OIG to FHFA: Be More Litigious Over Force-Placed Insurance

ThernOffice of Inspector General for the Federal Housing Finance Agency (OIG-FHFA)rnhas completed an evaluation of how well FHFA oversees Freddie Mac and FanniernMae’s management of lender-placed insurance (LPI).  FHFA has been conservator of the tworngovernment sponsored entities (GSEs) Freddie Mac and Fannie Mae since Augustrn2008.  </p

LPI,rncommonly called “force-placed” insurance, is ordered by a lender when itrnidentifies a lapse in the hazard insurance a borrower is required to carry on arnmortgaged property.  As one result of thernevaluation OIG concluded that the GSEs have suffered considerable financialrnharm in the LPI market, perhaps as much as $158 million in 2012 alone fromrnexcessively priced insurance coverage.</p

ThernGSEs rely on their servicers to ensure that borrowers maintain hazard insurancernand servicers outsource that task to specialty insurance companies that trackrnthe status of insurance coverage and force place policies when necessary. Two LPIrnproviders and their subsidiaries do most of this work for the GSEs’ servicers, Assurant,rnInc. and QBE Holdings, Inc.  Collectivelyrnthe company’s subsidiaries write more than 90% of the nation’s LPI coverage,rnaccording to industry observers.</p

Servicersrnadvance payment for the insurance premium to the provider then bills thernborrower who is responsible for paying the premium but does not always do so.  When a home is foreclosed the unpaid premiumsrnbecome the responsibility of the GSE that owns or guarantees the mortgage.  In 2012 the GSEs paid about $360 million forrnthis coverage and $327 million in 2013.</p

In 2012 and 2013 insurance regulatorsrnns in three large states, New York, California, and Florida, determined thatrnpremiums paid for LPI in their states were excessive and that those rates mayrnhave been driven up by profit-sharing arrangements between the servicers andrnLPI providers to whom they steered business. rnThese arrangements were often in the form of commissions or reinsurancerndeals. The regulators have employed a variety of enforcement techniques tornreduce LPI rates and prevent future abuses within their jurisdictions.  Forty-eight percent of earned LPIrnpremiums nationwide in 2012 were attributed to homes in those three states. </p

LastrnNovember, after receiving comments from the public and industry stakeholders,rnFHFA directed the GSEs to prohibit their servicers from receiving such LPIrnrelated commissions or entering into reinsurance arrangements with providers.  Both GSEs subsequently issued new servicingrnguidelines that took effect on June 1, 2014. rnHowever FHFA has yet to complete an assessment of whether there shouldrnbe litigation to recover financial damages to the GSEs from past abuses. </p

LPIrnis often sold as a group insurance master policy covering a predetermined grouprnof homes rather than a single home and is priced as a fixed dollar amount perrn$100 of coverage.  On average LPIrnpremiums are 1.9 to 2.3 times more expensive than insurance bought by borrowersrnon the open market.  Providers have givenrnreasons for this discrepancy such as that they must insure properties sightrnunseen.  Some experts maintain that thisrnrisk is offset by other factors – it is not as comprehensive as regularrninsurance, does not cover personal property, and has lower overhead as there isrnno individual underwriting.</p

The loss ratio is the percentage ofrnthe premium that an insurer pays out in claims. rnA high loss ratio indicates a high payout relative to collections, a lowrnratio indicates the insurer has retained a large portion of the premiumsrncollected.  The review by New York’srninsurance regulator (NYDFS) found thatrnAssurant’s insurance subsidiary had an expected loss ratio on file for the yearsrn2006 to 2012 of 58.1 percent while its actual loss ratio in those years variedrnbetween 17.3 percent and 42.8 percent. rnIn only one year, 2012, did it rise above 25 percent.  A similar scenario was found for QBE’srnsubsidiary where the expected ratio was 55.0 percent and it topped 20 percentrnonly in 2006 (20.7 percent) 2008 (29.0 percent) and 2012 (44.3 percent).  OIG noted that 2012 was the year SuperstormrnSandy hit the state. </p

AdditionallyrnNYDFS found that providers employed several mechanisms through which to sharernprofits with the servicers who gave them business.  Commissions were paid to the servicers’rninsurance agency affiliates of 10 to 20 percent of the premium but thesernaffiliates “do little or no work forrnthe commissions.”rnThe second mechanism, used by the Assurant subsidiaryrnwas a reinsurance arrangement where the LPI provider shared a set percentage ofrnits earned premiums and claims paid with servicer affiliates.  The New York study concluded that both commissions and reinsurance arrangements tend to incentivizernservicers to purchasernhigher priced LPI.</p

Similar actualrnloss ratios and premium sharing arrangements were identified in the other twornstates.  In New York the two providersrnentered into consent orders requiring them to pay $24 million in civilrnpenalties and provide restitution to borrowers. rnThey were also prohibited from remitting commissions to or entering intornreinsurance arrangements with servicers and to set new rates that would supportrnan expected loss ratio of 62 percent or more. rnProviders in the other two states agreed to rate reductions.</p

Mortgage borrowersrnhave also begun filing class action lawsuits against their servicers and LPIrnproviders alleging some of the abuses above. rnThus far several have been settled out of court for a total of at leastrn$674 million to date. </p

The new guidelines from FHFA that wentrninto effect on June 1 generally prohibit servicers and their affiliates fromrnreceiving any commission or incentive-based compensation from providers andrnexplicitly restrict any type of reinsurance arrangement. Finally, they give the GSEs the right to inspectrnany contractual documents between servicers and LPI providers to ensurerncompliance.rn</p

OIG found that FHFA has taken some steps to prevent the GSEsrnfrom being harmed further by their servicers and LPI providers but has notrndetermined whether the GSEs should pursue litigation to recover damages.  In response to OIG questioning, FHFA’s Officernof General Counsel said it had not yet conducted such an assessment,rnciting competing priorities, such as finalizing pending legal claims.rnOIG said its analysis indicates that such litigation could result inrnsignificant financial recoveries for Fannie Mae and Freddie Mac.</p

OIG recommends that FHFA assess the meritsrnof litigation by the GSEs against their servicersrnand LPI providers to remedyrnpotential damagesrncaused by past abuses in the LPI marketrnand take appropriate action in this regard. rnThe GSE’s could build their case based on the information collected byrnstate insurance regulators in their investigations and the GSEs may have been harmed in the same manner as the borrowersrnwho settled the class action lawsuits describedrnabove.  </p

The report from OIG acknowledges that the servicersrnand LPI providers would raise defensesrnto any such claims asserted by the GSEs,rnclaiming for example that they never expressly breached a contract; that the coverage at issue was purchasedrnin compliance with servicing guidelines. However similarrndefenses advanced in the borrower class action suits calling for dismissing therncases were denied by the courts.</p

FHFA accepted OIG’s recommendation.  The Agency will complete its litigation assessment within 12 months.

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