Most residential mortgages require homeowners to maintain insurance on their home. The logic behind that requirement is very straight-forward and actually quite reasonable: lenders want to protect the collateral for their loans (notwithstanding the uncertainties as to who actually owns debt). If a house is blown away in a tornado or burned down, their security interest evaporates and, if the homeowner defaults, they are essentially out-of-pocket the balance of the loan, which can be hundreds of thousands of dollars.
But what happens if a homeowner gets behind on their mortgage payments (which, in many cases, includes escrow for taxes and insurance) or they simply allow their insurance to lapse? The answer is that in most cases, the servicer will obtain what is called “force-placed insurance.” In other words, if the homeowner doesn’t have insurance coverage, the mortgage company will go out and buy it for them.
Sounds reasonable, right? On the surface, I believe this is a reasonable practice–if insurance is required by contract (i.e. the deed of trust), then the lender is justified in obtaining coverage.
HOWEVER, let me now introduce you to the real world of force-placed insurance. Lenders don’t shop around for the best rates for this force-placed insurance. They don’t use the volume of the policies they buy to get preferred rates. In fact, they don’t even pay close to the rates that the homeowner could obtain for themselves. Or even just a little more. No, the force-placed insurance obtained by the mortgage company is often time 3x, 4x, and up to ten times the price of a policy the homeowner had (and the force-placed insurance probably does not provide coverage for contents or third-party liability claims). The mortgage company will overpay to the point of ridiculousness, and then charge the homeowner for that overpriced policy.
Contracts often contain an implied duty of good faith and fair dealing. At a minimum, they require reasonableness from the parties. In my opinion, these force-placed insurance practices do not satisfy either.
The force-placed insurance racket is full of self-dealing by the banks and insurance companies, rather than good faith, arm’s length transactions. And homeowners pay for this. The abuse is so severe that the New York State Department of Financial Services recently investigated Assurant, which has close ties to JPMorgan Chase. Assurant (or its subsidiary, American Security Insurance Company, or ASIC) is the largest force-placed insurance company in New York. QBE is the other large force-placed insurance company. Following the investigation, Assurant agreed to a consent order and will pay a $14 million dollar fine. You can read the Assurant force-placed insurance consent order here. It is very interesting reading and offers a good explanation of force-placed insurance. A few highlights:
- Assurance/ASIC paid commissions of 10 to 20 percent to insurance brokers that are affiliates of mortgage servicers. These “insurance brokers” did little work, as would typically be expected of an insurance broker (imagine your local insurance agent).
- Insurers engaged in “reverse competition,” meaning insurers competed for mortgage servicers’ business. They did this by offering higher commissions, which was seen as a cost of doing business in this market. With higher premiums came higher commissions to the servicers, eliminating the incentive to reduce the cost of force-placed insurance.
- Force-placed insurance companies would often reinsure the policies through subsidiaries of the lender or servicer, paying a large percentage of the profits back to the subsidiary. In the case of ASIC, they had an agreement with Banc One Insurance Company, a subsidiary of JPMorgan Chase, in which 75 percent of the premiums charged by ASIC were basically funneled back to the Chase subsidiary (in exchange for them taking on a percentage of risk of loss, which historically has been very low). The Chase subsidiary has made approximately $600 million since 2006 under this arrangement.
- The reinsurance agreements incentivized higher premium rates. ASIC received a “ceding fee” (typically a percentage of the premium ceded to the reinsurer) as part of the reinsurance transaction; the higher the premium, the higher the ceding fee.
While this investigation against Assurance/ASIC is one of the first major repercussions the force-placed insurance industry has had, you can rest assured this was not the only instance of self-dealing and other shady arrangements. If you believe you have been overcharged for force-placed insurance, or been billed for force-placed insurance when it was not needed, contact Duke Seth at (214) 965-8100 to discuss your rights.