The Intelligent Quarterly from the publishers of The Insurance Insider

Spring 2012

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The use of force-placed insurance by banks in the US is under attack, and is viewed by many as open to abuse.

A recent article in the influential American Banker newspaper has led the charge against a previously little-known practice that has come to the fore in the US housing market crisis.

The investigation by the US banking sector's "bible" highlighted the high cost of force-placed insurance, its retroactive coverage and ties to the bank in the form of commission payments and reinsurance sharing.

This is the latest in a stream of criticism against the US mortgage industry. The article was widely picked up and reported on by the mainstream media in November - and will have done little to improve the standing of the insurance industry in the eyes of the US consumer.

That level of wider concern is focusing on the ethics of force-placed insurance - the practice of banks stepping in and buying an insurance policy on the behalf of a homeowner if and when they fail to keep up their insurance premiums.

But, there are many in the insurance sector that are critical of the clamour and defend the ethics of force-placed insurance as an essential component in US mortgage practices.

Easy to avoid
Trade bodies and industry analysts argue that force-placed insurance should be easy to avoid as the borrowers are given ample opportunity to get their own insurance.

"The rates charged for force-placed policies have been branded extortionate"

Industry analyst David Merkel, who is principal of Aleph Investments, told The Insurance Insider that if someone has a mortgage, they must have home insurance to protect the lender as a term of the loan - and not having this protection places the borrower in technical default.

And in order to protect the interests of lenders and investors in mortgage certificates, a mechanism is drafted into loan documents to allow the lender to force-place a home insurance policy after a grace period.

"Any homeowner can avoid force-placed insurance, they are given plenty of notice," notes Merkel, who has also been a buyside analyst of insurance companies.

"All they have to do is keep current on their insurance policy. As for any sort of long backdating, that's an abuse that needs to be corrected."

And it is this grace period that is the crux of the defence of force-placed insurance. Assurant, which makes 60 percent of its profits from force-placed cover, for example, contends that insurance is force-placed only after the borrower has been given repeated notice and ample opportunity to maintain insurance on the property.

However, Florida-based lawyer and mortgage law specialist Jeffrey Golant believes that force-placed insurance has been abused.

"There is no doubt that there is collusion between the banks and insurers," Golant told The Insurance Insider.

"From an insurance law perspective the practice of retroactive insurance is against Florida law."

Golant believes that the banks' conduct in this respect is probably illegal, and it was easier to pursue insurance companies in court because they are federally regulated.

This collusion, or what the National Association of Insurance Commissioners describe as a "cosy relationship" between banks and insurers, is allegedly manifested by the parties backdating insurance and offering kickbacks.

Golant cites one case he worked on when his client was current on her mortgage payments and claimed the lapse of insurance coverage on her home resulted from her previous insurer's error.

Unnecessary duplication
Much of the coverage in this case was unnecessary, he added, including duplicating flood and wind policies that were already in place. Golant said that charging her for retroactive hurricane protection for a year when there had been no significant storms was particularly strange.

"Retroactive insurance is odd," Merkel explains, before adding that there are reasons why it can be justified.

"It might be that the insurer is covering the loss costs from the period when the home was not covered."

American Insurance Association general counsel and manager of state programmes Eric Goldberg is also clear on the need for retroactive insurance.

"Although insurance tends to be prospective in nature, we can see situations where it is not clear whether coverage is in place so I can see the need for retroactive insurance," Goldberg told The Insurance Insider.

The rates charged by insurance companies for force-placed policies have also been branded extortionate.

Assurant shares took a battering after the American Banker report highlighted the potential abuses in the mortgage services market and raised questions over practices at the US insurer.

Shares were down some 11 percent on 10 November, after the article said that "there may be far larger problems in how servicers are handling distressed loans than the sloppy document recording that has been the recent focus of industry woes".

Assurant competes with Bank of America Corp subsidiary Balboa (currently up for sale), Berkshire Hathaway and Munich Re's subsidiary American Modern for sales of force-placed insurance. Bloomberg reported that Australia's QBE Insurance Group also competes in this market, but the company refused to comment.

Industry representatives think that the issue of policy rates has been exaggerated. "The rates that insurance companies charge are set by state commissioners," said Goldberg. "Those who have let their policy lapse are a higher risk and the rates reflect that."

Assurant told The Insurance Insider that pricing reflects the "unique risks" on properties that would otherwise be difficult to insure.

"We believe our rates to be among the lowest in the industry," the company states.

Commission controversy
And many across the industry believe the practice of insurance companies paying commission to banks to be perfectly legitimate, as the commissions are disclosed.

In the US District Court in March one case, Schilke v Wachovia Mortgage, centred on the issue of force-placed insurance. The plaintiff claimed that the premium for a force-placed policy included undisclosed commission paid to Wachovia by American Insurance Company. The case was dismissed.

Merkel said that the practice of undisclosed commissions is still legal, and views the commission for force-placed insurance as vital.

"It would be impossible for a force-placed insurer to do business without compensating the mortgage servicer, whether through commissions, which should be disclosed, or via reinsurance treaties," he said.

There is a statute in place, however, that is designed to protect borrowers and prevent abuse.

The Real Estate Settlement Procedures Act prohibits fee splitting and unearned fees for services that are not performed - and a specific provision in the Dodd-Frank Act requires that force-placed insurance be "bona fide and reasonable".

Golant comments that the problem with the Dodd Frank Act is that there has not been any case law to ascertain what "bona fide and reasonable" really means, and it is unclear who is in a position to enforce the law.

Goldberg maintains that there is nothing "nefarious" about forced-place insurance - and Golant said that borrowers can be "irresponsible at times", although he believes that banks and insurance companies are disproportionately punishing delinquent borrowers.

The consensus among trade bodies and industry analysts is that force-placed insurance is essential if banks are to protect their collateral, and is also easy to avoid as borrowers are given repeated notice before a policy is placed.

However, there are reservations about the practices that banks and insurers engage in once a force-placed insurance policy is in place, such as retroactive insurance and undisclosed commissions.