One of the more confounding aspects of the U.S. housing crisis has been the reluctance of lenders to do more to assist troubled borrowers. After all, when homes go into foreclosure, banks lose money.
Now it turns out some lenders haven’t merely been unhelpful; their actions have pushed some borrowers over the foreclosure cliff. Lenders have been imposing exorbitant insurance policies on homeowners whose regular coverage lapses or is deemed insufficient. The policies, standard homeowner’s insurance or extra coverage for wind damage, say, for Florida residents, typically cost five to 10 times what owners were previously paying, tipping many into foreclosure.
The situation has caught the attention of state regulators and the Consumer Financial Protection Bureau, which is considering rules to help homeowners avoid unwarranted “force- placed insurance.” The U.S. ought to go further and limit commissions, fine any company that knowingly overcharges a homeowner and require banks to seek competitive bids for force- placed insurance policies. Because insurance is not regulated at the federal level, states also need to play a stronger role in bringing down rates.
All mortgages require homeowners to maintain insurance on their property. Most mortgages also allow the lender to purchase insurance for the home and “force-place” it if a policy lapses or is deemed insufficient. These standard provisions are meant to protect the lender’s collateral -- the property -- if a calamity occurs.
Here’s how it generally works: Banks and their mortgage servicers strike arrangements -- often exclusive -- with insurance companies in which the banks agree to buy high-priced policies on behalf of homeowners whose coverage has lapsed. The bank advances the premium to the insurer, and the insurer pays the bank a commission, which is priced into the premium. (Insurers say the commissions compensate banks for expenses like “advancing premiums, billing and collections.”) The homeowner is then billed for the premium, commissions and all.
It’s a lucrative business. Premiums on force-placed insurance exceeded $5.5 billion in 2010, according to the Center for Economic Justice, a group that advocates on behalf of low- income consumers. An investigation by Benjamin Lawsky, who heads New York State’s Department of Financial Services, has found nearly 15 percent of the premiums flow back to the banks.
It doesn’t end there. Lenders often get an additional cut of the profits by reinsuring the force-placed policy through the bank’s insurance subsidiary. That puts the lender in the conflicted position of requiring insurance to protect its collateral but with a financial incentive to never pay out a claim.
Both New York and California regulators have found the loss ratio on these policies -- the percentage of premiums paid on claims -- to be significantly lower than what insurers told the state they expected to pay out, suggesting that premiums are too high. For instance, most insurers estimate a loss ratio of 55 percent, meaning they’ll have to pay out about 55 cents on the dollar. But actual loss ratios have averaged about 20 percent over the last six years.
It’s worth noting that force-placed policies often provide less protection than cheaper policies available on the open market, a fact often not clearly disclosed. The policies generally protect the lender’s financial interest, not the homeowner’s. If a fire wipes out a house, most force-placed policies would pay only to repair the structure and nothing else.
