LPI Controversy Likely to Add Federal Regulation
Most insiders support the Consumer Financial Protection Bureau’s plan to give lender-placed insurance a makeover. What they have a problem with is agreeing on how and how much the product needs to change.
Given its mission “to provide transparency and accountability to the servicing industry,” says Brad Durrer, operations manager at Wipro Gallagher Solutions, specific LPI rules now under consideration by the CFPB within the wider context of the mortgage servicing rules are likely to help gain “a greater clarity” for the borrower.
He warns however that new rules could benefit the industry only if regulation “does not erode the wire framework of the servicer, which is to provide a means by which to process loans post-closing.”
“The CFPB must intervene and further define minimal regulations for the lender-placed insurance product,” says Vik Jain, president of Wingspan Insurance Services.
LPI standards will be a good thing for the customer and the industry “because they will help remove disclosure challenges,” which appear to be the biggest issue for consumers who often complain they were not told how much more than a regular insurance a LPI can cost. LPI costs are high because they depend on risk and total premium costs. Lender’s premium costs include the reserves, administration costs, profits margin and the commission, to mention a few, he says, so one way or another those costs will be transferred to the customer.
The debate may be new but the controversy associated with lender-placed insurance is not.
The LPI controversy has been around during all the 30 years Jain has worked in the mortgage marketplace. Historically, the product has presented value to the lender. Over the years the original intent to “protect the lender’s interest” has shifted to multiple brokerage layers, he says. Today "the market is waiting for direction" from the CFPB.
It is tough to bring all the parties that are affected by LPI to agree on all the lender-placed insurance features. “What are the changes of everyone agreeing on it?” he says, probably it should not be expected. The problem with having all parties agree on the length of the grace period, or how high the price should go is that such agreement is difficult to achieve, he argues. “Then it will almost have to be a product that is federally regulated.”
Currently, only the states can regulate how much the commission or the insurance markup can be, he says, and the grace period or the cancellation provision currently are and must continue to be mandated at the state level.
In Jain’s view, while the CFPB can help improve the product through new guidelines that provide additional protections to the customer, LPI should not be regulated at the federal level.
The mortgage industry must make sure LPI is available because the market needs it, he says. “What I’m hearing on the street” is that the markups for the customer seem to be substantial, that regulators are now monitoring the market to ensure lenders charge only the state-mandated rates and overall more acceptable fees.
He recalls how years back after “Credit Life,” an auto loan insurance product that was very controversial and costly for the customer was ultimately regulated to control related costs, “all of a sudden” the number of companies that offered it dwindled down.
If the consumer cannot pay the premium it is a problem, Jain says. Plus, different shops apply different cost components to their LPI price structure. When lenders charge up to $3,000 for a LPI after the borrower has been paying $100 for the regular mortgage insurance that was dropped, the overcharge becomes unacceptable and a cause for public debates.
Compensation fees paid to mortgage banks/servicers and insurance companies for bringing homeowners into the fold are at the center of the LPI debate. Some consumer advocate groups maintain that LPI is too expensive because insurers pay compensation fees to servicers and that is an imbedded conflict of interest. But according to Durrer, that is not the case.
“Lender-placed insurance should not be considered a conflict of interest,” he argues. An analogy would be in comparing it to regular mortgage insurance, he says, which is required for any loan above 80% LTV to provide an added layer of coverage over the added debt risk that reduces loan equity margins. If MI helps mitigate equity risk from default, LPI protects the lender from collateral loss risks.
As a rule a verified homeowners insurance is issued at origination, he added, so if “for whatever reason” after loan origination the borrower does not have homeowners insurance on the house, “the collateral…then the risk of recovering the debt is extremely high for the lender.”
Loan risk is key in LPI-related decisions. “Lenders should not bear all of the risk of carrying a debt without homeowners coverage. This risk could prove catastrophic to the economic foundation [of the market] in cases of large natural disasters,” says Durrer. “The line in the sand is one in which borrowers should be insured.”
If insurance is required and the borrower cannot afford it, he says, servicers should document for both borrowers and auditors the length of time given to borrower to provide insurance on their own accord, the number of attempts made, both written and verbally, and offer the borrower at least two separate insurance companies plans and pricing options when they select a LPI provider.
“Allowing borrowers options of choosing between two companies plans and prices would mitigate this questionable practice,” he says. “Regulations can cause an enormous amount of burden in cost which ultimately impacts the borrower. This debate, which will more than likely lead to more regulation, will impact both borrower and servicer from a cost standpoint.”
“The CFPB has a difficult job in front of them,” says David Zugheri of Houston-based Envoy Mortgage. It has to play referee to legitimate concerns from both lenders and borrowers. Neither the consumer not the lender is at fault here, he added.
Servicers work for “razor-thin margins,” no wonder they do not spend a lot of time with LPI, he argues. Plus lenders and servicers have their hands full with the emergency situation created by the foreclosure crisis where they are the first responders.
In his view the root cause of the controversy surrounding LPI is lack of competition among servicers.
He argues that free-market competition always works best. Since the servicer-consumer relationship is like an arranged marriage, borrowers do not have a say, he says, they cannot fire their servicer. “The only way for a borrower to divorce a loan servicer is to pay the loan off,” and that is why servicers do not have any incentives to improve how LPI is assigned and managed. “Borrowers should have at least two to three insurance options to choose from.”