Debt Protection Insurance ……….. Don't Do It

I just opened the bill for my gas credit card (which I only use because I get 5% back on gas purchases) and I was disappointed to see a little advertisement fall out that suggested that I purchase debt protection insurance.  This type of insurance, which can also be called payment protection, credit shield, credit card protection, credit safeguard, or any number of other names, purports to pay your bills if you are dead, disabled, or unemployed.  The advertisement I received stated many myths about debt protection insurance as if they were true.  I'm going to address each myth stated and tell the truth about the subject. 

Myth:  "Debt Protection cancels your credit card payments in the event of death, disability, or involuntary unemployment."

Fact:  Note the use of the word "payments."  The only way in which debt protection pays off your credit card balance is if you die.  In the event of disability or involuntary unemployment, "there are eligibility requirements, conditions, and exclusions that could prevent you from receiving benefits under this program."  (this comes from the sales flyer.)  Even if you meet their requirements, conditions, and exclusions, it only prevents the needs to make the minimum payments due, up to $1000 per month (ack!), for up to six months.  Depending on your card's terms, minimum monthly payments will probably result in you owning more at the end that you did at the beginning.

Myth:  "Low-cost peace of mind.  Single Protection, which protects the primary borrower, is only $2.25 per $1,000 of your outstanding credit card balance."  (Note:  apparently this is a very inexpensive plan – I've seen rates as high as $1.50 per month for each $100 of coverage.)

Truth:  This insurance is very expensive. 

If you are looking at the death benefit coverage, SGLI (Servicemember's Group Life Insurance) costs 6.5 cents per month per $1,000 of coverage.

If you are interested in the disability insurance, you would be better off looking for disability insurance.  the way the military is structured, there is some form of disability coverage in the way that your benefits are structured.  If you are a civilian, you would find much better coverage, especially if you are eligible for an employer sponsored plan.   Keep in mind, this plan pays only the minimum monthly payment for up to six months.

The unemployment insurance is a little less clear cut.  If you carry a lot of credit card debt (let's say $50,000 to make the math easy), this insurance would cost you $112.50 per month.  The minimum payment due each month, assuming a common 2%, would be the maximum $1,000 per month payment on this policy.  If you were to become unemployed this month, and meet their requirements, exclusions and conditions, this could be a valuable benefit to you.  They would pay the $1,000 minimum payment every month for six months.  Of course, making that required minimum payment of $1,000 the first month would bring your balance down to $49,000.  Assuming an industry average 18% annual interest rate, you would be charged $735 in interest that month.  At the end of the month, you would be back to $49,735 in balance due, even without any new charges to your account.

If you have one of the cards that has recently changed the minimum monthly percentage to 4%, you're in big trouble.  With the $1000 minimum payment cap, someone with high debt won't have enough coverage to make their minimum monthly payment with this plan, resulting in late fees and other expenses.

Also, most plans (I hate to say all, even though I think it is true) require that the account be in good standing at the time that the claim is made.  This means not being over your credit limit, not having a past due balance, and your payments being completely up-to-date.  I have heard that the rate of refusing to pay on this insurance is amazingly high, and this is one of the most common reasons.  In addition, they rarely cover  second income or anything outside of the common "I have one job that pays me a paycheck" situation.  Also, if you lose your primary job but manage to secure a part-time or lower-paying job, they won't pay either.

If you have a smaller balance, and you anticipate involuntary layoff in the immediate future, and you thoroughly explore all the requirements, exclusions, and conditions, and your account is in good standing, and you have no emergency fund, this might be an option to consider.  Otherwise, take that $2.25 (per thousand dollars of balance) per month and put it towards paying off your credit card.   It is a much better use of your money.

Myth:  Protect yourself and your family.

Truth:  This insurance only covers the balance on one particular credit card.

Myth:  Ease your worries at a difficult time.

Truth:  Under certain, very specific circumstances, this statement
might be true.  If you become unemployed or disabled, and if you meet
their payment criteria, this will make the minimum payments for up to
six months.  That might be helpful to tide you over until you find a
new job or become full well again.

Myth:  Applying is fast and easy.

Truth:  It is easy to apply, and people who are eligible are usually approved quickly since this is such a good money maker for the insurance companies.  However, several groups are automatically excluded from coverage.  Depending on the plan, this will include people beyond a certain age (65 on my flyer), secondary borrowers, self-employed borrowers, those who have received unemployment compensation within the last two years, those who are presently unemployed, those who are on a leave of absence or receiving sick pay, and people who work less than full-time (definitions vary.)

As you can probably see, I don't like this type of insurance.  I am willing to concede that it might be a decent choice for certain people in very specific situations, but for 99% of the population, debt protection insurance is a bad choice.  As always, ask a lot of questions, do your homework, and make smart decisions!

About the Author

Kate Horrell
Kate Horrell is a military financial coach, mom of four teens, and Navy spouse. She has a background in taxes and mortgage banking, and a trove of experience helping other military families with their money. Follow her on twitter @realKateHorrell.
  • Destroyed

    I think you are grouping a few programs in that list that aren’t the same as another.

    I have a payment protection program on all my credit cards. In the case of unemployment, which I currently am, I can enact the protection and I don’t have to make a payment until I have found employment again. This means that I still have to pay the debt off eventually, but I get a break.

    It does not pay off my debt or cancel my payments. It postpones the payments and delays the time it will take to off my debt.

    This works for me and for others who understand the program.

    This is just one example of the difference in my experience compared to your example. I am sure there are others. So again, I think you are grouping a few programs in that list that aren’t the same as another.

    By the way, the single protection example you provided is really expensive compared to mine. My plan is only $0.85 per $100 of my balance. So if your example is a true stated price, then it is too high.

    Also, in my opinion, if someone has $50,000 of credit card debt, then they shouldn’t be worried about being duped into debt protection insurance, they should think of themselves as stupid for getting into that much debt in the first place.

    • I’m going to have to disagree with your assessment, Destroyed. Unless you have a good reason to believe that you are going to become unemployed in the near future and you won’t find work quickly, the math doesn’t work out. That isn’t a gamble I’m willing to take.

      I’m curious about several aspects of your plan. First, is there a minimum amount of time before you can claim benefits? Could I purchase a plan today, become unemployed tomorrow, and still benefit? Also, do you continue to be charged the insurance payments while you are unemployed? Are you still accruing interest while you are deferring payments? At what sort of rate? Is there a limit on benefits? Also, I am assuming that it only covers involuntary unemployment.

      If you have $500 of debt, you are paying $4.25 per month for your payment protection program. The minimum payment on $500 of debt, at a 4% minimum payment, is $20 per month. At $4.25 per month, you are paying an extra $51.00 a year for a benefit that you may or may not use. Better to take that $51 at put it towards your balance, or if you are really worried, put it aside. That is 2 1/2 months of minimum payments saved.

      I’ve run the math forwards and backwards, and over a lifetime, you would need to be unemployed over 20% of the time for this insurance to be effective. These calculations were made assuming that they suspend the premiums while you are receiving benefits and that there is no limit on maximum benefits. In addition, with the interest accruing while the benefits are in place, you would end up with significantly more debt when you became employed again.

      I am sure there are cases where people have benefited from this insurance and I am glad that it has worked out for you. However, I still can’t recommend it as a smart purchase.