Fannie Mae is seeking to save hundreds of millions of dollars in force-placed insurance premiums by lining up alternatives to the dominant carriers in the specialty insurance market, according to people familiar with its effort.
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 (AIZ) 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 revenues 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 force-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.
Kickbacks and a $6 Billion Market
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 force-placed 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 (JPM) 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 (WFC) 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.
Fannie Mae has also been agitating for changes to the industry. This March it declared that the cost of force-placed policies was unjustifiably high and harming both the GSE and its borrowers. Fannie announced plans to ban banks from accepting force-placed commissions and requested that underwriters submit proposals for a Fannie-specific program with lower costs, according to a request for information obtained by American Banker.
The GSE then went silent. It issued a terse update in May stating that it would indefinitely delay new rules for how servicers should handle force-placed insurance. The GSE gave no reason for the halt, but a QBE executive testified to Florida's insurance commission in July that the FHFA wished to coordinate Fannie's force-placed policies with those of its smaller rival, Freddie Mac.
That GSE alignment is yet to happen. Brad German, a Freddie Mac spokesman, says that the GSE didn't join the request for proposals that led to Fannie's plan. However, the smaller GSE is "reviewing options to improve lender-placed insurance practices and reduce costs where possible," he said.
Fannie went ahead, seeking ideas from incumbent specialty insurers and others seeking to break into the market. Multiple insurers have agreed to take on the insurance risk for 30% to 40% less than what incumbent carriers charge, representing savings of at least $150 million a year, and possibly significantly more, industry sources familiar with the initiative say.
Such discounts are possible by reducing the generous margins currently earned on the policies and paying commissions only to servicers who perform meaningful work, people familiar with the plan say.
Fannie's savings could potentially extend beyond lowered premiums, say critics of the existing industry arrangements. They argue that because servicers both file insurance claims on damaged properties in foreclosure and share in the profits from the policies, they have an incentive to minimize claims and pass the losses onto investors or guarantors like Fannie. Insurers have denied that such an incentive exists.
"Either claims are underpaid, or premiums are too high, or both," says Jeff Golant, a consumer attorney who has represented consumers in a number of force-placed suits in Florida circuit court and now represents plaintiffs in the Florida class action against QBE.
Fannie's proposal is expected to be unpopular with QBE and Assurant, although they would be invited to participate in the market under the new terms and continue to handle monitoring Fannie's portfolio for lapsed voluntary coverage and interacting with borrowers. The incumbent specialty insurers and banks have argued against drastic change, raising questions about the ability of other insurers to properly handle the work, industry sources say.
If Assurant and QBE decline to participate, Fannie has a fallback, sources say. Enough insurers are willing to underwrite the risk that capacity is not expected to be a problem, and insurance brokerage and services companies are ready to take on the policy tracking, placement, and administrative work, sources say.
"To Delay Is To Say 'No'"
Fannie Mae's force-placed program is ready to roll out, but it needs the FHFA's go-ahead, say people familiar its plans.
Although the FHFA has previously said it wishes to address issues in the force-placed market, the agency declined to confirm or discuss the above plan or offer a position on it.
A prolonged delay itself could pose a significant threat to Fannie's efforts, sources say. The GSE's proposal was put together before Hurricane Sandy struck the East Coast, causing an estimated $20 billion in property damage, a small fraction of which will fall on force-placed insurers.
Even taking into account Sandy's actuarial effects, the insurers that Fannie has lined up remain committed to writing business at the discounted rates, sources say. But because of increased reinsurance costs, the rates negotiated before the hurricane could rise if the FHFA's deliberations drag into next year, they add.
"The reality of having a catastrophic event in the middle of this is that to delay is to say 'no,'" a source says.
American Banker was unable to independently confirm that the rates would be conditional, although the Consumer Federation of America's Hunter said that the logic behind the concern seemed credible.
"January 1 is a big deal, because that's when reinsurance treaty arrangements get finalized," he says.