Part 4: Challenging the Force-Placed Insurance Business Model – The Regulatory Clean Up
In part 3, we discussed how money center banks created a force-placed insurance fee income source using captive insurance companies owned by the lenders. In this segment, we will discuss how regulators and class-action attorneys put force-placed insurance back on course.
It is not the intent of this post to inform you of these regulatory changes. If you are interested in these details, please read “Miniter Group’s Complete Guide to Force-Placed Insurance” or Miniter Group’s white paper “9 Steps to CFPB Compliance for Lender-Placed Insurance.”
Dodd-Frank Stops Fee-Income
The 2008 financial crisis caused politicians to move center stage for an economic reform bill. The result was the massive 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. This 2,300-page bill contained the words “force-placed insurance” 331 times.
The authors of the Dodd-Frank bill understood the issues associated with force-placed insurance fee income that was hurting Wall Street. The bill was lobbied heavily by the insurance industry and auto dealerships, among many others, but the lobby from Wall Street was successful in stopping the fee-income practices. The following Dodd-Frank requirements stopped the fee-income practice in its tracks.
- Escrowed loans can not be force-placed due to the non-payment of escrow premiums.
- There must be a “Reasonable Basis” or proof that a loan is uninsured
RESPA regulation before Dodd-Frank had a loophole that allowed servicers to force-place insurance using previously escrowed insurance premium if the loan was more than 90 days delinquent.
The CFPB’s re-write of RESPA addressed both items listed above and closed down the force-placed insurance fee-income loophole in one paragraph highlighted to the right.
This one paragraph in RESPA caused the money center banks to close their captive insurance companies and give up the fee-income underwriting profits from force-placed insurance.
“A servicer must make payments from a borrower’s escrow account in a timely manner to pay the premium charge on a borrower’s hazard insurance defined in 1024.31 unless the servicer has a reasonable basis to believe that such insurance has been canceled or not renewed for reasons other than nonpayment of premium charges.”
Force-Place Insurance Class Action Lawsuits
As stated in our last post, Wall Street organized borrowers, and class-action lawsuits began to appear in response to the abuses created during the fee-income era.
A lawyer in Florida filed the first class action litigation after an insurance tracker back-dated a force-placed insurance policy for 30 months on her property. The premium due was over $30,000. Discovery during this lawsuit showed that premium rates for this policy were $8.33 per $100 insured value, which is more than double the flood insurance rates filed with the state of Florida’s insurance department. For comparison purposes, the highest Florida flood insurance rate that we could use at the time was $3.33 per $100 insured value.
In 2010 a spokesman for the National Association of Insurance Commissioners (NAIC) told American Banker that insurance is “prospective in nature.” Therefore, policies “should not be back-dated to collect premiums for a time period that has already passed,”
Following this initial lawsuit, a wave of successful class action attempts appeared throughout the country. These class-action lawsuits included hazard and flood policies for both residential 1-4 and HELOC policies. A California flood hazard litigation was successfully argued against JP Morgan Chase for force-placing to maximum credit limits on HELOCS with zero balances.
The New York Department of Financial Services, Wall Street’s home state, issued 31 subpoenas to financial institutions. Subsequent litigation had the following common denominators:
- High Pricing – exceeding the states’ filed insurance rates
- Money Passing to the lender from force-place insurance carriers – Included Commissions, Fees, and Re-insurance
- Escrow Force-Placement – stopping escrow insurance payments for delinquent borrowers, causing a cancellation for non-payment of premium. The escrowed premium was then submitted to the lender’s captive insurance company to issue a force-placed insurance policy.
- Undocumented borrower notifications.
New York’s Department of Financial Services led the way with state regulatory scrutiny backed by Wall Street political doners. “We should consider whether banning these relationships makes sense,” said DFS Commissioner Benjamin Lawsky. “The perverse incentives that such financial arrangements may create “would appear to harm both homeowners and investors while enriching the banks and the insurance companies.”
Not Far Enough
In 2012 RESPA Servicing Proposal, the CFPB commented on problematic concerns the bureau had with force-placed insurance incentives:
“The Bureau also notes that it finds problematic the incentives that have reportedly influenced some servicers’ decision to obtain force-placed insurance, such as the receipt of commissions or re-insurance fees by servicers and their insurance affiliates on the force-placed insurance policies they obtain, or that a servicer or an affiliate of the servicer may have an ownership interest in an insurance company that writes force-placed insurance.”
In 2012, the CFPB came close to addressing the misaligned force-placed insurance business model but failed to provide regulation that changed the current model. Based on this “problematic” finding, we assumed the CFPB would address this in later updates to RESPA. As of 2020, the CFPB has not expanded on this problematic finding.
I hope that the force-placed insurance industry will soon adopt a new business model that aligns the borrower, lender, and insurance trackers before regulators dictate a less than the optimal business model for us.
As with many corrections in the banking industry, it was a combination of banking regulation and consumer class-action litigation that put the force-placed insurance industry back on course. Although the CFPB used RESPA to eliminate the fee-income era of force-placed insurance, it did not go far enough to address the fundamental business model incentives that are still problematic for our industry.
Next: We will look at Flood Insurance and how Biggert-Waters and the 2014 Homeowners Flood Insurance Affordability Act changed the game for force-placed flood insurance.