On July 21, 2010, President Barack Obama signed theDodd-Frank Wall Street Reform and Consumer Protection Act into law.Created to address the recent financial crisis, part of theDodd-Frank Act  established a new bureau focused onconsumer protection within the financial markets. A year later, theConsumer Financial Protection Bureau (CFPB) became operational witha far-reaching jurisdiction over many financial companies. CFPB hasbegun its examinations while also issuing notices revising andreinterpreting current regulations. Many of these notices payspecial focus to “lender-placed insurance,” a little-known andhistorically underserved niche in the insurance industry.

Read the sidebar “What is Lender-PlacedInsurance?”

Agents representing financial companies must be aware of theimpact CFPB's changes have on their customers. Consider the CFPB'sSupervision & Examination Manual issued in October 2011.Mortgage servicing accounts for roughly 30 pages of this 800-pagetome. Buried in Module 4 (Maintenance of Escrow Accounts andInsurance Products) is a single question that may impact howservicers, including community lenders like banks and creditunions, obtain lender-placed coverage:

8. Determine whether the servicer orany of its affiliates imposes mark-ups, or received commissions orother payments, related to any force-placed insurance products.

Some think this question casts light on the potential conflictof interest with the lender-owned agency receiving compensation asthe licensed agent of record on a lender-placed policy. As such, afew insurance providers have decided to no longer compensate agentsin this role. Additionally, one prominent bank-affiliated agencywith national offices has taken the unusual step of refusing to belisted as agent of record on all lender-placed policies and relatedcoverage. Although it may be premature to make such decisions basedon a single question in an 800-page manual, it is clear based onsubsequent publications that CFPB seeks to prevent situations wherea lender has incentive to improperly obtain lender-placed coverage.The potential to remove lender-affiliated agencies from thisprocess will no doubt create a void in the market, one that theindependent agent can fill by providing a necessary product tolending customers. Similarly, earlier this year, Fannie Mae issueda letter to servicers addressing lender-placed usage on FNMA loansand implementing new requirements. The letter sought to tie thecoverage amount to loan delinquency while also basing acceptabledeductibles on loan balance. Fannie Mae required that all carriersused to place coverage on FNMA loans be admitted in the stateswhere the servicer operates. These changes presented uniqueoperational challenges and for Florida and coastal area customers,the admitted carrier requirement posed a significant hurdle. Therevised requirements have been temporarily suspended pendingfurther review.

Related: Read “Torus' Jeff Grange: Libor Scandal'sImpact on D&O Market” by Mark E. Ruquet.

Subsequently, New York, Florida and California have held formalhearings on lender-placed insurance, culminating in the NationalAssn. of Insurance Commissioners (NAIC) public hearing in August.Although both Fannie Mae and the CFPB have focused on the processsurrounding lender-placed coverage, NAIC and these state-levelhearings highlighted the premiums charged to borrowers and the lossratios behind them. As a result, several states have requestedcarriers to re-file rates in the near future, some of which alreadyhave complied.

CFPB Amends Regulations X and Z

More recently, CFPB published proposed rules to amend bothRegulation Z (Truth in Lending Act, TILA) as well as Regulation X(Real Estate Settlement Procedures Act, RESPA). With public commentset to close in early October, CFPB plans to finalize the rules byJanuary 2013. Roughly 250 pages cover a variety of issues withinthe mortgage servicing industry but the proposed changes toRegulation X directly impact lender-placed coverage.

Highlights of the proposal related to the insurance industryinclude:

