What Is Collateral Insurance and How Does It Work?

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When you’re purchasing or leasing a vehicle, your lender or lessor will likely require you to have full coverage car insurance. This type of insurance financially protects the lender or lessor until you own the vehicle outright. However, if you can’t get full coverage or are unwilling to purchase it, your lender might purchase collateral protection insurance (CPI) for you — and you’ll still have to foot the bill. CPI covers the vehicle but doesn’t offer the same liability or medical coverage as a full coverage would.

What is collateral protection insurance?

Collateral insurance is a car insurance policy lenders take out to financially protect their investment in a vehicle. If a borrower fails to maintain full coverage car insurance (including collision and comprehensive coverage), the lender can buy collateral insurance instead and add the premium to the borrower’s monthly loan payment.

Lenders require this type of insurance to make sure the vehicle — the loan’s collateral — is financially protected in case of damage or loss. To note, collateral insurance is often less beneficial and more expensive for the vehicle owner than a standard car insurance policy. Because the lender chooses the coverage, it typically prioritizes their financial protection over the borrower’s specific needs.

Collateral protection vs. force-placed insurance

Force-placed insurance and collateral protection are alike: both are designed to provide insurance coverage when a borrower fails to secure coverage for themselves. However, there are some differences between the two terms. Force-placed insurance is a broader category that can apply to various assets, such as homes or cars, depending on the scenario.

Collateral protection specifically applies to vehicles. In essence, while all collateral protection insurance can be seen as a form of force-placed insurance, the reverse isn’t always true since force-placed insurance can apply to assets beyond just automobiles.

How does collateral insurance work?

Financing the purchase of a car comes with specific responsibilities. Aside from regular monthly payments, lenders usually require borrowers to have certain types of insurance coverage. That’s because, until the car is entirely paid off, it technically belongs to the lender. Should the vehicle suffer damage in cases where the borrower isn’t adequately insured, the financial loss affects both parties. Collateral protection insurance steps in to help ensure that damage to the vehicle is covered.

One of the challenges with CPI insurance is that its premium is generally non-negotiable, and it might not always be the most economical choice. When you purchase car insurance for a financed vehicle on your own, you can explore the market, compare offers and potentially discover more competitive rates.

It’s also important to keep in mind that the scope of CPI’s coverage is limited to the specifications in your loan agreement. If you’re seeking more extensive coverage, purchasing a full coverage policy offers financial protection against physical damage as well as liability, theft, weather, animals and more. Securing a policy yourself would enable you to tailor the coverage types and policy limits to your specific needs and preferences.

What does CPI insurance cover?

Collateral insurance primarily provides financial safeguards against physical damage to your car. At its core, it typically encompasses collision and comprehensive coverage. Depending on the specifics of the package your lender selects, it could also offer protection for medical expenses and liability — but that’s not always the case, so it’s important to read through the policy documents. Below is a detailed look at what type of coverage applies when.

• What comprehensive insurance typically covers
  

  • Theft: Should someone steal items belonging to your car (like the radio), comprehensive coverage helps pay for any costs associated with repair or replacement. It also typically covers damage your car sustains from someone breaking into it. Note that items stolen from your car (such as your wallet, purse or phone) are typically not financially protected under this type of coverage.
  • Vandalism: If your car is vandalized, comprehensive coverage helps pay for repairs or replacement up to your policy limits. Smashed windows, slashed tires and broken side mirrors are all examples of events usually covered by comprehensive coverage.
  • Fires: A fire can devastate your car’s appearance and functionality. Comprehensive coverage provides financial protection for both, up to your policy limits.
  • Falling objects: Although it is unlikely your car will be damaged by anything other than a falling tree or tree limb, stranger things can happen. Comprehensive insurance financially protects you against anything that falls onto your car and causes damage.
  • Animals: If a rodent, such as a mouse or rat, chews on your car’s wiring, comprehensive coverage could help pay for your car’s repairs. Comprehensive coverage also covers damage to your car if you hit an animal like a deer.
  • Weather events: Hail, lightning, flood water and other weather-related damage are typically covered under comprehensive insurance. However, if your car is damaged by water from a leaky pipe or roof (in your garage, for example), those types of damage are not usually covered.

