Bulletin No. 88-01

Life and disability insurance issued in connection with open-end equity loans secured by dwellings or mobile homes

Issued and entered April 25, 1988 by Herman W. Coleman, Commissioner of Insurance

I. BACKGROUND

The use of open-end equity loans secured by dwellings or mobile homes is becoming common. Under this arrangement, a lender will allow a borrower to borrow money from time to time up to a maximum specified amount. Repayment is secured by dwellings or mobile homes. The amount of the loan fluctuates.

Open-end equity loans have no period within which the loans are to be repaid. It is possible to determine when a certain loan amount should be paid off by application of repayment schedules. However, because the amount of the loan may increase at any time, there is no method to fix the term of the loan. Questions have arisen as to the application of Michigan insurance laws to life and disability insurance sold in connection with open-end equity loans.

II. ANALYSIS

Depending on the duration of the loan, group and individual mortgage life and disability insurance is governed by the Michigan Credit Insurance Act, MCLA 550.601 et seq.; MSA 24.568(1) et seq. Section 2 of the Credit Insurance Act, MCLA 550.602; MSA 24.568(2), provides:

All life insurance and all accident and health insurance sold in connection with loans or other credit transactions shall be subject to the provisions of this act except such insurance sold in connection with loans on dwellings or mobile homes where the term of the loan is in excess of 5 years.

Complementary to the Credit Insurance Act, Section 4418 of the Insurance Code of 1956, as amended (Code), MCLA 500.4418; MSA 24.14418, which regulates group life mortgage insurance, used to apply only where the term of the loan was in excess of five years. This test of time was eliminated in 1983. Section 4418 now provides:

(1) Group life insurance may be issued in connection with loans on dwellings or mobile homes when provided through a group if the lending or servicing financial institution directly or indirectly is the group policyholder. The insurance shall be only on a decreasing term basis and shall be limited in initial amount to the lesser of the amount of the loan or $80,000.00 adjusted annually by the United States department of labor consumer price index as computed for each calendar year. Only 1 policy or certificate of life insurance may be issued in connection with each mortgage loan. Dividends payable under these group policies shall inure solely to the benefit of the party paying the premiums on the insurance and shall be proportionate to that portion of the premium paid by or on behalf of the certificate holder. Policies issued under this section shall contain a conversion privilege specifying that within 31 days after the repayment of the mortgage, the insured may convert the insurance then in force to any permanent form of life insurance. The available forms of converted insurance shall include whole life. The insurer may limit the converted policy to a minimum of $1,000.00 or to a maximum equal to 80% of the insurance then in force, or both. If the loan for which the insurance was issued is repaid, any prepaid premiums in excess of $5.00 shall be returned to the insured.

(2) An insurer shall not directly or indirectly, by any means, device, transaction, or agreement, through its agents, employees, or otherwise, provide for or pay to the lending or servicing financial institutions any monetary or financial benefits as a result of insurance on the life of a borrower in connection with a loan on a dwelling or mobile home made or services by the financial institution, except as provided in this section for the types of insurance authorized by this section.

(3) Insurers may reimburse financial institutions making or servicing loans on dwellings or mobile homes and issuing insurance through group policies and for individual policies being serviced by those financial institutions before January 1, 1969, for reasonable expenses incurred in servicing the insurance. Remuneration provided by insurers for the financial institutions shall be on the basis of a reasonable compensation. The reimbursement and remuneration shall not exceed a sum expressed in terms of cents per month per policy or certificate, as shall from time to time be authorized by the commissioner as reasonably necessary on an aggregate average basis to compensate financial institutions for expenses and for a reasonable compensation as determined by the commissioner. A disability rider or provision in a life insurance policy shall not be considered a policy for computing an expense reimbursement.

The consumer protection provisions contained in Section 4418 now apply to all group life insurance on open-end equity loans secured by dwellings or mobile homes. These provisions include the right to receive dividends, conversion privileges, and limits on the reimbursement and remuneration of financial institutions.

While the application of Section 4418 is straightforward, how the Credit Insurance Act applies requires further consideration. The question to be examined is: Where the Legislature in the Credit Insurance Act has excluded some insurance from regulation based upon the duration of the loan, does the Act apply where the duration of the loan is not fixed?

In answering this question, two considerations predominate. First, the consumer protections contained in the Credit Insurance Act should be given broad scope. The absence of a set repayment date should not, in and of itself, allow lenders and insurers to avoid regulation by the Credit Insurance Act. Second, repayment schedules for open-end loans may be used in deciding whether the Credit Insurance Act applies.

Repayment schedules for open-end equity loans provide for the monthly payment of a minimum amount. Typically, the minimum payment is a percentage of the outstanding loan. Many open-end loan agreements provide for a monthly payment of 2% or a figure close to 2% of the outstanding balance.

Analysis reveals that, where the percentage monthly payment is known and the interest rate is known, the implied term of the loan can be determined. This implied term of the loan indicates whether the Credit Insurance Act applies. Where the implied term of the loan is in excess of five years, the Credit Insurance Act does not apply to the group or individual mortgage life and disability insurance issued in connection with it.

The table below shows when the implied term of an open-end loan is in excess of five years. The table works as follows: if the percentage monthly payment is [insert number from table] and the interest rate is [insert number from table] or more, then the implied term of the loan is in excess of five years.

For example, if the monthly percentage rate is 2% and the interest rate is 8% or more, the implied term of repayment is in excess of five years. If the monthly repayment rate is 2.3% and the interest rate is 13.5% or more, the implied term of repayment is in excess of five years.

Many equity loans have variable interest rates. Insurers will have to make their best estimate of whether the loan is likely to be repaid within five years. If so, the Credit Insurance Act will apply to the group or individual mortgage life and disability insurance issued in connection with it.

III. INTERPRETATION

Group life insurance issued in connection with an open-end equity loan secured by a dwelling or mobile home is governed by the provisions of Section 4418 of the Code. Group and individual mortgage life and disability insurance is regulated by the Credit Insurance Act except when the term of the loan is in excess of five years. Where the term of the loan is not fixed, the implied term may be determined by repayment schedules if the interest rate is fixed. The implied term indicates whether the Credit Insurance Act applies. The table set forth in this bulletin reveals where the implied term of an open-end loan will be in excess of five years.