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 multi-billion 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 (JPM) 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.
The GSE's staff briefed the FHFA on the idea on February 17 of last year and faced no objections, according to documents related to its force-placed insurance plan. Fannie issued a request for proposals to a dozen insurers about a month later. All were asked to design a program that saved money and increased transparency and competition.