Part 1 of Our 3-Part Blog Series on Collateral Protection Insurance
At State National, we have specialized in loan tracking and portfolio protection insurance for nearly 50 years. To us, the ins and outs of collateral protection are second nature — but others may be somewhat unsure of exactly what it is, how it works, and how different portfolio protection methods compare.
So, we’ve created a 3-part blog series to explain some of the nuances. Here in Part 1, we share a simple definition of what collateral protection insurance (CPI) is, what it does, and how it can benefit lenders.
What is a Collateral Protection Insurance (CPI)— and Do You Need It?
On the road of life, we all face obstacles — some we can manage, and others outside of our control. To minimize catastrophe caused by unavoidable hazards, it’s important to have security measures in place. In your personal life, daily security measures may involve wearing a seatbelt while driving or turning on your house alarm each night. Long-term security measures may involve maintaining an emergency fund or purchasing life insurance. Lenders also need to take both short-term and long-term steps to minimize unavoidable hazards in their institutions.
Collateral protection insurance provides a solution by helping mitigate the risk lenders incur when offering vehicle loans to borrowers. Because CPI can be helpful during all economic circumstances, it serves as both a short-term and long-term security measure.
Understanding how CPI works will help you decide if it is the best way to mitigate risk in your financial institution. And if CPI is the best choice, this understanding will help you choose a provider that is best able to provide the protection and service you need to make your CPI program a success.
A Complex Definition Made Simple
Collateral Protection Insurance (CPI) is coverage placed on a borrower’s vehicle, on behalf of a lender, when there is a lapse in insurance.
When borrowers take out an auto loan, their loan agreement usually requires that they maintain physical damage insurance to cover the loan collateral, naming your financial institution as an additional interest on the policy. Unfortunately, not all borrowers will fulfill this agreement, either never purchasing insurance or letting their coverage lapse. In fact, about 1 in 8 drivers in the U.S. is uninsured — and, in some states, the percentage of uninsured motorists is as high as 29%.
Lenders can choose to retain the risk of loss if damage occurs to uninsured vehicles. However, just like wearing a seatbelt is a smart choice for preventing harm in an auto accident, most institutions transfer risk through an insurance program, such as CPI.
How Does CPI Work?
CPI shares similar characteristics with all types of insurance: Policies are written, and CPI insurers pay claims when losses occur. However, there are also significant differences between CPI and other types of insurance. Lenders should understand these differences when choosing a CPI program and provider.
Borrowers who do not comply with loan requirements to purchase insurance on their own will have CPI policies issued under CPI program objectives. Once a program is in place, borrowers are not individually underwritten — issuance of a certificate of coverage is guaranteed by the provider.
Because CPI placement is determined by the status of underlying insurance, CPI requires a high level of service, monitoring, and management to avoid accidental lender-placed insurance. A CPI provider’s ability to quickly and accurately identify and manage a lapse in coverage directly correlates to saving a lender time and money.
Data on borrowers’ private insurance must be constantly collected and kept current to ensure that CPI placements are correctly made and that refunds are accurately issued when previously non-compliant borrowers do purchase the required insurance. This is one of the many reasons the CPI program provider a lender selects is of critical importance. An ideal CPI provider will offer borrowers hassle-free, turnkey ways to update their insurance on behalf of the lender.
Are Lenders Required to Use Portfolio Protection?
Although regulators often recommend having a portfolio protection solution in place, such a program is not required. Lenders can instead choose to retain the risk of loss if damage occurs to uninsured vehicles they repossess by self-insuring. Alternately, they can mitigate risk with portfolio protection options such as a blanket policy or CPI.
How does CPI compare to blanket and self-insurance? In Part 2 of our blog series, CPI, Blanket, and Self-Insurance: Which Is Better for Your Financial Institution? we’ll look at some of the pros and cons of each and provide insights into the six areas you need to consider when determining which type of program is right for you.
If you have any questions about this article or about portfolio protection in general, or if you would like to discuss your financial institution’s specific needs, call or email us today!