Setting the record straight on lender-placed insurance

As a consumer advocate and former Texas state insurance commissioner, I would like to set the record straight on lender-placed insurance, or “LPI,” an issue that impacts millions of Americans.

Those with knowledge of the intricacies of LPI would have found a recent op-ed in The Hill, penned by Scott Talbott of The Financial Services Roundtable,to be very misleading. Written as a rebuttal to a previous article that criticized the status quo and called for reform in the LPI market, the op-ed contained inaccuracies that should be clarified.

Everyone agrees that LPI is an important part of the overall housing finance system. LPI makes it possible for mortgage lenders and servicers to purchase property insurance on a mortgaged home if the owner does not obtain or maintain insurance on the property.

While the protection LPI provides is essential, it has become clear that there are deep, systemic flaws in its delivery – some of which have received increased public scrutiny in recent months. These flaws harm consumers and run counter to Mr. Talbott’s description of a well-functioning, competitive market.

One of the most common criticisms of LPI today is its extremely high cost: LPI policies cost two to ten times more than normal homeowners insurance policies, while offering less comprehensive coverage for the borrower. While some attribute higher premiums for less coverage to the increased risks associated with LPI, my research shows this factor only adds about 5 percent to the cost of such policies. 

The data prove that the true cause of LPI’s unreasonably high price is kickbacks to the lenders and other servicers of mortgages in the form of commissions tied to premium rates, below-cost services and phony reinsurance deals. When banks stand to profit by choosing the most expensive products, ones which consumers are automatically forced to purchase, premiums tend to skyrocket in a dynamic known as “reverse competition.”

The inefficiency of this system is clear in the low level of claims paid out for LPI compared to premiums being charged.  This “loss ratio” is a key indicator of whether the price of insurance accurately reflects the risks of providing coverage. Where LPI is concerned, it doesn’t. While voluntary homeowners insurance loss ratios nationwide have averaged 63.3 percent since 2004, those for LPI have averaged a pitifully low 27.9 percent.

This discrepancy speaks both to the lack of true competition and absence of transparency in the LPI market. Because of the lucrative “sweetheart” deals between LPI insurers and mortgage servicers, companies that can meet the demand to supply better products at lower, more competitive prices face tremendous barriers to entry, preventing premiums from adjusting to market pressures. 

While LPI directly affects millions of American homeowners, what makes this a national problem requiring federal action is its impact on taxpayers. Reverse competition has driven up the cost of LPI to the point that consumers, already under the financial strain of mortgage payments, often cannot afford to pay for the highly marked-up policies and therefore default, passing the costs on to public mortgage guarantors Fannie Mae and Freddie Mac and leaving taxpayers on the hook for the excessive charges.

Advocates for the status quo contend that serious consumer-facing market reform amounts to “dismantling” a perfectly healthy, competitive market. This seems ludicrous when you consider that just two insurance providers issue 99.7 percent of LPI policies and that the only competition at play in the market is reverse competition.

One need only look to the raft of state-led investigations, class action lawsuits, and the Federal Housing Finance Agency’s (FHFA) own proposal to curb commissions and “captive reinsurance” arrangements to see that this is no manufactured controversy. In fact this is an industry ripe for reform to enable real competition that lowers prices for consumers.

The argument that today’s LPI market is competitive does not pass the smell test. The claim that those seeking to drive reform are concealing their financial stake ignores the facts that (1) supporters of reform are mostly non-profit consumer groups such as the Consumer Federation of America and (2) the incumbents stand to lose far more than new entrants stand to gain if reverse competition were ended.

We should be encouraging companies motivated by the prospect of providing innovative, lower-cost and truly competitive products, not blocking them. Regulation alone cannot address the current systemic problems. Even critics of the system today agree that LPI is critical to the recovery of the housing market, which is precisely why policymakers – and the public – should insist that the LPI market be held to the same competitive standards expected of all other markets.

It is easy to understand why some are so heavily invested in preserving the current system, but we shouldn’t accept a status quo that rewards anti-competitive behavior. It is incumbent upon industry to help find a way to improve outcomes for homeowners and taxpayers. The stakes are too high for the actions of a few special interests to dictate the future of an industry so critical to the viability of the housing market.

Hunter is director of Insurance for the Consumer Federation of America, a former Federal Insurance administrator under Presidents Ford and Carter and Texas Insurance Commissioner.  He is a Fellow in the Casualty Actuarial Society.