Irwin A. Thomas, Supervisor
Bond, Crime, Commercial Glass, Credit
and other Casualty Lines
333 Guadalupe Street
P.O. Box 149104
Austin, Texas 78714-9102
Re: Guaranteed Auto Protection (GAP) Program/Debt Cancellation Contract
Your letter dated May 21, 1997.
Dear Mr. Thomas:
Richard Hetzel from FLS Services, Inc. forwarded your letter addressed to John Tullis of Balboa Insurance Company to the National Credit Union Administration's (NCUA's) Office of General Counsel for response. In your letter, you requested a written statement that credit unions may use debt cancellation contracts or agreements and that NCUA does not consider these contracts or agreements to be insurance.
As long as a federal credit union (FCU) is not engaged in a form of self-insurance as discussed below, it is our opinion that debt cancellation contracts or GAP Waivers are not insurance products and an FCU may use them. Our response is limited to FCUs. As to state chartered credit unions, you should propose these questions to the appropriate state authority for an answer.
From past information provided by FLS Services, Inc., we understand that Guaranteed Auto Protection or GAP is insurance purchased by an FCU to protect itself from a loss resulting when a vehicle securing a loan financed by the FCU is declared a total loss or is stolen and the borrower's primary insurance settlement is not sufficient to cover the outstanding loan balance. With GAP insurance coverage, the FCU would receive compensation for the difference between the borrower's primary insurance settlement and the outstanding loan amount.
A GAP program established by an FCU operates in two phases. First, an FCU financing the purchase or lease of a borrower's vehicle would ask the borrower if he or she wanted GAP protection. If the borrower elects GAP protection, the FCU would enter into a debt cancellation contract or GAP Waiver with the borrower. The debt cancellation contract or GAP Waiver states that the borrower is released from his or her obligation to pay the deficiency remaining between the primary insurance settlement and outstanding loan balance if the vehicle securing the loan is totaled or stolen. Each borrower who elects GAP protection is charged a fee by the FCU. Second, an FCU would purchase a GAP insurance policy from an insurance vendor for each vehicle that is the subject of a debt cancellation contract or GAP Waiver signed by a borrower. The GAP insurance policy would be between the insurance vendor and the FCU, not the borrower.
In your letter, you made reference to an opinion letter from Richard Schulman to Richard Hetzel dated November 16, 1995, in which we stated that an FCU may sell debt cancellation contracts to its members as an activity that is incidental to the FCU's express power of lending. You have asked for clarification of a statement that was made subsequently in the opinion that such debt cancellation contracts "are an impermissible activity when they require an FCU to forgive otherwise collectible loans."
An FCU cannot sell a debt cancellation contract under a GAP program in which the FCU, in reality, is engaged in a form of self-insurance. Self-insurance is defined as a "plan in which the insured (e.g. business) places aside in a fund sufficient sums to cover liability losses that may be sustained." BLACK'S LAW DICTIONARY 806 (6th ed. 1990). An FCU would be engaged in self-insurance if, for vehicles subject to a debt cancellation contract, the FCU established a special reserve to fund any resulting loan deficiencies instead of purchasing GAP insurance coverage from an insurance vendor. Also, an FCU would be considered engaged in self-insurance if the FCU established a special reserve to fund any loan deficiencies up to a certain dollar amount and then purchased insurance from a vendor to cover any excessive loss or liability.
When an FCU acts as a self-insurer, the FCU is, in effect, providing insurance coverage for member loans by assuming the payment risk of each loan. Self-insurance is not an activity incidental to any express FCU power. However, an FCU may enter into debt cancellation contracts or GAP waivers under its incidental powers provided that it purchases an insurance policy that covers the entire risk of loss.
You also asked whether NCUA considers debt cancellation contracts or GAP waivers to be insurance and whether an FCU that enters into such contracts or waivers to be engaged in the business of insurance. In the above-mentioned opinion to Richard Hetzel, we stated that the determination of whether a debt cancellation contract or GAP Waiver was an insurance product was to be made by the appropriate state insurance regulator. After further consideration, however, it is our opinion that debt cancellation contracts or GAP Waivers are not insurance products. We rely on a federal appellate court decision that holds that, since national banks are permitted to offer debt cancellation contracts under their incidental powers, debt cancellation contracts should not be considered the "business of insurance." First National Bank of Eastern Arkansas v. Taylor, 907 F.2d 775, 780 (8th Cir. 1990), cert. denied, 498 U.S. 972 (1990). Accordingly, an FCU would not be engaged in the business of insurance by entering into such debt cancellation contracts or GAP waivers with its members.
Sheila A. Albin
Associate General Counsel
cc: Richard W. Hetzel, President
FLS Services, Inc.