The largest of the government-sponsored enterprises has submitted the as yet unannounced plan to its overseer, the Federal Housing Finance Agency, sources say. Fannie is seeking to require banks and other mortgage servicers to replace existing force-placed policies on loans it guarantees with insurance provided by a consortium of carriers offering 30% to 40% discounts.
The plan poses a threat to a line of business that has proven highly lucrative to the two leading insurers, Assurant and QBE First. It also appears likely to cut off a revenue stream for the banks that service mortgages and have traditionally received a portion of the premium revenue from the insurers.
Force-placed insurance protects the creditor banks when financially troubled homeowners allow their voluntarily purchased hazard insurance to lapse. Banks ultimately bill homeowners for the premiums, which cost far more than voluntarily purchased policies. In cases where homeowners default, mortgage servicers pass along the unpaid costs of force-placed coverage to mortgage investors and guarantors such as Fannie Mae.
Fannie Mae's bid to reform the force-placed market has taken on increased urgency in the wake of Hurricane Sandy, which will likely lead to increased insurance costs in 2013. If the FHFA does not act promptly, rising reinsurance premiums could reduce the size of the discounts Fannie's program would obtain, sources say.
"That Fannie has found a consortium of insurers willing to do the work for such a large discount makes it clear that current rates are way, way excessive," says Robert Hunter, a former Texas insurance commissioner who now works for the Consumer Federation of America. "This is a very strong step in the right direction."
When homeowners allow standard hazard policies to lapse, banks have a clear contractual right to protect the value of the loans they service by obtaining replacement coverage. However, public officials and consumer advocates have accused insurers and banks of colluding in pay-to-play schemes that inflate the cost of forced-placed coverage at the expense of homeowners and investors.
Fannie's rules would apply to force-placed insurance on the 17.6 million loans that it directly guarantees, representing about one-third of the U.S. mortgage market. But the initiative could have a wider influence by pressuring underwriters to create policies that better serve the interests of their ultimate beneficiaries—mortgage investors and homeowners.
If Fannie's plan goes into effect, banks and insurers would have to either lower force-placed premiums across the board or charge Fannie borrowers far less than other consumers. Sources say Assurant and QBE First would have the option of competing for some of the business at the lower price points while retaining insurance tracking and administration work.
Banks and insurers that want to buck the Fannie plan would likely face logistical challenges. Major banks usually hire a single company to handle all aspects of their residential force-placed insurance business and would be reluctant to split the job up.
"Lenders don't want multiple systems in their offices," Hunter says. "Plus, it would be embarrassing. You can't tell borrowers that you want them to pay 40% more because you'd like to screw them for the extra dollars."
Fannie Mae declined to discuss or acknowledge its plan. The FHFA, the Mortgage Bankers Association and the American Bankers Association also declined comment before a formal proposal is released. QBE First spokeswoman Sabrena Tufts said the company does not address "speculation." Assurant spokeswoman Shawn Kahle said it was unprepared to speak on the terms of an undisclosed initiative but wishes to continue working with Fannie.
"We've spoken with Fannie many times about various approaches that could be practical and know that we have the operational expertise and capacity to ensure high-quality service to meet the needs of lenders, homeowners and Fannie," Kahle said in a written statement.
In the housing boom's heyday, force-placed insurance was regarded as an obscure commercial insurance product of little relevance to homeowners. Few borrowers defaulted on their loans, and the rare borrowers who did run into trouble were often able to refinance their homes and avoid force-placed policies' high costs.
During the bust, a glut of loan defaults coupled with the glacial pace of foreclosures turned forced-place insurance into a market with $6 billion in annual premiums, according to New York's Department of Financial Services. The pricey policies-which American Banker initially reported in 2010 sometimes cost ten times as much as the voluntarily coverage—drew the ire of consumer advocates, who argued that the insurance was actually pushing borrowers into foreclosure. Insurers and banks responded that the premiums were justified by the high risk of insuring in bulk defaulted, and sometimes abandoned, homes.
Financial ties between banks and insurers intensified the controversy over the policies' hefty fees. Major banks outsourced virtually all of the day-to-day work of administering the programs to Assurant and QBE but still collected commissions or received lucrative reinsurance deals from the insurers.
New York Financial Services Superintendent Benjamin Lawsky launched a probe of force-placed insurance last year, decrying "perverse incentives" and "gouging" at a May hearing. Insurance commissioners in California and Florida have demanded steep cuts in force-placed premiums.
A California lawsuit revealed that a JPMorgan Chase subsidiary collected force-placed flood insurance commissions despite employing no insurance agents. (The bank had already stopped accepting such commissions by the time the case settled.) Florida plaintiffs' attorneys alleged that QBE First paid less than 8 cents of claims for every dollar of premiums it collected on a portfolio of Wells Fargo loans, a payout rate that state regulators would regard as impermissibly low for many lines of property and casualty coverage. Wells has since dropped QBE.