which issues short-term microloans, argues Treasury’s recommendation is based purely on death benefits.

“Our clients, who voluntarily elect to make use of our combined credit life, retrenchment and disability cover insurance, enjoy not only death benefits, but also retrenchment and defined loss-of-work benefits, as well as temporary and permanent disability cover.”

However, Leanne Jackson, the head of market conduct strategy at the Financial Services Board, says any price caps to be proposed under the National Credit Act “are not intended to relate only to the price of death benefits, but will also address pricing of disability and retrenchment benefits. The various proposals in the report are not intended to be confined to death benefits, but are aimed at a fair-value proposition for all aspects of consumer credit insurance, including additional benefits such as cover for disability and retrenchment, as well as short-term insurance asset cover.”

While any legislation around the capping of rates will include all insurance benefits, rates can vary significantly depending on what cover is provided for by the credit provider.

City Press has examples of other microloan agreements where the credit premium charged was far lower – around R13 to R17 a month for every R1?000 borrowed. In these cases, the insurance covered life and retrenchment events.

This is still substantially higher than the rate recommended by Treasury, but it raises an important point – as a borrower, you do not have to take cover that includes expensive disability and critical illness cover.

For example, Capitec insures its own book and not individual clients, so there is no policy in the name of the individual and no direct charge to the client. Capitec’s cover includes death and retrenchment and pays balances in full for loans of six months or longer. If you are retrenched when the loan is less than three months old, 50% of your loan will be covered., which issues monthly loans, does not require any credit-insurance cover, although monthly or “pay-day” loans do tend to be more expensive, so one needs to make a comparison on the total costs.

Can you shop around?

While a microlender may, for example, only offer customers the more expensive cover that includes extended benefits, their customers are theoretically free to shop around, hence Van Aardt’s comment about cover being “voluntary”.

This assumes, however, that the customer has been made aware of his or her rights and can find alternative stand-alone insurance.

FinMark Trust, which conducts research on access to financial products, undertook research into the credit-insurance industry, which included sending mystery shoppers to request a loan.

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 cede existing cover.

FinMark Trust’s research found that many low-income earners were not necessarily educated enough to understand their rights around credit insurance. Through interviews with people who had just taken out loans, FinMark Trust researchers found that the customer had little awareness around credit insurance and saw it simply as “just another finance charge”.

Researchers found most consumers were more focused on buying the item they wanted and whether their loan would be approved than asking questions about the total cost.

Research by Treasury found that although theoretically customers were 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 could accept, thereby limiting the customer’s options and forcing them to take the insurance through the credit provider.

FinMark Trust’s researchers 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.

Even if a consumer is aware of his or her ability to choose alternative cover, there are also few options available to borrowers when it comes to stand-alone insurance cover.

Guardrisk’s Jordaan says the company does not at this stage offer this service, although there is a growing demand for it.

A customer can cede an existing policy to the credit provider, but if they do not have cover, then the only real option open to consumers is to be aware of the credit-insurance premium charged by a credit provider and to make comparisons, not only on the monthly instalment but also on the final total cost of the loan.

As Finbond’s Van Aardt points out: “If the client does not like what is quoted, the client walks out of the door to any of the many other credit providers in the country.”

Once the final recommendations from Treasury are issued, they will regulate the cost of insurance, but it is important we remain active consumers.

If you are going to borrow money, get quotes from other credit providers, understand the costs of the credit insurance and what cover it provides and remember you can cede an existing policy.

What is a reasonable cost?

Under the objective of treating customers fairly, a credit provider must not offer or demand that a consumer purchase or maintain insurance that is unreasonable or at an unreasonable cost to the consumer.

So what is a reasonable cost? The problem is that for a certain profile of customer, the risk of lending to them is almost too high to charge a “reasonable rate”.

Kobus Jordaan, managing executive at insurance company Guardrisk, explains that the risk of the client is a determinant in the rate charged for insurance.

So your credit risk – your credit behaviour and outstanding loans – is a determinant of your insurance risk. This risk is assessed by the credit provider and the insurer charges accordingly.

“The rate protects the credit grantor against bad debts in the event of an unforeseen event happening to the borrower, and is not a traditional mortality tariff.

As the credit risk is higher in the unsecured lending market, this influences the insurance rate, which has a correlation to the total cost of credit. Many other instances exist where the ‘credit score’ is used as an additional rating factor for insurance cover,” says Jordaan.

While some microlenders playing in the higher-risk space charge monthly premiums as high as R56 per R1?000 borrowed, traditional banks that may not service the high-risk market have rates as low as R5 to R6 per R1?000.

Draft proposals around consumer credit insurance will be released later this year, but the question is whether people in high-risk markets will be able to access credit at all if the rates are capped.

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