This imbalance is evident in the dire state of the insurance industry, particularly in the obscure, yet vital sector of lender-placed insurance (LPI). Dominated by two players exploiting the regulatory tools at their disposal to maintain the status quo, the LPI market is the very model of special interests running rampant over consumers and taxpayers.
For background, LPI is insurance taken out by a mortgage lender to protect a home in the event that voluntary coverage lapses or is nullified. This can happen for several reasons – from policy lapse to disputes over the types of coverage required. LPI simultaneously protects the lender and the homeowner, and is especially important in states like Florida, where mortgage defaults and weather damage to property are common.
LPI is important because it ensures that credit markets function properly. That is because billions of dollars of wealth, tied up in a range of securities, rests on mortgage values. LPI helps maintain public confidence in these mortgages and securities. As we know from recent experience, a collapse in property or mortgage values can have a devastating impact on the housing market and economy.
While the FHFA expressed its intention to end these practices, we are unlikely to see progress until a director is confirmed. In the meantime, the industry should work to enact reforms that will restore consumer confidence and drive the housing recovery.
First, we must address excessive policy costs. Premium rates 2-3 times more expensive than regular property insurance (sometimes, 10 times more) are imposed on borrowers. While some of that cost can be justified by the increased risk associated with LPI coverage, much is a result of “reverse competition:” a dynamic that, with commissions, incentivizes servicers to select unnecessarily expensive products.
Next, the serious lack of competition in the LPI market demands urgent attention. Just two players control nearly 90 percent of the LPI market, a situation resulting in inflated premiums, a lack of innovation and, ultimately, a subpar product for consumers.
The two companies dominating the industry have little incentive to lower prices. This is because homeowners paying for the inflated premiums have no part in choosing their policies. More often than not, homeowners cannot pay for the LPI chosen for them, in which case the GSEs – and American taxpayers – get stuck with the bill.
Finally, the FHFA, along with industry and consumer groups, should encourage greater transparency in the LPI market, its transactions and the underlying decision processes. Insurers and servicers must work together to increase the quality and availability of information to homeowners and the GSEs, and create a benchmark for the industry to work from.
The status quo is no longer acceptable and has troubled GSEs for some time. That’s why, in 2012, Fannie Mae solicited proposals for a creative solution to the problem. After a competitive process, Fannie Mae selected a plan, put forth by Breckenridge OSC, which would have allowed the GSEs to purchase LPI directly from insurance underwriters, rather than continuing to pay for lender-placed policies. The proposal is scalable to Freddie Mac and other providers, and requires no changes to existing tracking relationships among the servicing community.
Despite the initial progress, the FHFA vetoed the proposal at the 11th hour, without explanation. The plan would have offered more than $200 million in annual savings to taxpayers and homeowners with Fannie - held mortgages.
The FHFA must seriously consider the ideas proposed by respondents to its notice and should carefully evaluate Fannie Mae’s rationale for purchasing its own insurance. Giving the GSEs control of their own portfolios is in the best interests of the entire LPI market. If Watt is confirmed as FHFA director, he will face many challenges, but at the top of his agenda should be implementing a solution to the LPI issue – a solution that is fair to the GSEs, homeowners and taxpayers alike.
Carragher is CEO of Breckenridge Insurance Group.