Insurance companies, on average, take in far more in premium income than they pay out in claims for favorable loss ratio. Though it varies with the type of insurance (unemployment, disability income, life), the company and the year, a company typically pays out in claims between 10 and 45 percent of its premium income. The remainder is potential profit.

Some of this profit goes toward administrative expenses and sales commissions, though administrative expenses may be reduced because much of that work is done by the lending institution. Often a lender receives a group credit policy and then signs up credit insurance borrowers. Because the lender is responsible for seeking applicants and completing the application process, administrative economies should make group insurance less expensive to purchase than individual policies. Reduced administrative costs coupled with low loss ratios make this type of insurance very profitable for the insurance company.

However, the compensation process employed in the credit insurance industry creates potential for abuse, especially when insurance companies are allowed to rely on post claim underwriting as a method of canceling insurance policies and avoiding claims. This process is quite common in this line of business.

This is how it works. Because of the low loss ratio, the insurance company is able to offer the lender a significant commission for signing borrowers up for credit insurance. The lender also may receive other forms of compensation tied to claims experience; for instance, the fewer the claims, the greater the compensation. A lender’s profits from insurance sales may even exceed its profits from its loans. Moreover, the lender’s loan officers may receive an incentive or bonus based on insurance sales, which provides a personal motivation to sell credit insurance to a borrower. Furthermore, it is usually the loan officer, not the applicant, who completes the application for insurance.

This procedure is rife with potential for abuse providing the loan officer and the lending institution with economic incentives to assure that the insurance is issued. This environment offers a strong temptation for the loan officer to ignore or rephrase an applicant’s answer to a health question if the original answer might prevent the insurance company from issuing the policy.

Insurance companies are aware of this, yet they permit the lending institutions and the loan officers who are, in effect, their agents to be put in this position. Some insurance companies then assert when a claim is submitted that the applicant made material misrepresentations that require cancellation of the policy and result in a “no claim” payment. In effect, the insurance company has created an environment that encourages its own agents, the loan officers, to submit a false application. Then the insurance company subsequently denies a claim and cancels a policy because the application was false. Not all credit insurance companies do this, but more than a few do.

If you feel you are being pressured to buy this insurance, and especially if the loan officer quickly runs through the application questions and then thrusts the application in front of you for a quick signature, warning bells should be going off in your head. Stop, think about whether you really need the insurance and, if you decide you do, then carefully read the answers the loan officer has recorded on your behalf on the application before you sign it.

If your policy has been or is about to be cancelled for alleged material misrepresentation in the application, seek the advice of a lawyer experienced in this area of the law. This is especially true if an agent completed your application or advised you as to how to answer certain questions on the application.