• Defining lender-placed insurance—CFPB's definition of thecoverage excludes both lender-placed flood insurance and renewalsof borrower insurance by servicer. Note that conflictinginformation within the rules regarding flood will hopefully beclarified when finalized in 2013.
• Application of lender-placed insurance—A reasonable basis toplace coverage is established when the lender does not receive arenewal invoice for premium or receives a notice of cancellation ornon-renewal from the borrower's primary insurance carrier.
• Clarifying and acknowledging escrow's impact on lender-placedcoverage—Proposed rules require that servicers with escrow accountscontinue to pay the borrower's insurance (even if the borrower isdelinquent) rather than obtain lender-placed coverage. This is asignificant development for the independent agent, ensuring higherretention rates on property policies sold to customers with escrowaccounts. The rules also incentivize servicers without escrowaccounts to work with borrowers to renew property coverage. Thiswill help increase agent's retention rates on propertycoverage.
• Establishes a 45-day notice period where borrowers must benotified twice in writing (at least 45 and 15 days, respectively)before lender-placed coverage is applied and their loan charged.This letter cycle applies to both initial placement as well as therenewal of lender-placed coverage.
• Provides model forms for letters—CFPB's letters includerecommended verbiage as well as the use of bold text whereappropriate. When applicable, the letters show how the good faithestimate of lender-placed premium should be disclosed to theborrower.
• Removal and refunding of lender-placed premium—Once theborrower provides the lender with a policy number and contactinformation for the agent or carrier,  the lender mustconfirm the existence of coverage. In cases where the servicer willonly accept this information in writing, it must disclose thisabove-mentioned letters. CFPB also proposes requiring thatlender-placed policies be cancelled and premium refunded within 15days of servicer obtaining borrower's acceptable propertyinsurance.

Read “NAIC Promises Greater Focus on Force-PlacedInsurance as CFPB Proposes Rules” by Mark E. Ruquet.

Many of these changes simply seek to formalize and standardizehow the lender and its provider operate. A large portion of thefield already are compliant with these requirements or a few minorchanges away from compliance.

Eliminate fines

Rate and coverage always have been driving forces behindcompetitiveness in the lender-placed field. Under the eye ofincreased regulatory scrutiny, this won't change moving forward.But as the industry evolves as a result of regulation, it importantthat independent agents partner their lending customers withcompanies that are in tune with operational changes. The potentialfor fines from any number of government agencies (CFPB, FDIC, etc.)can often far outweigh the savings of working with an antiquatedprovider using outdated forms and procedures.

The work involved in tracking insurance and the potential finesas a result of missteps far outweigh the true exposure to uninsuredloss on borrower collateral. Given the increased regulatory burdenfacing lenders, many are seeking alternative approaches to internalinsurance tracking, including outsourcing the function to athird-party vendor.

Under this approach, the lender must verify the internalcontrols of the vendor to ensure that sensitive borrowerinformation is not compromised. The American Institute of CertifiedPublic Accountants SSAE 16 certification has become the industrystandard, recently replacing the SAS 70 among trackingproviders. 

Related: Read Arthur D. Postal's column, “Bank,Conservative Group Sue to Declare FSOC Unconstitutional.”

Using a file transfer protocol (ftp) site or similar secure filetransfer method, the lender provides loan information along withall insurance-related correspondence to the vendor on a scheduledbasis. In return, reports detail the insurance status of each loanin the portfolio. If adequate evidence of insurance has not beenprovided by the borrower, the vendor initiates a letter cycleadvising the borrower of the lapse and their insuranceresponsibilities under the loan agreement. If necessary, the vendorwill place the required coverage on behalf of the lender.

By outsourcing, the lender eliminates internal overhead and thepotential exposure to uninsured loss. Perhaps most importantly inthe current climate, the lender gains a resource with a partnerresponsible for this portion of regulation, as it is the vendor'sresponsibility to ensure that letter cycles and format meet themost current standards.

Sometimes outsourced tracking can be “too much of a good thing.”In situations where outsourcing doesn't fit a lender's corporateculture or is cost prohibitive but the lender still wishes to avoidtracking, another option to consider is blanket mortgagecoverage.

Two types of blanket coverage relieve the lender of its trackingand lender-placed responsibilities. Blanket impairment coverage issimilar to the mortgage protection/E&O coverage found in mostpackage policies, but with a specific endorsement eliminatinginsurance follow-up. Additional  E&O coverages areprovided but claims on uninsured physical damage are subject tofinancial impairment (foreclosure) by the lender and settled on anactual market value.

The blanket hazard alternative provides enhanced physical damageprotection as claims are settled on a replacement cost basis. Moreimportantly, the trigger to loss is not subject toimpairment/foreclosure. The trigger to loss is simply an otherwiseuninsured loss. Coverage does not include E&O protection andthe hazard program would not be an acceptable replacement for anyform of mortgage protection coverage found in the package.

The independent agent's role in this process can't beunderstated as it is his or her responsibility to help the lenderbalance the impact of operational decisions with coverage and costconsiderations. The inability to do so will not only lead to missedopportunities but increased potential for punitive governmentaction and uninsured losses.