Big Banks Win, Taxpayers Lose as Fannie Insurance Overhaul Spiked
As the overseer of mortgage giants Fannie Mae and Freddie Mac, the Federal Housing Finance Agency has a duty to safeguard taxpayer dollars. But the regulator may have done just the opposite earlier this month.
On Feb. 11, the FHFA held a conference call to inform a group of mortgage trade associations that it had vetoed a Fannie Mae proposal to buy force-placed insurance directly from underwriters. The news was greeted warmly by those listening in, given that Fannie's plan had threatened to cut mortgage banks from their profitable positions as middlemen.
Fannie's plan would have lowered the cost of some homeowners' insurance significantly and saved the government-sponsored enterprise at least $145 million annually, sources familiar with Fannie's plan and program documents state.
The FHFA's decision left plan supporters and others at a loss for an explanation save one—that the FHFA buckled under pressure from insurers and bankers, protecting controversial business practices that have drawn the ire of state insurance officials and consumer advocates alike.
"Incompetence or corruption. It's got to be one or the other," said Robert Hunter, a consumer advocate and former Texas insurance commissioner whose opinions dovetail with those of people closer to Fannie.
The FHFA disputes such assertions but declined to publicly discuss its reasons for rejecting Fannie's plan.
"Similar to how FHFA has proceeded on other issues, FHFA will work with Fannie Mae, Freddie Mac and key stakeholders…to address issues associated with force placed insurance," FHFA spokeswoman Denise Dunckel wrote in response to emailed questions.
Fannie Mae declined to comment on its regulator's rationale through spokesman Andrew Wilson. Inside the mortgage giant, officials had carefully vetted the plan and were confident that their cost-savings calculations were airtight, according to documents obtained by American Banker. (See the Fannie document in which the GSE laid out its rationale here.)
"Given the magnitude of savings for FNM and homeowners…it is crucial that an approval be given as soon as possible," project documents declared in December. "Lowering [force-placed insurance] costs will help some homeowners avoid default."
Force-placed insurance itself has been part of the mortgage landscape for decades. When a person buys a home with 20% down, virtually all mortgage contracts require him to maintain property insurance. If he doesn't, the mortgage servicer has the right to "force-place" a replacement policy to protect the creditor's 80% stake.
The bill for the replacement coverage—which is generally far higher than that of the original policy—is charged to the borrower. If the homeowner fails to pay up, the bank passes on the cost to mortgage investors and guarantors, of which Fannie Mae is the largest.
During the housing boom, force-placed insurance was an overlooked corner of the hazard insurance business. When housing prices collapsed, however, millions of borrowers defaulted, creating a massive foreclosure backlog and turning force-placed insurance into a multibillion-dollar industry.
Force-placed insurers assume unusual risks and have always charged relatively high premiums. What has drawn criticism in recent years is a web of financial ties between insurers and big banks that critics say has dramatically inflated costs.
Two specialty insurers—QBE and Assurant—have transformed the force-placed market into a near-duopoly by locking down major bank clients. American Banker first reported in 2010 that the insurers provided banks that gave them business with commissions or lucrative reinsurance deals.
But what duties mortgage servicers performed to earn that money was unclear. In one case, JPMorgan Chase collected insurance commissions through an insurance agency that employed no agents, depositions in a series of class actions revealed.
As the housing bust dragged on, regulators began to question whether the bank-insurer relationships amounted to a kickback scheme. They also grew uncomfortable with a market where the bills were passed along to others and banks had an incentive to buy the priciest coverage available.
New York's Department of Financial Services launched a probe in the fall of 2011 and held hearings on the force-placed market last May. "This is an industry…that has just a massive problem," Superintendent Benjamin Lawsky said at the time. He expressed particular concern with "large commissions being paid by insurers to the banks for what appears to be very little work."
Insurance commissioners in California and Florida have also launched probes of the force-placed market.
The public controversy surrounding force-placed insurance revolved around its high cost for struggling homeowners. But Fannie Mae took notice as well.
As guarantor of roughly 18 million home loans, it ultimately picks up the tab for force-placed insurance when borrowers don't. The GSE's hazard insurance costs rose from around $25 million a year before the financial crisis to $631 million in 2012.
Fannie spent months considering ways to cut costs. It ran into a significant hurdle from the outset, people familiar with the effort say. Banks and insurers told Fannie officials that their force-placed insurance arrangements constituted private contracts. They declined to disclose to Fannie how much it was paying and for what purposes its money was being used.
"Fannie Mae has limited ability to track premiums, claims, refunds, deductibles, and other key [force-placed] information," states a 2012 force-placed project brief summing up the "current state" of the market.
Bank and insurer advocates dispute the contention that the industry obfuscated, but concede that Fannie has been unable to obtain details on its force-placed insurance bills.
Fannie officials eventually resorted to scrounging through state insurance filings to find basic data about insurance written on its mortgage portfolio.
Fannie's data-gathering problem and its cost concerns stemmed from a common issue: The mortgage servicers who actually bought the force-placed policies weren't the ones paying for it.
Fannie officials eventually concluded that the simplest fix was for the GSE to buy insurance for itself. Such a move would cut banks out of the equation and enable Fannie to leverage its size into bulk discounts.