The Trouble With Frankenwaivers
In September, the CFPB announced a settlement with California finance company Lobel Financial, following an investigation into Lobel’s use of “Loss Damage Waivers” as a substitute for Collateral Protection Insurance (“CPI”). Borrowers who allowed their insurance to lapse found themselves with a “force placed” waiver and $70 monthly charge. The waiver obligated Lobel to cancel the outstanding balance in the event of a total loss and to pay for repairs if the car could be fixed.
Lobel’s trouble with the CFPB involved allegations of unfair and abusive behavior in managing the waiver product. The CFPB did not criticize the use of waivers as a substitute for CPI. That is my job.
To begin, let’s get our vocabulary straight and spend a moment discussing the perils mixing product attributes. A loss damage waiver is a product sold in connection with a rental agreement. It releases the rental customer from liability for damage to the rental property. A damage waiver does not cancel installment credit debt (or the financial obligation on a closed-end lease, in case you’re wondering). That would be a Debt Cancellation Agreement (“DCA”). So no matter what they called it, the waiver that Lobel sold was really a DCA .
Well, it was mostly a DCA.
The Lobel waiver it did more than just cancel debt on total losses. It also paid for repairs. A neat trick, no argument, except that a paying for repairs is a form of indemnification that stitches an insurance attribute onto what otherwise is a non-insurance product. By promising to pay for repairs, the finance company Frankensteined their product, creating a monster, part DCA and part insurance policy. The problem, of course, is that only licensed insurance companies may legally engage in the business of insurance. It’s something state insurance departments take seriously. Covering repairs under a DCA violates state insurance law. This is true in every state, whether you like it or not.
We can pretend that Frankenwaivers are not a regulatory abomination. Even then, they are a reckless substitute for CPI, for a couple reasons. The first has to do with the balance of creditor and debtor rights contemplated by CPI. The insurance is designed to protect the creditor’s lienholder interest up to, but not exceeding, the scope of the physical damage insurance it replaces. In other words, a creditor may not force place more expansive coverage than the insurance it required the debtor to maintain. Because personal auto insurance policies settle total loss claims at the insured vehicle’s replacement cost, a force place DCA that cancels what is often the higher outstanding finance balance goes too far, and violates one of the central principles of CPI.
Force placing a DCA also raises TILA issues that do not occur with CPI. Reg Z allows a creditor to exclude cost of required property insurance from APR, provided the debtor is allowed a choice of insurance providers. Thus, the cost of force placed insurance is not considered a cost of finance when the creditor adds CPI in response to the debtor’s failure to provide or maintain insurance (See Staff Comments to 12 CFR §1026(d)(2)). DCAs do not get the same treatment. The charge for a DCA may be excluded only if the purchase is voluntary and disclosed as such. (See Staff Comments to 12 CFR §1026(d)(3)). The charge for a force placed DCA is a cost financing, subject to all the terrible scrutiny expected of these things.
Seeing as I may have left spittle on the page, I should say that I don’t dislike DCAs. They can be incredibly effective when used correctly. But they are not substitutes for insurance and should never be treated as such, unless of course, you like living dangerously.
