Protect yourself from debt protection

Life is unpredictable, the ads remind you. Don’t let your family suffer if you can’t pay your credit cards on time. Pay this “small” monthly fee and we’ll make, or even suspend, your payments if you experience a crisis.

So-called “credit protection” plans are pushed relentlessly by banks, credit unions and other credit card issuers. But the Los Angeles Department of Consumer Affairs has some advice: Don’t buy.

“People think it’s really good, but they’re spending their money for, really, nothing,” says Rigo Reyes, the department’s acting director.” A recent report from the U.S. Government Accountability Office bears him out.

“Fees for these products can be substantial, with the annual cost often exceeding 10 percent of the cardholder’s average monthly balance,” according to the GAO, which is Congress’ audit and investigative arm. The credit card issuers, the report said, raked in $2.4 billion in fees for debt protection in 2009, more than half of it pure profit.

The plans are so full of exclusions and loopholes that card holders only received about 21 cents worth of actual benefits for every dollar they spent on “protection,” the GAO found. This 21% payout ratio is far lower than other types of insurance. The new health reform law, for example, mandates that payout rates for health insurance be at least 80%.

Once colloquially known as “credit insurance”, the plans are supposed to prevent penalties, fees and negative credit reports by keeping cardholders’ bills up to date should death, disability, divorce, job loss or some other emergency keeps them from paying on time.

But as state laws regarding insurance have been tightened, Reyes says, credit card issuers have changed the name to eliminate the word “insurance” and tweaked the product—now known as “debt protection”—so that it could be regulated under less stringent federal oversight.

Those federal rules are likely to tighten if and when the new federal Consumer Financial Protection Bureau comes online this summer as part of the financial reform act recently passed in Congress. But reform opponents hope to weaken the newly formed bureau and maintain the high profit margins debt protection offers to credit card issuers, at the expense of cardholders.

In the meantime, Reyes says, paying a dollar for 21 cents’ worth of coverage “isn’t a wise investment.”

“Save the money,” he suggests, “and use it to pay down the balance on your credit card.”

Posted 5/11/2011