Notes from this afternoon's DFS hearing into Force Placed Insurance

Monday May 21, 2012 Afternoon Session

Late Start 1:24am

DFS: Next Panel…swear in

Bernie: Working on LPI for 20 years, shining a light is well overdue.

Here’s a summary; LPI market is characterized by reverse competition. 3 entities, and the borrower ultimately pays. The insurer markets to the Servicer, not the borrower. Stringent regulation is required. The DFS Credit Insurance Regulation acknowledges the problem.

LPI expenses aren’t reasonable and shouldn’t be passed on to borrowers. They should only be directly associated with LPI. An overcharge of $500 million since 2004 in New York.

$270,000 per day overcharges continuously.

No evidence for charges in 3 days. Not one servicer or insurer provided any data.

They used excuses and absurb rationales but 0 evidence, and 0 data.

They’re clearly excessive. The DFS should get to work immediately.

The rates should produce 80% or greater loss ratios.

The single most effective action to stop abuses is to require LPI insurers to reduce rate levels to cover expected costs of insurance and filter out excessive profits. It shouldn’t make a profit.

Instead of 5%, they were 8 times more profitable than filing.

In an era of 11-13% being reasonable. American Security was 50%. 4 times greater than reasonable profit.

$1.4 billion = 30% of net premium and $200 more than net after tax income.

Captive Reinsurance received $100’s million and paid very few claims.

What’s causing this? The structure of the market: Reverse competition. Borrowers have no power, but costs are passed to the borrower. Greater competition for servicer business leads to higher LPI prices.

GMAC pays nothing to track insurance on loans. It’s their responsibility. The expenses associated are the responsibility is associated with that loan. Not only does GMAC contract it, but they don’t pay for it. Only the consumers are paying it because the cost of the tracking is built in.

It’s born by the 1-2% of consumers with force placed insurance. It’s hard not to be outraged at the most vulnerable consumers being shouldered with this cost.

The insurance is subsidizing unrelated activities. It’s not the borrower’s place to fund these activities.

FNMA’s bulletin should be taken into consideration. FNMA was going to implement changes. Any servicer request must exclude lender placed insurance commission by the servicer or any related entity. They’re not going to reimburse any cost for insurance tracking. Finally, they said any other cost beyond the actual cost of the premium. They must be competitively priced and commercially reasonable.

There’s certain expenses that shouldn’t be permitted: commissions, admin fees, captive insurance, unrelated transactions.

Tracking – someone has to load insurance info from loan docs to a database for the servicer to track insurance. They have to provide customer service and contact agents. None of these costs are associated with the provision of LPI Insurance. All activities are performed by the LPI vendor. It’s reasonable for them to do that, but unreasonable to charge borrowers for it.

10-15% False Placement rate because of Tracking Errors. Why should LPI borrowers pay for the expenses associated with poor performance of the servicer? (Six Sigma)

Commissions to Affiliated Producers – Servicing providers, reviewing letters, broker commissions, the producer managers the rating program, QC, commissions are a cost of doing business. None of them justify these commissions, let alone the massive commissions being paid. The role is to shop the market. The broker doesn’t engage in quality control of vendors or a company.

These commissions are a kickback to offset the cost associate with servicing. There’s no justification. There’s no Risk Management purpose served. There’s no reason for borrowers to pay these fees.

QBE First the agent gets a significant commission from the QBE company for administering the program. American Security paid over $160 million for “management agreements and service contracts”.

There’s so much self-dealing in the market to provide profit. A reasonable profit load.

The loss ratio should be 85%. They should be refilling their rates including catastrophe.

Homeowners need complex rating models, get individual info, claims history, credit history, etc (all attached to the loan info, which LPI Insurers have access to). None of these expenses are present in LPI. There’s no sales activity that doesn’t result in a policy like on a voluntary policy.

Data and evidence supports what a reasonable rate would be. There’s actual data reported by insurers. It includes actual economic and actuarial analysis. The servicers have simply said we may get a catastrophe.

The data don’t indicate exposure. If LPI Insurers were more concentrated, in years with a cat event, LPI loss ratios would jump more than voluntary, but what you see is LPI loss ratios remained low even when homeowners ratios were high. That suggest LPI isn’t as catastrophe prone as voluntary. Why? The witnesses are incorrect. I would suggest the nature of the coverage. It doesn’t provide personal property or additional living expense.

