Credit insurance: Time to end discrimination

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1 Policy position June 2012 Credit insurance: Time to end discrimination Access to credit, especially mortgage loans, is the only way for families to afford a home, a car or other major capital outlay that a household needs in life. Credit insurance is a financial arrangement often linked to a mortgage loan that allows the borrower not to have to resort to a mortgage 1 or other form of security (surety, cash collateral, etc.). Linked insurance is increasingly a condition of mortgage loans. Insurance has many advantages for the borrower over pledging real property as security (threat of foreclosure) or a surety (where the person standing surety may have to repay the borrower s debt if he defaults). But there are still many problems in accessing credit insurance and the risk premiums for it. According to a 2010 study done for the European Commission s DG EMPL 2, The factors age, sex and disability (or rather the underlying health condition) are widely used in the design and supply of financial products. Pricing of consumer insurance and credit products is generally based on segmenting the population of covered risks and placing them into groups or classes having similar characteristics (and hence similar levels of risk). The criteria used to sub-divide the population of risks are those which are believed to reflect the probability of loss, including age, sex or disability. [ ] In a highly competitive market, private insurers have a natural incentive to distinguish between risks as precisely as possible and charge premiums which are as accurate as they can be in actuarial terms. [ ] However, the incentive to do so will be reduced if the market is not competitive, especially if the product in question is mandatory by law [ ] or is one which is essential in practice. Fine-tuned differential pricing of insurance can also lead to very highrisk consumers being priced out of the market or even refused insurance altogether. Excluding high-risk consumers from credit insurance may end up in their being charged high additional premiums or even excluded from accessing any form of credit. In France, a 2009 survey found that people who constitute a poor health risk faced particular difficulties. Health professionals have taken issue with some medical risk assessment questionnaires for utterly disregarding advances in modern medicine and being based on totally arbitrary risk calculations. Worse still, so little do insurers know of illnesses that the cost of additional premiums can be found to triple between insurers. Similarly, some insurers refuse to cover disability or death for known non-fatal diseases 3. 1 This is a specifically French law distinction that unfortunately does not apply in common law countries of the Anglo-American tradition, where mortgage, mortgage loan and real property loan refer to the same thing and the borrower s or mortgagor s home will always be at risk in the event of payment default, even with linked endowment insurance which may not cover the amount of the mortgage. Tr. 2 "Study on the use of age, disability, sex, religion or belief, racial or ethnic origin and sexual orientation in financial services, in particular in the insurance and banking sectors", p.6. 3 Article 60 million consumers, 438, May

2 As also noted in the study done for the European Commission, this situation can change where guaranteed access to credit insurance and non-discrimination are legislated for. An economist might argue that this phenomenon is quite consistent with overall market efficiency, in the sense that such individuals cannot be efficiently insured. However, at this point the argument shifts from the language of economics to the language of rights, with critics of current insurer practices arguing that it is wrong to deny services to a person as a consequence of something which they are powerless to change. Weighing these opposing views against each other is impossible, because they are simply incommensurable. Whether individual human rights should trump market efficiency is a policy matter, not an economic question. However, once it is decided that high risk individuals should have the right to secure cover, it is then possible to compare different ways of achieving this aim and weigh the benefits of each. 4 There are various ways in which an insurer can mitigate his lending risk and ensure business profitability. The two main ones are (1) risk-based pricing based on the individual and his likelihood of defaulting, and (2) spreading the risk among the widest borrower pool in numbers and profiles. Competition, however, tends to exploit the former and work against the latter. Is it reasonable to exclude an entire section of the population from access to credit - especially what is known as real property loans thereby denying them any possibility of getting onto the housing/home ownership ladder because of their personal characteristics, like being a high health risk? Insurance must operate on a principle of solidarity, not competition, and it is the duty of lawmakers to ensure that it does. The question that now arises is: how? What can be done? Is it legitimate to exclude an entire section of the population from access to credit, in particular what is known as real property credit, and thereby deny them any possibility of accessing housing and home ownership simply because of their profile, like people with a high health risk? The job of insurance, as far as possible, is to operate on the basis of solidarity, not competition, and it is the lawmakers duty to ensure that it does. The question that arises is: how? What are the options? In the Member States The AERAS 5 (from the French acronym for insurance and borrowing with an increased health risk) scheme in France makes insurance available through an assessment of the applicant's personal circumstances. AERAS is a good practice, but has limitations. It is only available to a certain category of individuals, and its terms are also restrictive. The maximum term of personal consumer loans is 4 years, the maximum amount is 15,000, it cannot be combined with other loans, and the age limit is 50 at the date of the loan. For mortgage loans, the borrowing limit is 300,000 and the borrower cannot be over 70 when the last scheduled payment is due. So, the potential borrower base is restrictively defined, the cost of insurance can remain high and the notion of "increased risk" is still widely included and takes no account of advances in medicine. Personal microcredit is a system that has mainly developed in France and Belgium, but its use also remains open to question in that microcredit can only be a solution if certain conditions are met, including a thoroughgoing study of the borrower s application and the purpose of the loan (e.g., reintegration into work and society). It bears mentioning here that credit is too often put forward as a solution in and of itself to people s financial problems, when credit actually needs to be part of a much broader strategy and cannot substitute for social welfare, social assistance (CPAS basic benefit) and other policies. 4 p

