Every lender has unique needs. It is important to take a holistic approach when exploring risk mitigation options. The key questions to ask when deciding on how to manage risk in your loan portfolio are:
- How much risk can you tolerate vs. how much do you want to transfer?
- What are your goals and objectives?
- What do you expect in return?
Can a lender simply self-insure their auto loans? They can, but retaining the responsibility of covering financial losses due to uninsured and/or damaged collateral undermines the fundamental purpose of any insurance program, which is risk transference. A self-insured lender assumes all risks and absorbs any losses that occur.
To minimize uninsured losses, some self-insured lenders attempt to track borrowers’ private coverage in-house and follow up with those who don’t show proof of insurance. However, this kind of tracking is time-consuming, difficult to execute without advanced technology and highly trained staff, and rarely effective without a mechanism for policy placement.
With a blanket insurance policy, lenders pay a premium based on the total number of loans, typically a fixed dollar amount per vehicle or a percentage of the outstanding balance. Through a blanket policy, all borrowers must bear the cost of an uninsured borrower.
Some states do not permit this cost to be charged to borrowers, and it must be absorbed by the financial institution. This can weaken your competitive edge, especially as the best borrowers can choose a lender that can offer lower rates and fees because they are not building this premium cost into the loan.
Additionally, the cost of a blanket policy on a growing book of business will increase regardless of whether or not a policy’s loss ratio — the ratio of claim payments lenders receive to premiums they pay — worsens.
Collateral Protection Insurance (CPI)
CPI affects only borrowers who fail to purchase or maintain insurance and offers your institution the same protection as if the borrower maintained private insurance.
CPI providers use sophisticated technology to track the insurance status of each loan and send appropriate notices to borrowers who do not maintain required insurance on their financed vehicle. If the borrower fails to submit proof of insurance in response, the lender may choose to place a CPI policy on the loan to protect the financial institution’s interest from damage or loss.
They then pass the cost to the non-compliant borrower by adding the premium to the loan balance. The charge is removed as soon as private coverage is reinstated. It costs financial institutions little or nothing to obtain this protection.
Which Is Better for Your Business? Five Considerations When Insuring Your Auto Loan Portfolio
- Determine the level of risk your institution is willing to assume.
- Consider market drivers, costs and broader economic conditions.
- Consider how an insurance product leverages new technology to improve administration and reduce borrower noise.
- Recognize the overall impact on you and your borrowers.
- Analyze your losses, their sources, and how they impact your bottom line.