September 21, 2021

Fair Game: Hazard Insurance With Its Own Perils

It’s about time.

 Investigators are training their sights on a type of hazard insurance policy known as force-placed insurance, a type of policy that has driven up costs for homeowners and pushed some into foreclosure. People who buy certain mortgage securities may be getting hurt, too.

Benjamin M. Lawsky, the superintendent of the New York State Department of Financial Services, is investigating institutions that underwrite and sell force-placed insurance. Last fall, his office began sending subpoenas to insurance agents and brokers. Requests for information also went out to insurance companies that write such policies.

Working his way up the chain, Mr. Lawsky’s office issued a new set of subpoenas late last week. According to a person briefed on the matter who was not authorized to discuss it, the subpoenas went to loan servicers that imposed force-placed insurance on borrowers, as well as to insurers affiliated with those servicers.

Among the servicers that received the subpoenas were Morgan Stanley Mortgage Capital Holdings and CitiMortgage. Insurer affiliates that received requests for information include BancOne Insurance, a unit of JPMorgan Chase, and Alpine Indemnity, an affiliate of PNC.

“Force-placed insurance appears to be the dirty little secret of the mortgage industry,” Mr. Lawsky said in an interview last week. “It is a silent killer harming both consumer and investors while enriching the banks and their affiliates.” 

Representatives of PNC and JPMorgan Chase declined to comment. Mark Rodgers, a spokesman for Citigroup, said the bank was working with Mr. Lawsky’s office. “CitiMortgage does not sell homeowner’s insurance to consumers,” he said. “If a homeowner does not provide an insurance policy, CitiMortgage secures a policy to protect the interest of the investor. Whenever the homeowner submits proof they have obtained insurance on their own, the lender-placed insurance is canceled.” 

A spokesman for Morgan Stanley said its mortgage company “does not have an affiliated agent, broker or insurance company to procure force-placed insurance.”

Force-placed insurance has exploded during the foreclosure crisis. Once a backwater that generated $1 billion a year, it is now a $6 billion-a-year business. Much of its growth has come on the backs of homeowners.

When homeowners run into financial trouble, they often let their hazard insurance lapse. Because lenders require homeowners to be insured against damage or total loss — say, from a fire — policies are then forced on the borrowers and added to their monthly mortgage payments.

There is a lot to love about force-placed insurance — if you sell it. The policies typically cost at least three times as much as ordinary property insurance. Some borrowers have been charged much more — up to 10 times the prevailing rate — according to people knowledgeable about these practices who spoke on condition of anonymity to maintain business relationships.

Mind you, force-placed policies do not protect homeowners from loss. Only lenders are covered. But homeowners must pay the freight. And lender-placed insurance typically does not carry deductibles, as typical policies do.

Borrowers have also complained of being forced to buy this high-priced insurance even when it is unnecessary. Back in 2007, a borrower with a mortgage serviced by Countrywide Financial described how the lender automatically signed her up for flood insurance even though she had proved that such insurance was unnecessary. Not being able to meet the extra payments, she fell behind on her mortgage. Countrywide then began foreclosure proceedings. 

All in all, force-placed insurance represents a major profit center for mortgage servicers and the companies that write the policies. In many cases, you will not be surprised to learn, the servicers and the insurers are affiliated. This sets up the potential for conflicts of interest among loan servicers that are often supposed to represent investors owning mortgage loans bundled into securities.  

Many banks have set up affiliates that provide this insurance or take on some of the risks that other companies have insured, known as reinsurance. These cozy relationships are a focus of investigators.

Consider the potential for mischief when a mortgage servicer administers a loan owned by an investor. If a loss is incurred on the property that is insured by an affiliate of the servicer, it is not in the servicer’s interest to file a claim on behalf of the investor to cover the loss.

Because such relationships are not typically disclosed, investors may be unaware that these conflicts exist. Faced with a loss on the property, the investor may simply accept it without protest.

Insurers that are not affiliated with lenders have paid fees from 15 to 20 percent of the policy to the banks that place the insurance, according to former industry executives. This indicates how lucrative the business is. 

A more consumer-friendly way to deal with insurance lapses would be for servicers to advance money to the borrower’s existing carrier to keep the policy current. Then, the servicer could bill the borrower for the coverage.

But that would stop the lush profits generated by forcing high-cost insurance on borrowers.  

Insurers that provide this kind of insurance say they must charge higher rates because homeowners who allow their policies to lapse are riskier. But these policies are not typically money-losers. According to data from the National Association of Insurance Commissioners, the average loss ratios on lender-placed insurance are about 22 percent. This compares with loss ratios of 65 percent on traditional homeowners insurance.

AMONG the tricks of this trade that investigators may examine is one that sometimes coincides with a mortgage refinancing. During the bubble years and to a lesser extent even today, lenders can add new coverage to existing policies if a property has increased in value. If a homeowner has, say, coverage for a $200,000 home that she refinances for $225,000, the amount of insurance she might be forced to finance is $425,000.

 Mr. Lawsky’s office has recently struck agreements with some servicers that protect against common abuses in this coverage. Last fall, for example, when Goldman Sachs sold Litton Loan Servicing to Ocwen Financial, Mr. Lawsky’s office had to approve the transaction. That approval was conditional upon Ocwen agreeing not to place this type of insurance with affiliates and requiring that it impose only competitively priced policies. 

Adding to homeowners’ troubles by forcing them to buy overpriced insurance is yet another ugly aspect of the mortgage servicing business. Let’s hope that shedding light on these practices will begin the process of eliminating them.

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