Fannie Mae intends to replace traditional force-placed insurance on its loans with policies from a provider of its choosing, a move that could upend big banks' controversial force-placed insurance practices.

"Fannie Mae will soon implement changes to its Lender-Placed Insurance (LPI) requirements to significantly reduce costs to homeowners, taxpayers, and Fannie Mae," the government sponsored enterprise announced in a mortgage servicing news bulletin.

The GSE is asking insurers to offer proposals for force-placing policies on its portfolio. The request for proposals is "structured to ensure that insurance costs are significantly reduced," the GSE said.

The move may mark a significant repudiation of current industry practices, in which lenders generally buy coverage from carrier partners that pay them commissions. Fannie's announcement noted the utility of force-placed insurance but appears to echo complaints that commission payments and other costs unnecessarily inflate the cost of force-placed insurance.

The GSE also argued that current industry practices are forcing some borrowers into default and causing Fannie to incur losses as the loans' guarantor. Similar allegations have been made in the past by private mortgage investors, though they lack the contractual authority that Fannie has to dictate changes in servicing practices.

"An expensive LPI policy can often become an obstacle to a delinquent borrower seeking to avoid foreclosure," Fannie's bulletin states. "If the borrower defaults in mortgage loan payments and does not cure, Fannie Mae must reimburse the servicer for LPI premiums. Costs to Fannie Mae ultimately become costs to taxpayers."

Critics of banks' current force-placed insurance programs responded enthusiastically to Fannie's plan.

"This has the potential to really change the market," says Diane Thompson, an attorney for the National Consumer Law Center. "This could have a significant impact on reducing costs to homeowners and Fannie."

Banks' force-placed insurance policies have become increasingly controversial over the last two years. The New York Department of Financial Services is investigating alleged kickbacks paid to banks by insurers, and several of the country's largest banks face force-placed class action suits.

Andrew Wilson, a spokesman for Fannie Mae, declined to say when the request for proposals will be complete. There are currently two major insurers in the market, Assurant Inc and QBE Insurance Group.

Assurant said that it looked forward to participating in the RFP.

"We have spoken with Fannie many times about possible alternatives that are practical to implement for servicers, Fannie and homeowners," a spokeswoman says. "We will continue to discuss the alternatives as the RFP process moves ahead."

Wilson says that Fannie's conservator, the Federal Housing Finance Administration, is well aware of its plans. Fannie will be elaborating on what the changes mean for banks, he says, "in the near future."

"There will be guidance to servicers about when and how to procure lender-placed insurance," he said. "This will be communicated to servicers at the appropriate time."

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