In a vast—and largely digital—lending landscape, big banks and FinTechs often hog most of the financial glory. They’re more visible and have slick advertising that suggests they’re the best and safest...
Across the board, the largest asset a financial institution has is its loan portfolio. But each financial institution is unique regarding its business goals and borrower demographics; therefore, finding the right loan risk management program can be elusive. Financial institutions should carefully evaluate their current and future exposures to risk, internal systems and resources, and legal considerations when choosing the right one.
In this blog, we’ll explore three different types of risk management programs: self-insuring, blanket coverage, and lender-placed insurance.
Self-Insurance: Relying on Borrowers to Cover Losses
Financial institutions that opt for self-insurance choose to absorb the cost of physical damage or theft losses resulting from uninsured collateral in their loan portfolio. Under this type of protection strategy, financial institutions are not able to track whether borrowers maintain the insurance required by most loan security agreements.
Self-insuring may be the appropriate choice for financial institutions if the ultimate cost related to self-insurance can be absorbed without substantial changes in the overall quality of loans or interest rates and fees. But when losses and operating expenses begin to creep upward, financial institutions are left searching for additional revenue sources to offset those costs—or select an alternative loan risk management approach.
Blanket Insurance: Covering Your Own Losses
With single-interest insurance, commonly known as blanket insurance, financial institutions pay a small premium on all loans to cover insurance losses on uninsured collateral. Like self-insurance, there are typically no insurance tracking measurements performed under this type of risk management program.
Blanket insurance is designed for a loan portfolio with a low percentage of uninsured borrowers. Financial institutions should balance the benefits of this type of risk management program with the competitive impact in their marketplace. Without internal controls in place to determine which borrowers are maintaining their insurance coverage on the collateral being financed, the percentage of uninsured borrowers will likely increase and as losses rise so too will the cost of the blanket policy.
Collateral-Placed Insurance: Protecting Collateral with CPI
Collateral Protection Insurance (CPI) is a limited dual-interest program that provides protection for both the financial institution and the borrower. It is intended to protect the lender’s interest in the event a borrower doesn’t maintain adequate comprehensive and collision coverage on their vehicle. At the same time, it helps keep drivers on the road by covering repairs on vehicles that borrowers might otherwise walk away from in the event of a loss.
With CPI, financial institutions are always insured if a certificate is in place on the collateral being financed at the time of loss. Unlike being self-insured, which is no insurance at all, or blanket insurance, CPI employs a tracking program to identify uninsured borrowers and provide insurance coverage to protect the financial institution’s interest. When a lapse in coverage occurs, borrowers receive several notices reminding them of their obligation to maintain insurance coverage and informing them that CPI will be placed on their loan if they fail to do so. Since CPI does not provide liability coverage, borrowers are required to purchase liability coverage to meet the financial responsibility laws of the state in which they live.
There are two distinct CPI programs available to meet the risk management needs of any financial institution:
This coverage includes provisions for physical damage, theft, and repossession expenses, as well as optional lender coverages such as repossession expense reimbursement, mechanic’s lien reimbursement, instrument non-filing, and skip and premium deficiency coverage. Financial Institutions typically pay an annual premium for the coverage, which is determined by a percentage of the borrower’s outstanding loan balance. With the rising cost of vehicles driving average loan balances higher, traditional CPI premiums have increased significantly over the last few years. As a result, financial institutions are likely to increase borrower payments to avoid a large lump-sum balance remaining when the loan matures which would contribute to higher deficiency balance charge-offs.
Twelve years ago, SWBC pioneered Hybrid CPI, a new approach to collateral-placed insurance that has borrower-focused cost benefits and offers greater coverage flexibility for financial institutions. Hybrid CPI features low-cost, flat monthly premiums regardless of the borrower’s outstanding loan balance. The improved cost structure minimizes administrative work for financial institutions, reduces flat cancellations, and virtually eliminates partial refunds. It also results in fewer borrower repossessions, which means fewer deficiency balance charge-offs related to the addition of CPI premiums. Hybrid CPI provides the same physical damage coverage to borrowers and lenders as traditional CPI while addressing regulatory concerns regarding collateral-placed insurance.
Choosing the right protection for your auto loan portfolio is important. The right coverage not only protects your institution’s assets, but it also can add value for borrowers, demonstrate your commitment to responsible lending practices, and help you stay relevant in the highly competitive auto finance market.
As Senior Vice President of Automotive Products, Michael works closely with our Collateral Protection Insurance (CPI) carriers to manage existing CPI programs and develop new coverages for our clients. He is responsible for underwriting, corrective action, skip tracing, and asset recovery as they pertain to our CPI and blanket VSI products.