Loan Zone: Auto Loan Compliance
This is bonus coverage from the February issue of CUES’ Credit Union Management magazine.
For financial institutions, avoiding risk completely is impossible. However, managing risk surrounding auto loans is definitely achievable with a well-developed collateral protection program. An effective program enables a financial institution to monitor and mitigate risk associated with procedures, processes, compliance and consumer-friendly services. The following overview of best practices and metrics should be considered when initiating and sustaining a collateral protection program.
1. Implement fair premium rates.
Noticing a premium added to a loan balance for lacking auto insurance can be stressful for consumers—especially when they are actually maintaining adequate insurance. Your program can prevent this type of stress by determining which consumers are truly insured. Adding a fair premium to consumers’ loan balances when they lack adequate insurance is necessary; the challenge is maintaining as low a rate as possible to be fair to the borrower while providing the financial institution with adequate coverage should something happen to the vehicle.
2. Focus on consumer benefits.
A good auto insurance program focuses on providing the best possible consumer experience. Such program features as fair premium rates, grace periods and the friendly handling of impairments—such as non-payment or listing the lienholder on a borrower’s policy—all serve as benefits to consumers. Grace periods offer extra time for a borrower to provide their own adequate car insurance, removing the penalty for borrowers who experience a short lapse. Similarly, certain impairments—such as recognizing a deductible in excess of a financial institution’s limits—should not be reason to place insurance and add a premium to an auto loan balance.
3. Practice consumer-friendly refund processing.
It’s critical for a program to process premium refunds quickly. Providing a refund for a premium the creditor placed on an auto loan should begin immediately after a consumer provides proof of insurance and should be completed as quickly as possible. Regulatory standards typically require that a financial institution make such a refund within 15 days of receiving proof of insurance. When refunding, a consumer-friendly refund method should be employed. For example, pro rata (proportional) refunds are fair to consumers and follow industry-wide standards, including those set forth by the National Association of Insurance Commissioners and the Consumer Financial Protection Bureau.
The CFPB prohibits unfair, deceptive or abusive acts and practices. Programs should avoid the inclusion of policy fees, processing fees and interest on fully refunded premiums. In addition to putting your credit union at risk of violating UDAAP regulations, these unfair practices can create consumer aggravation and a negative brand perception.
4. Adopt a strategic approach to consumer notifications.
When considering managing the risk associated with insurance on collateralized loans, it is important to recognize that only a very small percentage of borrowers do not maintain their own insurance. Typically, just 1 to 3 percent of the auto loans in a credit union’s overall portfolio are uninsured. Determining which borrowers do not have insurance versus which borrowers have not provided insurance verification is a large part of a successful collateral protection program.
The content and delivery of insurance verification notifications should be considered and executed strategically to help your credit union stay compliant and maximize consumer response.
Although sending notices through the mail may seem like a thing of the past, this method continues to exist as part of many programs’ engagement efforts, often due to regulations. However, in addition to traditional notification methods, newer enhanced programs engage consumers in ways that accommodate a variety of consumer lifestyles. For example, emails, texts and various other digital messages are now employed. Engaging with borrowers in a way that encourages response and adapting your program to acknowledge the diversity in communication preferences is key.
5. Provide multiple avenues for verification.
Verifying insurance on auto loans is a necessary practice for every program, and doing so quickly and accurately requires a little more effort than simply sending notices and relying on the consumer to respond. Many programs employ a variety of practices to obtain proof of insurance. Traditional methods include electronic data interchange, manual entry into an insurance tracking database and call center operations. In addition to these services, programs may also employ such proactive techniques as interfacing with insurance carriers on behalf of the consumer and outbound calls to agents to verify refunds and maximize refund accuracy.
Instead of strictly requiring physical documentation, it is beneficial to open up additional avenues to verify insurance. Programs may enable digital uploading of insurance information, which helps minimize the administrative burden for credit unions by allowing consumers to self-verify their insurance, and it allows consumers to upload their documents in real time while the subject is top of mind.
6. Stay focused on the service.
The primary purpose of a collateral protection program is to monitor and mitigate risk. The program’s services should focus on keeping your credit union’s interest in vehicles protected while maintaining a positive and effective line of communication to consumers. However, some financial institutions may view the program as an opportunity to generate revenue. Due to industry rules and regulations, generating revenue through policy fees, processing fees and other administration fees paid by the consumer is not encouraged. Even if such fees are issued within regulation, in many cases the risk of potential brand damage does not offset the revenue benefit.
7. Measure the program’s success with performance metrics.
To gauge the success of a collateral protection program, it’s important for a credit union to regularly review performance metrics. Many key performance indicators provide insight to a program’s effectiveness, including premium charged, claims data and loss ratios. Understanding the number of consumers who have lender-placed insurance (lender-placed insurance penetration), how many were fully refunded after placement (false placement rate), the notice per loan ratio and the verification efforts that took place are important indicators to measure.
Including measurable data taken from the perspective of the insurance carrier, predictive analytics, peer benchmarking, data analysis and measuring the effectiveness of consumer engagement will help ensure the program is well-rounded and carefully designed to mitigate risk.
Strong collateral protection programs should adapt and evolve based on the needs of the members served by your credit union. A program should supplement, rather than dictate, auto lending strategies to satisfy your overall goals. Taking advantage of alternative approaches and advanced technology will help programs sustain the health of auto loan portfolios.
* This document is for informational purposes only and should not be construed or relied upon as legal advice. The information may not reflect the most current legal developments and regulations vary by state. Contact your attorney to obtain advice with respect to any particular issue.
David Hilger is CIO of CUES Supplier member Allied Solutions, Carmel, Indiana.