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Hurricane season is underway and so far there have been only two serious storms. Image: iStock.
Hurricane season is underway and so far there have been only two serious storms. Image: iStock.

A Stormy Season for Lender Placed Insurance

AUG 15, 2014 11:06am ET
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Weather-wise, we're having a placid season. Hurricane season is two months underway and so far, there have only been two named storms, neither going above Category 2.

I imagine that flood insurers and major mortgage banks are keeping their fingers crossed for another season like 2013 not a single hurricane rated Category 2 or greater in the Atlantic, Caribbean or Gulf of Mexico.

But that's not to say the industry wasn't a bit stormy, what with all the class action lawsuits related to force-placed insurance.

Not only did major insurers and banks face a flurry of homeowner lawsuits last year, but also in June of this year the Federal Housing Finance Agency barred the practice of banks collecting commissions (aka kickbacks) from insurers. Force-placed insurance ballooned to a $1 billion-a-year industry after the housing bust in 2008, and the FHFA is considering taking legal action against major banks to recover losses from alleged insurance kickbacks that may have cost Fannie and Freddie hundreds of millions of dollars since then.

The FHFA's Office of the Inspector General said FHFA should sue its servicers and lender-placed insurance providers because the insurance safeguards the value of homes "in the event of a fire or other covered incident" and Fannie Mae and Freddie Mac took a hit on these properties due to excessive premiums and lawsuits based on those higher premiums.

The OIG said servicers outsource to specialty insurance companies that track borrower insurance policies and when providers see a lapse in hazard insurance, they put in the LPI. In other words, a bad hurricane season means we can see more LPI on the overcast horizon.

In 2012, the GSEs paid nearly $360 million in LPI premiums, which was mainly on foreclosures and what the FHFA deemed "excessive costs," but tack on a strong hurricane season and we can see that number etch substantially higher. With all the pressure and scrutiny on industry practices, it will be very interesting to see how the number of force-placed flood insurance policies changes this year over last.

Financial regulators found that the LPI rates were excessive in a number of states. In 2012 and 2013, New York, Florida and California accused two companies of charging excessive LPI rates and began to enter into consent orders to settle the claims. In 2012, Hurricane Sandy did some damage to Florida but the damage in New York and New Jersey was significant in October of that year.

Hurricane Sandy affected 24 U.S. states, including the entire Eastern Seaboard. On Oct. 29, New York City streets, tunnels and subway lines were flooded, cutting power in and around the city. Total damage in the United States amounted to $65 billion. Florida was included in that total. That makes $360 million seem like peanuts compared to the damage a hurricane can do to insurance companies.

We need to take that into account when we look at fees for lender-placed insurance companies. On foreclosures, the OIG and states believed the costs were excessive, but Hurricane Sandy is an example of damage that can be done by a major hurricane. At a time when the waters are warming, the chances of severe hurricanes can increase, even in locations like New York City.

Florida has weathered its share of hurricanes, hit more times than any other U.S. state. Ironically, it hasn't had a hurricane in eight straight years after the worst two back-to-back years on record. That said, the Atlantic Basin still has a high level of activity as witnessed this year with Hurricane Arthur, the earliest hurricane to ever hit North Carolina.

For Florida, in 2008, Tropical Storm Fay recorded four landfalls in the state, causing $560 million in damage and that was not even a hurricane.

The back-to-back hurricanes in 2004, four hurricanes, were the most recorded for the state of Florida in a single year. And, of course, New Orleans is still reeling from Hurricane Katrina in 2005. Florida had three hurricanes that year including, Katrina and Hurricane Wilma, which caused $20.6 billion in damage.

Since 2005, Florida has been safe from hurricanes. Let's hope it stays that way.

The FHFA-OIG recommends the FHFA look at the possibility of lawsuits by the GSEs against their servicers and LPI providers to "remedy potential damages caused by past abuses in the LPI market and, then, take appropriate action in this regard."

The FHFA's general counsel has not yet considered lawsuits over the LPI rates due to finalizing pending legal claims, but the OIG report said the general counsel will consider it. Is LPI excessive when we consider incidents of $64 billion in damage to U.S. states in 2012?

The FHFA OIG believes the GSEs owe it to themselves to look at suing the servicers and the LPI companies, but they also owe it to these companies to protect themselves in cases of natural disasters. That's what insurance is all about. We hope we don't have to use it, but it is a necessary evil.

Let's hope "climate change" takes another year or two off so that we don't see the severe damage we saw almost two years ago in New York City and nine years ago in Florida. But if it rears its ugly head in the year ahead or next year we'll also know that mortgage lenders have protection on those properties, whether the foreclosures are man-made or a result of nature.

Phil Huff is CEO of Platinum Data Solutions.

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