Last week, national banks won big when the OCC – no surprise, to be sure – sided with them in favor of federal preemption. This battle now will be fought out in the courts, where the OCC and national banks also won an important round a few days ago despite efforts by some to use Dodd-Frank to frustrate the federal financial-regulatory framework. But, even as national banks celebrate their victory on preemption, another challenge looms: the CFPB’s authority to take some of their prized products off the market.
Case in point: credit protection. If the CFPB sides with insurers and their regulators, it may find a product to govern backed by a formidable coalition of industry, regulators and consumer advocates. Bankers will feel even more picked on than before, but CFPB action backed by industry allies will, at the least, confuse the opposition now facing the new consumer agency.
Credit-protection products are a long-simmering dispute between the OCC and state insurance regulators. They provide borrowers with protection – insurers would say insurance – against risks that endanger a borrower’s ability to repay a loan. Some of these risks result from loss or fraud – for example, when a credit card is misplaced (although of course a borrower’s risks here are $50 absent gross negligence and a creditcard company’s decision to care). Other risks are more serious – for example, death, disability or unemployment leading to inability to honor a mortgage. Should the debitcard reforms advance and fraud become a greater risk, the product could also get a new lease on life in this sector.
The overall credit-protection biz got a black eye from single-premium credit life insurance. This product was often very expensive and front-loaded into mortgages so that borrowers thought they were protecting themselves, but often did so at the cost of such expensive policies that mortgages proved prohibitive and borrowers ended up in foreclosures that then turned out not to be covered by the insurance due to lots of very picky, very tiny fine print. Congress has largely banned single-premium credit life, but many variants on it (often with significantly improved consumer protection) continue. These include monthly credit policies provided by insurers and similar products – usually called debt-cancellation contracts – offered by national banks.
What’s the difference? In theory, not much – a borrower buys protection in hopes of not facing foreclosure or loss if serious life events undermine his or her ability to repay. In fact, though, the products are very different. For one thing, the bank provides the loan and also the credit-protection product, creating potential conflicts of interest based on which is priced how to whom. To address this, bank regulators require certain disclosures when “non-deposit products” are sold, but these are principally aimed at advising customers that these products aren’t backed by the FDIC, not ensuring that pricing is fair or that conflicts are made clear. The disclosures do say that the borrower need not take the credit protection to get the mortgage, but disputes have long raged over whether customers believe this – even assuming they see and understand the disclosure.
Some of these conflicts are also rife when the products are provided by insurers because insurers were affiliated with lenders and, in the subprime mortgage arena, also in cahoots with them. But, as insurance products, comparable offerings are subject to state insurance-regulatory scrutiny. To be sure, this also didn’t do diddly from the consumer’s point of view with single-premium credit life. But, it’s supposed to, since state insurance rules are required to review policy pricing to ensure that it is fair. If the rules work, a level of protection is provided through insurance products not built into banking lookalikes.
Another key distinction for insurance products comes from state rules to ensure the ability of an insurer to honor its claims over time. Capital rules are supposed to do the latter for banks, of course, but their relevance for insurance-like products is, at best, uncertain. Further, the FDIC’s approach to bank resolution does not ensure long-term claims-paying capacity in the manner of state insurance guaranty associations because the FDIC is focused on bank products, not claims on insured depositories resulting from bank products that are insurance in all but name.
Do all these regulatory differences mean that bank credit-protection customers are abused? Not necessarily, but this product has long been offered below the radar of the banking agencies and outside the scope of the insurance supervisors. This all came unglued in the U.K. last week, when a multi-billion dollar settlement was reached with that nation’s biggest banks on a similar product, dubbed “payment protection insurance” across the pond. Could the product similarly create costly legal and reputational risk here?
This brings us back to the CFPB. The Dodd-Frank Act bars it from governing insurance products – that industry was luckier than banks when it came to setting up the new Bureau. For entities under its aegis, the CFPB packs a punch, especially with regard to any product deemed “abusive.” This term is broad and its scope wholly undefined, but it covers an array of practices that, should the CFPB cite them, permit the new regulator to stop a product cold or force its wholesale redesign. Could credit protection be the test case? Our guess is that it’s a candidate for CFPB consideration, if only because it gives insurers their best opportunity in over a decade to claw back products long offered by banks in ways that insurers and their regulators think arbitrage state insurance. regulation