• What collision insurance typically covers
  

  • Collision with another vehicle: Typically the coverage most people need, collision coverage helps pay for damage from collisions with other cars or objects, whether it is your fault or not. It does not cover damage to the other person’s car, though; that is covered by liability insurance.
  • Collision with a fixed object: If you back into a parked car or run over a sign, your collision coverage could cover the damage to your vehicle. It will not, however, pay to repair the object you hit. For that, you would need property damage liability insurance.

Collateral protection refunds

Errors can occur in any financial process and occasionally, lenders might mandate borrowers to obtain CPI insurance even when it’s unnecessary. If you find yourself in a situation where you were wrongly asked to purchase CPI, there are steps you can take to try to rectify the situation.

1. Proof of insurance: The initial step is typically to present your lender with valid proof of insurance, demonstrating that your vehicle was already insured with the type of coverage required by your lender during the period in question. In some cases, merely showing the declarations page of your insurance policy will suffice. This document provides detailed information about your coverage, including the types of insurance you’ve purchased, the policy’s duration and its limits.
2. Contacting your insurance agent: If the lender remains unconvinced, you might need to facilitate communication between them and an agent from your insurance company who can verify your car insurance coverage details.

Once your lender is satisfied with the evidence and confirms the existence and details of your independent policy, it should cease the CPI charges. However, be mindful of any periods during which you might not have had an active insurance policy. For those specific days or months, the lender might still charge you for CPI, considering it a back-payment for insurance. This means that even if you later secured your insurance, you might still owe the CPI amount for the timeframe when your vehicle wasn’t insured.

Always maintain open communication with your lender. If you’ve initiated or made changes to your insurance policy, promptly inform them. This proactive approach could help avoid unnecessary additional costs and complications.

Frequently asked questions

• Why is CPI insurance so high?
  

  CPI insurance tends to cost more because it’s typically a one-size-fits-all policy, lacking customization based on individual risk factors. Lenders choose the policy to primarily protect their own interests, not necessarily to get the best deal for the borrower. Additionally, administrative costs associated with monitoring uninsured borrowers and implementing CPI can drive up the price. Furthermore, as borrowers don’t have the option to shop around for CPI, competition doesn’t drive down the rates. As a result, CPI often comes with higher premiums than a typical personalized auto insurance policy.

• How do I avoid CPI?
  

  The most straightforward way to avoid CPI is to ensure you’re adequately insured before driving away from the dealership and to maintain continuous coverage without any lapses. Securing a full coverage car insurance policy can be especially effective in meeting lenders’ requirements. Insurance cards and the declaration page of your policy are vital documents that show insured dates and can be provided to lenders as proof of compliance. Independently comparing rates from trusted providers and securing a policy based on your specific coverage needs is typically a solid approach to steering clear of collateral protection insurance.

• What is the best car insurance?
  

  The best car insurance for you varies based on your individual needs, including your risk tolerance, coverage needs and personal preferences. By law, most states require drivers to carry liability insurance that meets specific minimum coverage limits. However, if your vehicle is financed or leased, your lender will likely require full coverage — typically including both collision and comprehensive insurance — as a condition of the loan.

  Even if you own your car outright, insurance experts generally recommend carrying more than the state-mandated minimum to ensure adequate financial protection. However, full coverage comes at a higher cost, so some drivers with older or lower-value vehicles choose to carry only the required minimum to save on premiums.

• What happens if you don’t pay for the CPI put in place?
  

  It’s generally not a good idea to avoid paying for collateral protection coverage on your vehicle, for several reasons. Most importantly, if you do not pay the premiums, the insurer is likely to cancel the policy, leaving you without any financial protection in the event of an accident or other vehicle mishap. You may also incur late fees or other penalties. Since the CPI payments are often folded into your loan payment, your refusal to pay could also result in a default of your loan agreement, with the possibility that your car could be repossessed. If the CPI is too expensive, an alternative could be shopping around for the necessary full coverage car insurance coverage to compare rates and find a better deal.

• How do I get cheap car insurance?
  

  It never hurts to shop around for auto insurance, especially if you’re trying to find cheaper coverage. Instead of letting your policy renew automatically, you may want to request quotes from several insurance companies, asking for the same coverage types and policy limits, so the quotes are easier to compare. Since each provider weighs risk rating factors differently when determining premiums, you might find the price you’re quoted varies greatly even for the same coverage. Don’t forget to ask about discounts you may be eligible for that could further lower your premium, too.