Thursday, November 11, 2010

The Unhappy Life of Forced-Placed Insurance and the Ongoing Mortgage Scandal

So, what is forced-placed insurance, and why would it be unhappy -- other than being "forced," that is? The concept behind forced-placed insurance as it relates to mortgages is as follows: should a homeowner fail to meet his insurance premiums, then the loan servicer can step in to buy an insurance policy that is comparable in coverage. The mortgaged property thus remains fully insured, protecting the interests of both the homeowner and the lender. Hey, what's not to like?

Well, as Barry Ritzholtz at The Big Picture points out, what makes perfect sense at the conceptual level can be abused in the real world, "and when the servicer owns the insurer, abusive practices, excessive commissions, and self-dealing transactions have become the norm."

This story was originally broken by Jeff Horwitz at American Banker. Ritholtz pulls some gruesome examples of abuse from the original piece that highlight the disconnect between theory and practice as it relates to this situation. Check out, for example, the following:

Consider one case found by Horwitz. A homeowner’s $4,000 insurance policy, was paid by the loan servicer, Everbank via escrow. But Everbank purposely let that insurance policy lapse, and then replaced it with a different policy –  one that cost more than $33,000. To add insult to injury, the insurer, a subsidiary of Assurant, paid Everbank a $7,100 kickback for giving it such a lucrative policy — and, writes Horwitz, “left the door open to further compensation” down the road.

That $33,000 policy — including the $7,100 kickback –  is an enormous amount of money for any loan servicer to make on a single property. The average loan servicer makes just $51 per loan per year.

Here’s where things get interesting: That $33,000 insurance premium is ultimately paid by the investors who bought the loan.

These investors are not happy.

Well, goodness, it is difficult to see how anyone would be happy in this arrangement ... except, well, the insurer. And the loan servicer. *sigh*

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