Cost-Benefit Consideration in Regulating Debt Protection Products
The U.S Government Accountability Office ("GAO") recently issued a report entitled "Consumer Costs for Debt Protection Products Can Be Substantial Relative to Benefits but Are Not a Focus of Regulatory Oversight" (the "Report"), which analyzed the regulation of debt protection products. The Report stated that the "financial benefits to consumers may be limited" because "a relatively small proportion of the fees consumers pay … is returned to them in tangible financial benefits." In addition, the Report concluded that these products can be difficult for consumers to assess. The GAO found that "ensuring that these products represent a fair value to consumers would be consistent with the new agency's mission." Thus, the Report recommended, and the agency agreed, that the Consumer Financial Protection Bureau ("CFPB" or "Bureau") "factor into its oversight of credit card debt protection products, including its rulemaking and examination process, a consideration of the financial benefits and costs to consumers." Companies selling debt protection products should assess their disclosure and pricing practices and prepare for the CFPB to issue rules that are similar to those proposed, but held, by the Federal Reserve Board in September 2010.
Costs and Benefits of Debt Protection Products
Debt protection products are sold by credit card issuers to their customers through phone solicitation, account statement inserts, and the internet. Generally, these products either pay off or suspend a customer's balance or monthly minimum payment if a qualifying event—such as death, disability, or unemployment—occurs. These products are not uniform, however, and different issuers may place limitations on the qualifying events, apply benefit caps (e.g., maximum death benefit of $10,000), or limit the duration of benefits (e.g., six months for involuntary unemployment).
Customers are charged a monthly fee based on the cardholder's monthly outstanding balance. The Report noted that fees charged by the nine largest credit card issuers ranged from $.85 to $1.35 per month for every $100 of the outstanding balance. Fees are charged whether or not the consumer pays the balance in full, but zero balance accounts are not charged the fee. A number of card issuers included the cost of the debt protection on the cardholder's account statement, but it was not a uniform practice across the industry.
The Report found that, in 2009, customers of the nine largest credit card issuers paid $2.4 billion in fees and received $518 million in benefits—21 cents for every dollar paid. An estimated 5.3 percent of customers received a benefit, and the average value of the benefit was $607. The combined profit for surveyed issuers from debt protection products was $1.3 billion.
Although the Report found that consumers generally received a number of tangible and intangible benefits from the products, it determined that the fees were "substantial in relation to the aggregate financial benefits consumers receive, and [that] consumers may have trouble evaluating different products and deciding whether the product is best for them." The benefits of the products were limited by their relatively high cost, eligibility requirements, amount and duration limits, and the negligible practical benefit of cancelling minimum monthly payments (typically only $40 per month for the average credit card balance).
The Report also described a study of debt protection products for home equity loans that found consumers were often unable to calculate the monthly total fee correctly, understand the eligibility requirements or exclusions, or easily obtain full terms and conditions prior to purchasing the products. The GAO did note, however, that there were very few consumer complaints regarding these products to the relevant banking regulators and the FTC.
Regulation of Debt Protection Products
As detailed in the Report, debt protection products are banking products governed entirely by federal statutes and regulations. The Truth-in-Lending Act ("TILA") governs debt protection products through disclosure requirements implemented under Regulation Z. Regulation Z imposes such basic requirements as: (1) expressly disclosing that the protection is optional; (2) expressly disclosing the fee for the initial term of coverage, and thereafter on the periodic statement; (3) explaining, if the product includes debt suspension benefits, that interest will continue to accrue during the suspension period; and (4) obtaining the consumer's initials or signature on a written affirmative request for the product after providing the required disclosures. The Office of Comptroller of the Currency ("OCC") regulations, which apply only to national banks, impose additional disclosure requirements regarding applicable conditions and obligations and the customer's right to cancel, and they ban misleading advertisements or practices. The Federal Trade Commission Act ("FTCA") also prohibits unfair or deceptive acts or practices in the sale or marketing of debt protection products.
However, neither TILA, the OCC regulations, nor the FTC regulates the fees charged for debt protection products, nor do they regulate the costs relative to the benefits of the products. Instead, the Report noted that bank examinations include consideration of fees in relation to safety and soundness.
The Report gives a detailed comparison of debt protection products to the credit insurance products that are regulated by state insurance law. From a consumer's perspective, credit insurance products operate in the same manner as debt protection products, but state insurance laws "establish a reasonable relationship between the premiums that customers pay and the benefits that they receive." Thus, the Report attributes the dramatic decrease in credit insurance products, as compared with the corresponding rise in debt protection products, at least in part to the regulation of the insurance product and the ability for issuers to earn additional profits from the lack of federal price control.
The Bureau's Potential Response
In its Comment on the Report, the CFPB noted that Dodd-Frank "grants important new authorities to the Bureau to ensure that the terms and features of consumer financial products and services are 'fully, accurately and effectively disclosed to consumers in a manner that permits consumers to understand the costs, benefits, and risks' and also to protect consumers from 'unfair, deceptive and abusive practices.'" The CFPB agreed with the GAO's conclusion that it should consider "consumer awareness and understanding of the costs … and benefits" of credit protection products when evaluating the existing disclosure rules and regulating the products generally.
Although the GAO report suggests that the Bureau "factor into its oversight and regulation" of debt protection products the "financial benefits and costs to consumers," the Bureau does not appear to have direct power to regulate the cost of these products. The Bureau could investigate whether the perceived disparity in cost and benefit to the consumer itself constitutes an "unfair, deceptive, [or] abusive practice" pursuant to the guidelines in the Dodd-Frank Act and attempt to regulate pricing on that basis. Such regulations are not likely, however, considering the lack of precedent supporting price-based regulations—without some additional factor—in cases interpreting Section 5 of the FTC Act.
The more likely result is that the Bureau implements in some fashion the Regulation Z disclosure revisions proposed by the Federal Reserve in September 2010, but subsequently held until authority is transferred to the CFPB. The September 2010 proposals would require that: (1) all disclosures be in 10-point or larger font, under appropriate headings, and in some cases presented in question and answer format; (2) issuers determine that consumers have met any applicable age or employment criteria before enrolling them in the products; and (3) issuers disclose the maximum fees charged for the products. Given the GAO report, the Bureau would likely consider adding disclosure requirements that encourage the consumer to assess the costs and benefits of the product considering, for example, the actual level of minimum monthly payments that would be avoided.
Next Steps for Credit Card Issuers
The Bureau previously identified credit card disclosures and enabling consumers to understand the products they purchase as priorities. The GAO Report will likely result in a consideration of how debt protection product disclosures could better convey the actual benefits the products will provide to different types of consumers. Credit card issuers should prepare for these potential rule changes by assessing both the quality of their disclosures and product pricing relative to benefits.
Of short-term concern to issuers is whether the Report will lead to state attorney general or private plaintiff litigation. Given the current environment for consumer protection and state autonomy, the Report may have identified issues related to pricing disparity and certain practices that an attorney general or plaintiff could test under their respective state unfair trade practices acts. Issuers should assess whether their products are implicated by the Report (e.g., (1) failing to cap the balance on which fees are charged at the amount of the benefit; (2) allowing ineligible consumers to purchase the product; or (3) requiring consumers to request refunds after cancellation).
Jones Day's Consumer Financial Products & Services team advises clients regarding the issues discussed in this Alert, including assessing the litigation and compliance risks of financial products.
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