A Washington state investigation revealed abuses in the sale of credit insurance, fueling concerns voiced nationally by regulators who are conducting a probe of the industry.

Minnesota Mutual, a St. Paul-based life insurance company, must refund $417,000 to policyholders in Washington beginning this fall as part of a settlement reached with state officials.The agreement was reached after it was revealed that the insurer made improper payments to lending institutions that handle the sale of credit insurance, regulators said.

Credit life insurance is a policy purchased by a borrower, and often issued by a lender, to repay a loan, such as a mortgage, in case of the policyholder's death or injury.

Regulators say it inflates the cost of a loan and the borrower may not be aware that the same insurance costs less if purchased separate from the loan.

Particularly in a down economy, lenders and their insurers may use the sale of such insurance to boost commissions and income.

Lenders may select the insurer that pays the highest commission or bonus - costs that are passed on to the policyholder in the form of higher insurance rates.

The National Association of Insurance Commissioners, Kansas City, Mo., is conducting an investigation of credit insurance with the hopes of gaining major reforms.

"Historically, the product has been overpriced," said Kevin Hennosy, a spokesman for the commissioners.

A recently released study by the commissioners shows that in 1990, only 41.5 cents of every credit insurance premium dollar went to pay claims.

Regulators suspect much of the rest of the money is paying for unduly generous commissions and bonuses for lenders.

In Washington, the problem centered on fees the insurer paid to the lenders who processed the insurance business.

The insurer called the fees "administrative," saying the amount depended on the loss history of the lender.

But the state called the fees "dividends," a type of payment prohibited by state law.

During the investigation, the department learned of other companies that may be making similar improper payments and has launched separate probes, said Richard Marquardt, the state insurance commissioner.

''We strongly disagree with the state of Washington Insurance Department on this issue," said Dennis Prohofsky, second vice president in Minnesota Mutual's law department.

''We remain convinced that the original payments to our financial institution clients were made properly. We worked with the department to resolve the matter in order to avoid disruption of ongoing business in the state of Washington. We have modified our procedures to conform with the department's wishes," he said.

About 9,000 Washington residents will be awarded cash or credit amounts ranging from $25 to several hundred dollars under the settlement.