Of all the things we could pass along to our loved ones in the event of an unexpected death, debt is the one most of us would like to avoid. Yet with household debt at record levels that risk is greater than ever for many Canadians.
That's where creditor life insurance comes in. The most common form, mortgage life insurance, has been around for decades but more recently there has been a surge in demand for life insurance on ballooning consumer debt such as credit cards and car loans.
What is creditor life insurance?
Life insurance of any kind can be a touchy subject because its demand is rooted in a fear that family members will be left behind to struggle financially without a major breadwinner. Its initial value is piece-of-mind, and piece-of-mind is priceless.
Unlike conventional term life insurance, which allows the holder to name a beneficiary, creditor life insurance makes the lender the beneficiary. The survivors of the policy holder benefit indirectly because outstanding debt will not be deducted from the assets in the estate, which in some cases could exceed the value of the estate.
Like term life insurance, creditor life insurance policies can also apply in the event of disability, job loss or critical illness.
Creditor life insurance is usually offered as an option when a loan or line of credit is established; giving the lender a jump on any other options that could make more sense.
Is creditor life insurance right for you?
Conventional term life insurance and creditor life insurance are both paid for through regular premiums set by the insurance company. In the case of conventional life insurance the amount of coverage, or pay out, usually remains the same from the day it is purchased. However, the payout for creditor life insurance falls as the debt declines over time. When the debt is gone, so is the coverage.
Creditor life insurance may seem like a good value in the beginning but at some point during the life of the debt the premium may not justify the coverage. One way to get more bang for your life insurance buck is to extend your conventional life insurance to cover any outstanding debt. As the debt declines, and is eventually gone, your beneficiaries will get that much more in the end. You also have the option to lower your premiums by lowering your coverage.
Another big difference between conventional life insurance and creditor life insurance is the way premiums are calculated by the insurance company. When taking out a conventional life insurance policy a medical examination is required and actuarial charts are consulted to determine the probable age of death. If the policy holder is healthy and has a good family medical history the premiums will be lower because the insurance company will receive more payments over time. The opposite applies for high risk policy holders, such as smokers, with a poor family medical history.
Creditor life insurance holders, on the other hand, are put into a general pool of policy holders and premiums are calculated according to the average. Age and health still play a role but to a lesser degree. That means smokers with poor family medical histories could get a break and healthy policy holders could be compensating them. Premiums also depend on the size and type of loan, with credit card insurance having among the highest.
A few other considerations ...
Overall, premiums for creditor life insurance are generally smaller but unlike conventional life insurance the lender can legally cancel your coverage at any time for any reason.
Also, if you move your loan to another financial institution you will need to establish a new creditor life insurance policy, which could limit your options when shopping for the best interest rate or consolidating your debt.
Finally, before agreeing to creditor life insurance do some basic math. Premiums are normally included in regular loan payments along with interest on the loan and the principle (the actual amount borrowed). Every dollar paid in premiums and interest is a dollar not paid down against the loan. It is also a dollar that will compound over time and lengthen the time it takes to pay the loan, and lengthen the premium and interest payments.
The unspoken objective of the lending industry is to drive wedges between the amount you pay on a regular basis and the principal on your debt to prolong the life of a loan. Interest is one wedge and life insurance premiums are another. Banks have only recently been allowed to sell insurance products and it's no coincidence the popularity of creditor life insurance allows them to generate revenue from two streams: interest in the lending department and premiums in the insurance departments.