New York Superintendent of Financial Services decried "perverse incentives" in the force-placed insurance market on Thursday and recommended banning insurers from the standard practice of making payments to referring banks.
The comments came during Lawsky's opening remarks for what is scheduled to be three days of hearings on the force-placed insurance market.
Force-placed insurance has become a lightning rod the past few years for criticism that the premiums charged are excessive due to ill-disclosed payments underwriters make to the banks that refer them business. The premiums are ultimately charged to homeowners, who in many cases already face financial difficulties.
Banks buy force-placed insurance to cover the homes of borrowers who have allowed their property coverage to lapse. The policies are designed to protect the interests of homeowners and the investors who ultimately own the loans. Lawsky indicated in his opening remarks that the policies may instead have become a way for insurers and banks to wrongly extract money from both.
State attorneys general, mortgage giants Fannie Mae and plaintiffs' attorneys have all taken issue with particular industry practices, but little information about size and structure of the industry has been publicly available.
Industry officials have denied wrongdoing and asserted that force-place coverage's relatively high premiums reflect the cost and risks involved in providing it.
Lawsky warned in his opening remarks on Thursday of a "web of tight relationships" between banks and insurers. He further declared that that structure of the force-placed industry raises numerous "red flags" that suggest banks and insurers may be colluding to charge homeowners unjustifiably high premiums.
"This perverse incentive, if it exists, would appear to harm both homeowners and investors while enriching the banks and the insurance companies," Lawsky said. "Some potential reforms are fairly obvious. We should consider whether banning these relationships [payments from insurers to referring banks] makes sense.""
New York's Department of Financial Services is yet to disclose the full scope of it's fact finding, but Lawsky's remarks indicate that force-placed coverage may be more prevalent and more lucrative than industry outsiders previously recognized.
Bolstered by a slew of mortgage defaults and a slow foreclosure process, the force-placed insurance industry more than tripled in size to $5.5 billion in premiums in 2010 from $1.5 billion in 2004, Lawsky said.
Insurers have paid out very little of that money in claims, Lawsky said. In New York, for example, Assurant has told regulators that it expects to pay out 58% of its force-placed revenue in claims. Over the past decade, however, the company's actual payout was less than 25%, Lawsky said.
Assurant, whose officials will testify on Thursday afternoon, has previously defended the cost of its policies as reasonable, given the relatively high risk that providing force-placed coverage poses.
Balboa Insurance, another force-placed underwriter, may have produced even lower payouts. Balboa collected $1.5 billion of force-placed premiums in 2010, of which $1.2 billion was profit, according to Lawsky. Balboa was a subsidiary of Bank of America (BAC) until its sale last year to Australia-based QBE. Under the terms of Balboa's sale to QBE, Bank of America has agreed to continue providing the insurer with its force-placed insurance business.
"The high premiums can push distressed homeowners over the foreclosure cliff. They also impact investors in mortgage securities," Lawsky said, noting that banks repay themselves for covering force-placed premiums when a foreclosed home is sold.
Balboa and Assurant collectively write more than a 90% of force-placed insurance, Lawsky said.
Bank of America is the only major bank that was directly affiliated with a force-placed insurer. However Lawsky said his agency is concerned about the financial arrangements between mortgage servicers and supposedly independent insurers.
"In some cases this [a financial arrangement] takes the form of large commissions being paid by insurers to the banks for what appears to be very little work," Lawsky said. "In other cases banks pay high premiums for coverage that is highly profitable and then those big profits revert right back to the banks through reinsurance agreements.""
Lawsky cited JPMorgan Chase's (JPM) reinsurance agreement with Assurant as potentially problematic.
JPMorgan Chase, for example, pays very high premiums, he said. "Assurant then turns around and reinsures 75% of the risk through JP Morgan's Vermont-based captive insurance subsidiary. JPM is, in effect, paying itself high premiums."
In addition to representatives of Balboa and Assurant, consumer advocates, mortgage industry analysts and representatives of JPMorgan Chase are expected to testify at the New York Financial Services Department hearings.
The full schedule is here.
This article was reprinted with the permission of American Banker.
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