Saving an ignored housing safety net

Lender-placed insurance has stood for decades as a critical safety net that makes mortgage lending possible.  When a person buys a home, they agree to insure the property and keep it in reasonable condition. In exchange for a home loan, the bank holds that home as collateral until the loan is paid in full.  However, if that buyer for some reason ceases to insure their home, the lender-placed insurance system allows the bank to acquire insurance to protect their asset. This is called lender-placed insurance and it is critical to ensuring the housing market remains stable for all.

Somehow all this has become a controversial idea.  An op-ed in The Hill recently suggested that the Federal Housing Finance Agency (FHFA) should toss the current system overboard.  While the author charged this would be for the good of the taxpayer, the author of that article omitted that the alternative they supported would have been for their financial gain.

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Currently, mortgage providers can select who they purchase their lender-placed insurance from in a competitive marketplace. Yet some critics have embraced the notion that mortgage-backing GSEs such as Fannie Mae should step in and force loan servicers to buy insurance from a mandated carrier, which would essentially eliminate an entire industry that seeks to protect the housing market. The FHFA appropriately put the brakes on a proposed plan to look at a number of complications inherent in the idea, which was the right call.

Before we dismantle an entire industry, policymakers should know a few things—the current lender-placed insurance market is competitive, it provides a critical service to ensuring the stability of the housing market and mortgage lending, and simply put, it works.

While the FHFA plan would designate a singular mandated carrier, the current market includes at least nine providers. There is no need or precedent for federal intervention to select one specific player; today’s industry leaders have earned the business through investment and growth, and other insurers can as well. This will keep rates competitive and drive down commissions. In fact, with the evolution of the industry, a number of providers have reduced or foregone commissions, resulting in lower costs to consumers.

Some would argue lender-placed insurance should cost the same as standard home insurance, but this doesn’t pass the smell test or justify moving to a single, government mandated provider. Lender-placed insurers agree to take all lapsed properties in a lender’s portfolio, sight unseen, which carries more risk than traditional home insurance. Additionally, a large number are in hurricane-prone areas that many conventional carriers will not serve.  So while rates are higher, this is a critical function to keeping stability in the housing market and consumers are notified that lender-placed insurance will be provided unless they can show evidence of coverage. Consumers always, and should, have the option of choosing their own insurance first.

The current system is also made up of providers who understand the business and the risks involved.  Critics of the current industry wrongly argue that FHFA could save tax payers “tens of millions” of dollars by going to a new mandated carrier model. However, the proposed Fannie Mae plan fails to provide for an integrated exposure management function or experienced entities with the capacity to monitor millions of potentially lapsed properties.  These are huge tasks requiring specialized capabilities that today’s providers have invested in building over many years. These capabilities reduce surprise claims on unidentified uninsured properties and incorrect policy placements. They also ensure that carriers can allocate capital, utilize reinsurance support and maintain sufficient resources to pay claims. Without these functions, higher rates would be required.

Additionally, lender-placed insurance is regulated by the insurance departments in 50 states, and the federal government.  In this environment, significant regulatory oversight has already resulted in revisions to provide more flexibility and, in a number of cases, lower costs to consumers.  The industry continues to improve and evolve.

For decades, the lender-placed provision has protected homebuyers, lenders and mortgage investors alike.  In Superstorm Sandy, thousands of homeowners were able to rebuild thanks to lender-placed insurance policies.  As the housing market recovers, there’s ample room for improvements in the mortgage system.  But junking the insurance safety net that has protected homeowners, lenders and investors for years isn’t the answer.

Talbott is senior vice president of Public Policy at The Financial Services Roundtable. He also serves as counsel to the organization and runs the Roundtable’s Political Action Committee.