3 The Partyka Act 6 in force in Belgium since January 2010 seeks to address the problem of access to credit insurance especially for people with increased health risks through: - the introduction of a code of conduct and a standardized medical questionnaire, - requiring insurers to properly inform borrowers (by distinguishing basic from additional premiums and, if applicable, giving written reasons for the additional premium or refusal to insure), - allowing borrowers to get a second opinion on their application, - establishing an insurance rating supervisory office to check the amount of (objectively and reasonably justified) additional premiums, - creating a compensation fund financed by insurers and mortgage lenders to pay a borrower s additional premiums above a certain percentage, - creating a standardized coverage where additional premiums exceed 200% of the underlying premium. Overall, 13 Member States in the EU have rules on using both age and disability as factors in calculating the risk for financial products and seven Member States have rules on disability only. At EU level The EU s competences in combating discrimination stem from different articles in the EU treaties (Article 10, 19 TFEU and 2, 3.3 TEU). But these competences must be translated through directives or other EU executive and legislative instruments. Directives 2000/43/EC (equal treatment irrespective of racial or ethnic origin) and 2004/113/EC (equal treatment between men and women in access to the supply of goods and services) are examples of principles enshrined in the EU treaties being applied. A Commission proposal for a Directive (COM (2008) 426 final) 7 to extend the non-discrimination rule to religion, belief, disability, age and sexual orientation has not yet gone through, having been deadlocked by some Member States in Council. The fears surrounding the adoption of this Directive can be illustrated by the European Court of Justice ruling of 1 March 2011 (Case C-236/09) invalidating the scope for insurers to offer different premiums based on an individual s sex on the grounds that this exception (under Directive 2004/43/EC cited above) was incompatible with the Charter of Fundamental Rights of the EU (Articles 21 and 23) and the European treaties. As a result, no new insurance policy taken out after 21 December 2012 will be able to charge differential premiums based on the policyholder s sex. 8 COFACE s Recommendations 1) Assess the scale of the problem The 2009 study of the matter commissioned by DG EMPL identified consumer complaints of discrimination but painted no overall picture of applications, additional premiums and refusals of credit and credit insurance on the grounds of health, disability or age. COFACE calls on the European Commission to collect more statistics on the scale of difficulties that people with disabilities, elderly people, and those with an increased health risk have in accessing credit and credit insurance &numac= #top

4 2) Identify existing good practices As mentioned above, there is already a wide range of practices within the EU Member States. COFACE calls on the European Commission to have a study done to identify and assess such practices where found (effect on access to credit and credit insurance). The study should emphasize the workability of existing systems that facilitate access to credit and credit insurance given the main argument of credit institutions and insurers that including people who they consider too high a risk is inconsistent with the commercial interest, profitability and financial soundness of their businesses. 3) Ensure the timely revision and update of medical questionnaires and risk assessment criteria COFACE sheds light on two facts: firstly, some medical risk assessment questionnaires do not take into account the advances in modern medicine in such areas as cancer treatment, some serious illnesses or disabilities and as a consequence do not accurately evaluate risk. Secondly, for a person with disability or a serious illness, it is not uncommon that two insurance companies propose additional premiums of completely different level, thereby proving the lack of objectiveness of the criteria used to evaluate risk. COFACE calls upon public authorities, at both European and national level, to closely monitor the revision and update of medical risk assessment questionnaires in the insurance sector. In case of abuse, public authorities should legislate in order to guarantee the quality and fairness of risk assessment by insurers. 4) Resolve the deadlock over Directive COM (2008) 426 final By adopting the principle of non discrimination on the basis of age or disability, this directive could have major consequences on the risk assessment and guarantee the principles of solidarity in the field of insurance. COFACE calls on Council to adopt this Directive in order to more effectively tackle the multiple discriminations against people with disabilities, the elderly and people in poor health. The Directive could be transposed on the basis of the study identifying good practices already operating in many Member States. 5) Launch a consultation on discrimination in access to financial services COFACE suggests that the European Commission put the issue of discrimination in access to financial services out to consultation in order to collect relevant experiences from Member States, private stakeholders and voluntary organizations. The consultation should include specific sections on the different financial products like consumer credit, mortgage credit, credit insurance etc. This consultation could provide a basis for future Commission initiatives to tackle overindebtedness and social exclusion. 6) Explore other ways of expanding access to credit and credit insurance Other avenues to be explored include: Freedom of contract - An individual who decides to take out a loan and credit insurance must also be free to choose their insurance. This is already the case in France where the possibility for a consumer to choose a different insurance from the one bundled with a financial 4

