In recent years, traditional credit insurance, the lending industry's long-time credit protection product of choice, started to give way to debt
cancellation and debt suspension products. The initial movement began in the bank sector but today, the migration from credit insurance to debt cancellation and debt suspension products (collectively, debt cancellation), is beginning to emerge in the credit union community. This product shift is being fueled, in part, by shrinking margins on interest income that have resulted in the need to develop new sources of non-interest income that are consistent with the credit union community's commitment to providing high member value. Additionally, recent revisions to the NCUA Incidental Powers rule identified debt cancellation products as a new service for credit unions.
While debt cancellation products bear some similarity to credit insurance, they are not regulated insurance products. With credit insurance, a third party (the insurance company) ''indemnifies'' the credit union member in the event of a specified loss. Debt cancellation agreements, however, are two party agreements between credit unions and their members in which, in exchange for a fee, the credit union agrees to cancel or suspend debt and/or waive finance charges should the member experience a predefined event such as death, disability or unemployment. Products can be developed for virtually any loan type including credit cards, equity credit lines and loans, auto loans and other secured and unsecured loans.
Advantages to the Credit Union
Debt cancellation products are amendments to loan agreements. They are lender owned and lender branded. Each credit union has the freedom to offer the combination of benefits that best match its member's needs and each credit union can set the cost - benefit equation that is in alignment with its desired balance of member value and non-interest income opportunity.
Because debt cancellation is a credit union product, not an insurance product, credit unions and their representatives need not be licensed to offer the products to members. Additionally, because debt cancellation programs can be uniform across states, with respect to the fees charged and the benefits offered, they tend to be less complicated and less expensive to administer and distribute than credit insurance products that can vary widely by state. This can be especially advantageous to credit unions with national or multi-state memberships.
A well managed debt cancellation program can also help to mitigate credit risk. Although credit unions have enjoyed relatively low loan delinquency rates as compared to banks and thrifts, current economic conditions and a broadening membership base mean that credit unions will inevitably face new credit risks.
Debt cancellation products can help members preserve their credit records and provide members and their families with much needed relief when faced with financial hardships such as death, disability or unemployment. They can also provide protection for a wide variety of events not typically covered under credit insurance. For example, benefits can be designed to help members with the financial strain often associated with life events such as marriage, divorce, the birth or adoption of a child, nursing home confinement, college enrollment, active military duty, hospitalization and relocation due to natural disaster.
Authority and Regulatory Considerations
The NCUA, OCC and OTS have all authorized their lenders to offer debt cancellation and Suspension products. In 1997, the NCUA issued a letter that opined that federal credit unions could offer debt cancellation agreements to their members. More recently, in its revised Incidental Powers rule, NCUA 12 CFR 721, issued August 2001, the NCUA specifically confirmed that debt cancellation contracts are a pre-approved power for federal credit unions, stating that, ''debt cancellation and debt suspension agreements provide a convenient and useful way for a federal credit union and its member to manage the risk of nonpayment due to financial hardship'' and that ''these agreements are appropriate financial tools for federal credit unions and their members.''
In addition to granting ''product authority'', revisions to NCUA regulations have removed the limits of non-interest income credit unions can earn.
While it is wise for state chartered credit unions to check the law governing their state of domicile, it is widely believed that under state parity provisions, state chartered credit unions can also offer debt cancellation products to their members. The majority of jurisdictions provide state chartered lenders with federal parity and have formally acknowledged that debt cancellation is a financial institution product not subject to state insurance regulation. The National Association of Insurance Commissioners (NAIC) has formally acknowledged that it does not consider these products to be insurance.
Case law and banking regulations dating back to 1964 support the authority of lenders to offer debt cancellation. As recently as September 2002, the Office of the Comptroller of Currency (OCC) issued final regulations on the subject (12 CFR 7 and 12 CFR 37) formally stating that debt cancellation products offered by national banks are ''loan products'', not insurance products, and therefore, are outside of the regulatory scope of state insurance departments. The regulations went on to ensure consumer protection by delineating specific requirements that lenders must meet in terms of program disclosure and limitations with respect to changing the terms of debt cancellation agreements. Finally, the regulation addressed safety and soundness by requiring banks to manage the risk associated with debt cancellation contracts and debt suspension agreements in accordance with safe and sound banking practices.
