By Jennifer Van Horn
Whether due to short gaps at renewal time, or to loss of coverage due to a carrier decision, there are times when borrowers fail to maintain continuous property insurance. By default, lenders assume financial risk any time a borrower’s insurance lapses.
Financial Institution have two insurance options available for risk mitigation connected to insurance default. The first is lender-placed insurance, also referred to as creditor-placed or force-placed insurance. Lender-placed insurance requires a lender to issue individual certificates or policies once aware the property is no longer insured by the borrower.
The second is blanket insurance, which will broadly provide property coverage, regardless of whether or not the lender is aware of a coverage lapse, in exchange for premium calculated on outstanding loan balances for a defined group of loans.
Lenders will typically choose one – or both – of the following to help mitigate risks connected to collateral:
- Actively track borrower coverage and order force-placed insurance when lapses are detected. Keeping track of insurance on each individual loan and collateral record – checking for renewals and responding to cancellation notices – allows lenders to force-place insurance as soon as it’s determined that the borrower no longer has sufficient coverage. Lenders may choose to track coverage in-house or hire a third-party tracking vendor. The latter option typically provides lenders with additional guarantees and protections against unidentified or overlooked coverage deficiencies. Costs for force-placed insurance, when correctly preceded by federally mandated notices, may be charged to the borrowers. However, costs incurred for monitoring insurance are borne by the lender.
- Purchase blanket insurance to cover all loans. Lenders can buy a blanket insurance policy to cover key segments of, or their entire loan portfolio. Blankets do not require insurance monitoring, and instead cover eligible losses reported by the lender once confirmed that other insurance does not exist. Blanket policy premiums are paid by the lender and cannot be charged back to borrowers. Blanket insurance policies are underwritten with an expectation of low claim frequency. Therefore, they are relatively inexpensive and should remain so as long as used sparingly.
Which coverage is right for your institution?
Here are some things to consider when deciding whether to track and force place, or purchase a blanket:
- Serviced mortgages often require tracking and force placement. Both Fannie Mae and Freddie Mac explicitly forbid the use of blanket policies in lieu of insurance tracking and require force-placed insurance. Small Business Administration guarantees and numerous investor agreements also carry requirements to track and force place for deficient or lapsed borrower insurance. Knowing the terms and conditions of the pertinent mortgage lending and servicing agreements is key.
- Flood insurance requires tracking and force placement. Federal regulations explicitly prohibit the use of blanket policies in connection with flood mandatory purchase loans.
- Blanket policies are ideal for junior liens. Insurance tracking for a junior lien has an added element of expense (and frustration) tied to mortgagee removal/replacement errors, which increases efforts required to keep them documented. Second mortgages and home equity lines of credit (HELOCs) make excellent candidates for blanket coverage because the loss risk is reduced, and tracking expenses can run high.
- Blanket can provide E&O to self-tracked portfolios. For a host of reasons, many lenders are best served by track and place programs. For example, errors and omissions (E&O) coverage can be extremely limited for lenders that track their own insurance. Consider pairing a blanket insurance policy with an active track and place program for discounted blanket rates and as an added safety net for mishandled documents and unknown exposures.
- Cost of track and place vs. blanket. While it might seem on the surface that total costs associated with a track and place solution versus blanket insurance are higher, be careful not to assume complete savings for mail-handling expenses in connection with blanket coverage. Thoughtfully evaluate ongoing escrow, mandatory purchase and other servicer-related responsibilities, which may result in the same amount of handling effort as would be exerted if tracking and force placing. With accurate numbers in each column, a cost-benefit analysis is possible.
- Know the cost of losses. Most incurred losses are tied to collateral securing both non-escrow first mortgages and/or near-to-non-performing mortgages. Because insurance premiums are higher where losses are more common, risk-heavy portfolios are always better candidates for force-placed insurance, where premiums can be passed through to the defaulting borrowers.
- Caveat emptor – buyer beware. It is not uncommon for historically high-loss portfolios to receive attractively low blanket premiums on newly issued policies, despite the active loss history. If it looks like the carrier hasn’t accounted for loss history, it’s likely because they have not. Should losses continue at the same rate as before, future blanket renewal premiums will need to account for the actual losses paid and will become unaffordable. Worse yet, reinitiating a tracking program after major losses often leaves lenders unprotected while they work to re-document insurance status at the loan level before they can begin to order force-placed insurance policies again.
Depending on the financial institution’s portfolio, HUB recommends a mix of tracking, force-placed insurance and blanket insurance to ensure full and adequate coverage. Contact your HUB Financial Institution specialist to determine the right combination to help reduce your total lender risk.