5 product is secured by law. But many obstacles remain: if they refuse the group insurance proposed by their bank or credit institution, they have to propose insurance that provides at least the same level of cover as the group insurance. The issue then is how to ensure that the terms or guarantees of the group insurance are not unreasonably high to prevent the free play of competition? There is also the issue of processing the application, which is made more complicated when the individual decides to take out insurance of their choice. Clarity of contracts - Consumers must have access to clear and especially comparable information to be able to choose from what is on offer. Here, legislation should - and in many countries already does - provide for standard information sheets. - Consumer reviews (especially online) on credit insurance products can also be a way to help consumers choose a product adapted to their needs. Continuity of contracts - Debt-burdened individuals not uncommonly consolidate their debts into a single new loan rather than declare personal insolvency or bankruptcy. In this kind of consolidation, insurance policies taken out and paid to that point are terminated and a new insurance policy is taken out on much tighter conditions and higher cost. Ideally the insurance already in force should be able to be transferred or at least adapted to the new contract, rather than starting over from scratch. Substitute one form of surety for another - Individuals should be able to replace one form of security like a mortgage by another depending on what they possess (a share portfolio, for example). Extend an existing life insurance guarantee - Many people have health and/or life insurance. These policies could be extended to cover a loan instead of having to take out additional insurance. A social public insurance for lending bodies - Instead of letting the individual carry the burden of signing up for a private credit insurance, Member states' public authorities can set up a social public insurance for lending bodies which would insure them against the default of clients representing a high individual default risk. The level of the contribution of lending bodies to this insurance could be calculated on the basis of the total number of loans awarded. This could enable lending bodies to offer all customers the same advantageous interest rate and would avoid the need to carry out thorough health enquiries (or enquiries about other risk criteria) which are discriminatory, controversial and do not respect the right to privacy. Such insurance schemes already exist in certain fields such as insurance against workplace accidents and injury. Offers of credit: - Encourage banks and lenders to concentrate their lending policy on a proper assessment of the borrower s ability to pay (e.g., through the positive file: see COFACE's position on the positive file) rather than focus on additional premiums for "risks" like age. Many older people already have assets and therefore are able to pay so the "risk" they pose is next-to-nil and easily dismissed if these guarantees are taken into account. 5

6 - Encourage the development of responsible credit products in the private, public or cooperative system that meet the needs of individuals previously excluded from the traditional financial and economic system in particular. - Fund low-cost credit for certain categories of persons (e.g., a rate below 2%) - Develop microcredit and microinsurance, focusing on the social purposes of these instruments For insurers and financial institutions: - The US Community Reinvestment Act introduced in 1977 requires banks to show that they are meeting the credit needs and successful development of all segments of the local communities where they operate, and may be penalized if they do not. - "Pay or Play": banks or insurance companies wanting to cater only to a select or lowestrisk customer base pay a tax to support more socially-oriented banks or insurance companies. Conclusion While the business of insurance may require risks to be calculated as accurately as possible so as to offer competitive premiums while guarding against the risk of payment default by borrowers, it is totally unacceptable to exclude more or less by default an entire category of individuals who are not to blame for the higher risk they pose. What fault attaches to a person with a disability, an elderly person or a cancer survivor for being at higher risk? Moreover, as was noted above, while some people may objectively be higher risk than others, insurers risk assessments, and consequently their offers, are anything but consistent. While COFACE does not argue for an absolute right to access credit, some universal principles must be laid down, like assessing applications on the borrower as a person rather than by computerized scoring to offer a default product. Financial institutions must start from the basis that anyone can lay claim to credit but only that which is appropriate to their needs and ability to repay. In order to mitigate the adverse effects of competition, legislation must be in place to ensure that everyone can access the essential credit they need to plan for the future. Access to credit and credit insurance is vitally important to families. Whether to move from renting to home-owning, starting a family or having a home fit for children to live in, buying a bigger car to ferry a large family around, home renovations to improve insulation or fitting solar panels these are investments that can often only be made through access to credit. Being denied that access affects all family members, but every family needs to invest, regardless of whether its members are affected by serious illness, disability or other criterion deemed "high risk" from an insurer s viewpoint. To consult other COFACE positions on financial services and financial inclusion, please see the following page: CONTACT COFACE - Rue de Londres 17, B-1050 Brussels Tel: Fax: Skype: coface-aisbl [email protected] Web: COFACE is supported by the European Union Programme for Employment and Social Solidarity - PROGRESS ( ). For more information see: 6