In addition to the NCUA and OCC the Office of Thrift Supervision (OTS) has also deemed debt cancellation as a permissible power for federally chartered thrifts.
Debt cancellation agreements are subject to Regulation Z requirements. As such, the fact that debt cancellation coverage is optional and not required to obtain credit must be disclosed in writing, debt cancellation fees must be disclosed to the member and the member must receive applicable Truth in Lending disclosures.
Another regulatory consideration relates to the taxability of debt cancellation benefits. While there is no definitive regulation concerning the taxable nature of benefits under a debt cancellation agreement, IRS Private Letter Ruling 200131027 (PLR) provides significant insight into the Internal Revenue Service's view of the taxability of debt cancellation benefits. The PLR takes the position that lenders are not required to issue a 1099-C when debt cancellation benefits are activated and a debtor's obligation is eliminated. Since, however, PLR's do not constitute a formal IRS ruling, each credit union should seek an opinion from its own tax advisor.
Managing Debt Cancellation Program Risk
The revision to the NCUA rule prohibited credit unions from ''self-insuring'' the debt cancellation claims risk. Subsequently, the NCUA reconsidered its position on this issue stating that credit unions can assess and prudently assume the claims risk for debt cancellation products. This position was reiterated most recently in a December 23, 2002 letter issued by the Office of the General Counsel of the NCUA. Credit unions can, however, transfer all or part of the risk to a third party - generally via a contractual liability insurance policy (CLP).
A CLP is a two-party casualty insurance contract between the credit union and an insurance carrier. Under a CLP, the credit union would be reimbursed for loan losses (canceled/ suspended debt and/or waived finance charges) stemming from its debt cancellation program claims.
Credit unions electing to assume all or some of their debt cancellation claims risk are advised to seek reserving and risk management advice from a risk manager experienced in debt cancellation.
Building a successful debt cancellation program really boils down to a few critical elements. First, the products offered must provide member value and enhance the member relationship. Second, claims administration and member service must be comprehensive and at the highest quality levels. Third, product fees must be actuarially sound and in harmony with the credit union's overall financial and member value objectives. Finally, the product marketing must be ''member friendly'' and the distribution channels and strategies must balance increased program participation with controlling risk.
Depending on start up objectives and available resources credit unions can either develop and manage all elements of their debt cancellation programs internally or elect to outsource some or all of the critical program elements to a qualified partner.
Credit unions that choose to keep all program development and functions in house will generally need to recruit staff with the necessary expertise to develop products, build infrastructure to support the program and develop and test marketing/distribution programs. Depending on the size of the credit union, the amount of resources dedicated to the initiative, the number of loan products for which debt cancellation will be offered and a host of other variables, the program start up period could range anywhere from one to three years. Credit unions, however, can dramatically speed up program implementation timeframes by outsourcing some or all of the critical program elements.
Credit unions that choose to outsource can capitalize on existing expertise and resources. By gaining access to existing product design capabilities, marketing strategies and infrastructure credit unions can implement debt cancellation programs in as little as 60 to 90 days.
A pioneer in the debt cancellation industry, Complementary Products Group (CPG) has been successfully designing and managing debt cancellation programs for over 12 years - longer than any other program service provider. Debt cancellation/suspension is our core business and we are the only major provider whose products and services were specifically designed for debt cancellation. Our staff includes every discipline required to deliver all of the elements critical to a successful debt cancellation program including product design, actuarial and risk management, marketing, analytics, sales training/management, administration, legal, financial and technical systems.
By partnering with Complementary Products Group you get the benefit of:
- A portfolio of debt cancellation/suspension products proven successful in the market as well as custom product design capabilities
- Privacy sensitive marketing and distribution strategies with a verifiable track record of success
- Superior program administration that emphasizes the enhancement and preservation of the underlying relationship between credit union and member
- An existing infrastructure designed for and dedicated to supporting debt cancellation programs
- A compliance group that continuously monitors the program and the regulatory environment to ensure regulatory compliance
- A risk management team experienced in debt cancellation product pricing and risk management
- Authority to secure contractual liability coverage on behalf of the credit union