The Federal Housing Finance Agency (FHFA) is taking action to resolve issues surrounding lender-placed insurance (LPI) by directing Fannie Mae and Freddie Mac to prohibit servicers from being reimbursed for expenses associated with captive reinsurance arrangements, but some consumer advocates and mortgage industry watchers say the measure will have little effect.
In a Nov. 5 press release, the FHFA said the decision to take action was a result of comments the agency fielded after posting a notice in the Federal Register in March. The captive reinsurance arrangements had become controversial because, the agency noted, ‘reportedly, premiums for lender-placed insurance are generally double those for voluntary insurance and, in certain instances, significantly higher.’ In the two-page notice, the FHFA had also mentioned that there were concerns about servicers receiving commissions and other remuneration from insurance companies and about servicers owning insurance companies.
The FHFA says it will provide guidance to sellers and servicers to prohibit these practices and will also provide implementation schedules, but that's not enough, says Sarah Edelman, policy analyst, housing finance and policy, for the Center for American Progress in Washington, D.C.
‘They have not provided enough information, and it's hard to know whether to take this action seriously,’ Edelman says. ‘It's hard to say when we will see any implementation and whether this will bring down costs for consumers.’
Lender-placed insurance, or force-placed insurance, is insurance that a mortgage servicer buys when a borrower's homeowner's insurance lapses. The lender tries to recoup the cost from the homeowner or from a foreclosure sale. If the servicer cannot recover the cost, the expense is passed along to government-sponsored enterprises (GSEs) Fannie and Freddie.
‘The basic concept of LPI is not controversial,’ says Tracey Carragher, CEO of Breckinridge Insurance Services, based in Kennesaw, Ga. ‘LPI simultaneously protects homeowners and lenders. When functioning properly in a competitive environment, LPI provides an important safety net for mortgage lending and encourages investment.’
The controversy is in the lack of a competitive environment. ‘The artificially high price of LPI is primarily the result of those industry practices that have come under scrutiny: kickbacks or commissions tied to premium rates, the offering of below-cost services and illegitimate reinsurance deals,’ Carragher says. ‘At a basic level, these practices incentivize anti-competitive behaviors and directly lead to higher costs.’
Carragher adds that Breckenridge and its subsidiary OSC had proposed a consortium approach in which the GSEs would buy insurance directly from the insurance companies. In November 2012, Fannie Mae announced it would purchase insurance directly from providers – a proposal that was supposed to save $300 million.
The Center for American Progress supported this idea, and Edelman says she thought it was going to pass. ‘It appeared to be moving full-steam ahead, but the FHFA squashed it,’ she says. ‘They didn't provide an explanation. Then they said they're going to do something about it, but they haven't done much.’
The LPI controversy has been around for years but has received more attention lately, says attorney Robert Wallan, a partner with law firm Pillsbury Winthrop Shaw Pittman in Los Angeles. ‘A lot of it is reactionary to the recession and the drop in the housing market,’ he says. ‘When you have a high number of foreclosures and borrowers that are in some distress, you tend to have an increase in defaults, not only in payment of loans, but also a failure to pay insurance premiums.’
Wallan points out that insurance is regulated by states, and some states have taken a more aggressive approach. Earlier this year in New York, Gov. Andrew M. Cuomo announced settlements with Assurant Inc., QBE, Balboa and American Modern, the largest force-placed insurers in the U.S. The settlements, which came as a result of public hearings and investigations, include restitution for homeowners who were harmed, $25 million in penalties paid to the State of New York and some changes in what the companies must report to the New York Department of Financial Services. California and Florida also had public hearings.
The topic is not just an insurance company issue, Wallan says, and servicers need to make sure they stay up-to-date on rule changes. ‘It's more complex than high premiums are bad,’ he says. He points out that lender-placed insurance is not underwritten and that risk drives some of the high premiums.
That's a point the National Association of Federal Credit Unions (NAFCU) made, too. In a recent statement, the NAFCU says it is ‘disappointed’ in the FHFA's decision to move forward with prohibitions and that the decision ‘may hamper credit unions' ability to limit risk.’
Carragher says it's hard to know what effect the FHFA's decision will have.
‘Commissions and kickbacks are essentially a way for insurers to provide value for banks that give them business. Under the directive, that value can still be created – and most often is – through offering services at reduced prices. Many banks have already announced that they have eliminated kickbacks and commissions, so the impact on mortgage servicers … is limited.’
Edelman says the FHFA can do more. ‘We would like to see the FHFA take action to bring costs down for consumers.’
Nora Caley is a Denver-based freelance writer.