The one unlawful and litigious thing you may not realize about CPI insurance
What is Collateral Protection Insurance?
Borrowers and lenders, who are new to their role often ask: "What is Collateral Protection Insurance?" Of course, most answers talk about the insurance policy aspects of collateral protection insurance.
However, a more accurate answer is that collateral protection insurance combines a sophisticated borrower insurance tracking system with a lender-placed insurance policy issued when a vehicle loan is not adequately insured.
Collateral Protection Insurance (CPI Insurance) has become the de-facto standard for tracking car insurance to protect lenders' collateral.
The end game of CPI auto insurance is to preserve the value of the vehicle collateral associated with the lender's loan. When the CPI insurance tracking system uncovers uninsured collateral, lender-placed insurance protects the vehicle for both the borrower and the lender.
The Slippery Slope of CPI
The "slippery slope" of CPI Insurance occurs based on the effectiveness of implementing a collateral protection insurance program with a lender. The critical area is due diligence to avoid scrutiny from both state-based insurance commissioners and class-action litigators.
Is Collateral Protection Insurance Legal?
Yes, Collateral Protection Insurance (CPI) is legal and overseen by lending and state-based insurance regulators.
In 1991, many successful class-action lawsuits decimated most of the lender-based CPI programs in the US. As a result, very few lenders' boards of directors would allow the use of a CPI program.
But this all changed in 1997, when the National Association of Insurance Commissioners (NAIC) introduced the CPI Model Act to enable lenders to use Collateral Protection Insurance with certain restrictions to keep lenders from class-action litigation. The introduction of the CPI Model Act began the slow re-emergence of CPI insurance for lenders.
What Does Collateral Protection Insurance Cover?
The collateral protection insurance policy is a "limited dual interest" insurance policy covering the borrower's vehicle.
Dual interest means that the insurance protects both the lender and the borrower.
For example, a CPI insurance policy will cover both the lender and the borrower against physical damage and other perils to the vehicle only after the borrower is issued or force-placed with a CPI policy. This policy is issued when the lender's insurance tracking system has determined that the borrower's insurance on the vehicle has lapsed.
Other important "lender coverages" are part of the Collateral Insurance Policy. These coverages are only for the benefit of the lender and typically apply after repossessing the vehicle. A poorly implemented collateral protection insurance program may invite potential regulatory scrutiny and litigation based on how lenders implement these post-repossession coverages.
A detailed coverage review of the standard CPI policy is beyond the scope of this article. Moreover, we will focus on lender coverages available after a vehicle repossession when the borrower no longer has a financial interest in the vehicle.
The two significant categories of lender coverages include:
- "repossession expense reimbursement"
- and "skip" coverage.
The lender may file claims for repossession expense, towing and storage, mechanics liens, and skip tracing associated with recovering the vehicle from a delinquent borrower. In addition, CPI claims can include payment of ACV or other semi-retail valuations if the lender cannot recover the skipped vehicle.
Skip Losses Associated with Collateral Protection Insurance
Skips occur when a borrower is delinquent on payments and the lender attempts to repossess the collateral. The borrower is aware of pending repossession, so they hide the vehicle to avoid repossession.
Since 1997, Miniter Group, the largest VSI provider in the US, has collected data on 109,000 post repossession vehicle claims totaling $214 million. Up until 2014, this data has shown that physical damage losses in a lender's portfolio accounted for 90.5% of collateral losses, while skip losses made up the remaining 9.5%.
During the last quarter of 2014, Miniter Group observed a significant increase in the frequency and severity of skip claims, which increased from an average of $9,042 before 2014 to $13,475 in 2016. Today, this number has risen to $22,970 in 2022.
Skip losses that occur as part of a lender's vehicle portfolio have significantly increased since 2014 and now represent well over 50% of all vehicle losses. This change in loss profile has tempted lenders to re-evaluate collateral protection insurance claims payments associated with a skip.
Challenges of The 1997 NAIC Model Act
Section 6 of the NAIC Model Act prohibits borrower premiums from being used for the cost of:
- mechanics lien,
- or other liens
that do not arise from covered losses. However, this section also states that these coverages may be endorsed in the policy as long as premium charges are not passed to the borrower.
The One Thing You May Not Realize about CPI Insurance (You'll Plummet Down the Slope)
The Model Act clearly separates borrower and lender coverages within the CPI policy and the associated premium that the lender must pay. Comingling of borrower and lender premium is where the slippery slope can occur.
Lenders who use borrower premiums to pay for lender coverages would violate the Model Act and thus be subject to insurance regulation and potential class action attempts.
Make Sure You Don’t Find Yourself on the Slippery Slope
A simple check to ensure that you can justify your position on lender coverages is to look at your collateral protection policies' loss ratios. Ask your CPI Insurance provider for a detailed loss ratio from inception to date or at least the last 12 months. This report must separate the lender, and borrower premiums remitted and detail a loss ratio for your skip coverage. Separating the premium will show a loss ratio percentage for your lender coverages.
If the skip loss ratio is 80% or below, you are paying a reasonable premium for the risk the insurance company is taking.
However, if this ratio is above 100%, your program may be at risk of scrutiny regarding comingled premiums to cover the skip losses.
Do the math: If you question your loss ratio, calculate your lender coverage claim payments and divide this by the premium you paid for lender coverages during the same timeframe. Being proactive in monitoring this loss ratio should be part of your vendor management plan for your Collateral Protection Insurance vendor.