The high cost of insuring your loan

Despite an investigation into the rates charged by credit providers for insurance, borrowers are still paying high rates for their credit insurance.

Personal loanIf you were stuck for cash and needed to borrow R5 000 which you would pay back over just four months, how much do you think you would pay for that loan? Well if you are a high-risk client (ie, a low income earner with a bad credit history, employed in a sector with high retrenchment rates), that loan could cost you as much as R7 840.

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, which was 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 was the credit life insurance at a massive R1 155 – payable as a R288 per month premium. That represents around 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 at R1 386 payable as premiums of R346 per month.

Research conducted by National Treasury last year found that in general the rates charged for credit life were around ten times higher than for stand-alone life covers 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 like 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,” says Jordaan.

Yet in its paper Technical review of the consumer credit insurance market South Africa National Treasury and the Financial Services Board recommended that credit life should be capped at a premium of around R4 per month for every R1 000 borrowed. In comparison some credit providers are charging rates as high as R56 per R1 000 – more than ten times the recommended rate.

What are you paying for?

Dr Willie van Aardt, CEO of Finbond Mutual Bank which issues short-term micro loans, argues that the National Treasury 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,” he said.

Leanne Jackson, head Market Conduct Strategy at the Financial Services Board, says, however, that 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 by the credit provider.

There are examples of other micro loan agreements where the credit premium charged is far lower – around R13 to R17 per 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 National Treasury but it raises an important point – as a borrower you do not have to take cover that includes extremely expensive disability and critical illness cover.

What is a reasonable cost?

Under the objectives 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”.
Guardrisk’s Jordaan explains that the risk posed by the client is a determinant in the rate charged for insurance. So basically your credit risk – ie, 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 micro-lenders playing in the higher-risk space charge monthly premiums as high as R56 per R1 000 borrowed, traditional banks which may not service the high-risk market have rates as low as R5 – R6 per R1 000.
With the draft proposals around consumer credit insurance to be released later this year, the question that will need to be asked is whether people in high-risk markets will be able access credit at all if the rates are capped.

For example, Capitec insures their 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., who issue monthly loans, do not require any credit insurance cover, although monthly or “payday” loans do tend to be generally more expensive so one needs to make a comparison on the total costs.

Can you shop around?

This brings us to the point around choice. While a micro-lender may for example only offer customers the more expense cover which 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 their rights and that the customer 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 use existing cover.

FinMark Trust’s research found that 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 that most consumers are more focused on buying the item they wanted, and whether their loan would be approved, than to ask questions about the total cost.

Research by National Treasury found that although theoretically customers are 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. 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 their ability to choose alternative cover, there are also very few options available to borrowers when it comes to stand-alone insurance cover. Guardrisk’s Jordaan says that the company does not at this stage offer this service although there is a growing demand.

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.

Finbond’s van Aardt points out that “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 National Treasury are issued they will regulate the cost of insurance, but it is important that 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 that you can cede an existing policy.

This article first appeared in City Press

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