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

Read the sidebar “What is Lender-Placed Insurance?”

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

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

Some think this question casts light on the potential conflict of interest with the lender-owned agency receiving compensation as the licensed agent of record on a lender-placed policy. As such, a few insurance providers have decided to no longer compensate agents in this role. Additionally, one prominent bank-affiliated agency with national offices has taken the unusual step of refusing to be listed as agent of record on all lender-placed policies and related coverage. Although it may be premature to make such decisions based on a single question in an 800-page manual, it is clear based on subsequent publications that CFPB seeks to prevent situations where a lender has incentive to improperly obtain lender-placed coverage. The potential to remove lender-affiliated agencies from this process will no doubt create a void in the market, one that the independent agent can fill by providing a necessary product to lending customers. Similarly, earlier this year, Fannie Mae issued a letter to servicers addressing lender-placed usage on FNMA loans and implementing new requirements. The letter sought to tie the coverage amount to loan delinquency while also basing acceptable deductibles on loan balance. Fannie Mae required that all carriers used to place coverage on FNMA loans be admitted in the states where the servicer operates. These changes presented unique operational challenges and for Florida and coastal area customers, the admitted carrier requirement posed a significant hurdle. The revised requirements have been temporarily suspended pending further review.

Subsequently, New York, Florida and California have held formal hearings on lender-placed insurance, culminating in the National Assn. of Insurance Commissioners (NAIC) public hearing in August. Although both Fannie Mae and the CFPB have focused on the process surrounding lender-placed coverage, NAIC and these state-level hearings highlighted the premiums charged to borrowers and the loss ratios behind them. As a result, several states have requested carriers to re-file rates in the near future, some of which already have complied.

CFPB Amends Regulations X and Z

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

Highlights of the proposal related to the insurance industry include:

Defining lender-placed insurance—CFPB's definition of the coverage excludes both lender-placed flood insurance and renewals of borrower insurance by servicer. Note that conflicting information within the rules regarding flood will hopefully be clarified when finalized in 2013.
Application of lender-placed insurance—A reasonable basis to place coverage is established when the lender does not receive a renewal invoice for premium or receives a notice of cancellation or non-renewal from the borrower's primary insurance carrier.
Clarifying and acknowledging escrow's impact on lender-placed coverage—Proposed rules require that servicers with escrow accounts continue to pay the borrower's insurance (even if the borrower is delinquent) rather than obtain lender-placed coverage. This is a significant development for the independent agent, ensuring higher retention rates on property policies sold to customers with escrow accounts. The rules also incentivize servicers without escrow accounts to work with borrowers to renew property coverage. This will help increase agent's retention rates on property coverage.
Establishes a 45-day notice period where borrowers must be notified 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 the renewal of lender-placed coverage.
Provides model forms for letters—CFPB's letters include recommended verbiage as well as the use of bold text where appropriate. When applicable, the letters show how the good faith estimate of lender-placed premium should be disclosed to the borrower.
Removal and refunding of lender-placed premium—Once the borrower provides the lender with a policy number and contact information for the agent or carrier, the lender must confirm the existence of coverage. In cases where the servicer will only accept this information in writing, it must disclose this above-mentioned letters. CFPB also proposes requiring that lender-placed policies be cancelled and premium refunded within 15 days of servicer obtaining borrower's acceptable property insurance.

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

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

Eliminate fines

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

The work involved in tracking insurance and the potential fines as a result of missteps far outweigh the true exposure to uninsured loss on borrower collateral. Given the increased regulatory burden facing lenders, many are seeking alternative approaches to internal insurance tracking, including outsourcing the function to a third-party vendor.

Under this approach, the lender must verify the internal controls of the vendor to ensure that sensitive borrower information is not compromised. The American Institute of Certified Public Accountants SSAE 16 certification has become the industry standard, recently replacing the SAS 70 among tracking providers.

Using a file transfer protocol (ftp) site or similar secure file transfer method, the lender provides loan information along with all insurance-related correspondence to the vendor on a scheduled basis. In return, reports detail the insurance status of each loan in the portfolio. If adequate evidence of insurance has not been provided by the borrower, the vendor initiates a letter cycle advising the borrower of the lapse and their insurance responsibilities under the loan agreement. If necessary, the vendor will place the required coverage on behalf of the lender.

By outsourcing, the lender eliminates internal overhead and the potential exposure to uninsured loss. Perhaps most importantly in the current climate, the lender gains a resource with a partner responsible for this portion of regulation, as it is the vendor's responsibility to ensure that letter cycles and format meet the most current standards.

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

Two types of blanket coverage relieve the lender of its tracking and lender-placed responsibilities. Blanket impairment coverage is similar to the mortgage protection/E&O coverage found in most package policies, but with a specific endorsement eliminating insurance follow-up. Additional E&O coverages are provided but claims on uninsured physical damage are subject to financial impairment (foreclosure) by the lender and settled on an actual market value.

The blanket hazard alternative provides enhanced physical damage protection as claims are settled on a replacement cost basis. More importantly, the trigger to loss is not subject to impairment/foreclosure. The trigger to loss is simply an otherwise uninsured loss. Coverage does not include E&O protection and the hazard program would not be an acceptable replacement for any form of mortgage protection coverage found in the package.

The independent agent's role in this process can't be understated as it is his or her responsibility to help the lender balance the impact of operational decisions with coverage and cost considerations. The inability to do so will not only lead to missed opportunities but increased potential for punitive government action and uninsured losses.

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