Another reason to discount is that both insurers right country-wide and diversify their risk geographically. In the event of a cat in NY, it’s unlikely CA or AZ or NV will have one too. That’s what insurance companies do.

REO vs nonREO claims – REO is investor owned. The borrower no longer has an interest. LPI covers both non REO properties and REO properties. It’s reasonable to except more REO claims. REO should be higher than LPI. The info should be broken down by REO & nonREO and borrower rates should only reflect the nonREO claims.

Balboa is waiting for recent rate change to go through. That argument has no merit. They routinely file new rates within a year or 2. Historical premiums are recast. It’s a basic actuarial practice.

Why act quickly? There’s overwhelming evidence of excessive rates, and you have a statutory responsibility to borrowers. They filed false information and knew it. It’s important for you to consider what’s commercially reasonable so it’s not interpreted in a bad way.

Finally the single most effect way for reverse competition in LPI insurance is De-incentivize the market to address these problems. Don’t ask these insurers and servicers to act against their interest, remove the interest. I’m happy to answer any questions.

DFS: One question, a minimum of 80%, what would you suggest if they don’t meet the loss ratio?

Bernie: I don’t have an opinion on refunds or loss ratio rebates for prop casualty insurance. At a minimum is model NEIC models. Review the experience annually. I really believe that’s the department’s responsibility including paid and incurred claims. If you think they’re unreasonably stuffing reserves, look at that too. It’s the department’s responsibility so they should require insurers to come in whenever they’re not meeting the 80 or 85% loss ratios.

DFS: How do provide adequate notice for LPI on the statement, etc?

Bernie: I have views but there are folks who really work on these type of disclosure issues, like the CFPB and their reliance on behavioral economics. We’re pushing for best practices on consumer disclosures. Marketplace testing needs to take place to ensure the consumer is being empowered instead of a servicer liability shield.

DFS: Mr. Berbaum, you said one of the reasons it should have a lower cost is because it’s a group policy with no individual inspections. Insurers say that fact is the among the reasons there are high costs. They take on the homeowners without individual inspections.

Bernie: It’s logical to expect properties not underwritten would have higher cost, all other things being equal. The coverage afforded on the LPI policy is less so while there might be a greater frequency of claims under LPI, the severity may be significantly less.

I wanted to get back to rebates. What I am certain is insurance companies shouldn’t have been permitted to overcharge consumers based on false information given to the dept or based on kickbacks or inappropriate, and possibly illegal fees. To the extent you find that’s the case, I think it’s personally reasonable to rebate excessive amounts.

DFS: What are your suggestions for more LPI competition?

Bernie: The problem isn’t just in LPI. It’s in PMI, Title Insurance, etc. It’s the structure of the market. There’s no direct to consumer. In order to get the lender’s business, the lender has the market power and they command consideration.

One possibility is to require the lender/servicer pay for insurance and not be permitted to charge the borrower as a separate charge. That’s feasible for title insurance but not for LPI because the LPI insurance premiums are for 1-2% of the portfolio. Making the lender pay and not permitting a separate charge to the borrower, the lender has all the incentive for lower premium and has power to demand that lower premium.

Ensure rates are reasonable or nonexcessive (actually for the first time, I disagree. Charging those 1-2% a servicing fee for the service of shopping insurance is perfectly acceptable and incentivizes the servicer to price shop. The markets are big enough that voluntary insurers can participate).

DFS: limiting retroactive billing

Bernie: One of the really good things about LPI is that it’s automatic coverage. I don’t want my testimony today to be seen as a criticism of the product. It’s an essential product of the market (it’s a service).

It protects borrowers, investors, lenders. The question is how long should it take to discover if there’s a lapse in coverage? In one situation in Florida, a borrower refinanced the loan and the servicer said ok you have insurance at the time of closing. The borrower got the refinance. Then a month later, the borrower got a notice that there was a problem with the insurance. The borrower didn’t hear anything again until over 6 months later when they heard from the servicer that you haven’t had insurance (actually the loan tracker), it was an $18k annual premium. The borrower was outraged and didn’t know there wasn’t coverage. The borrower got a voluntary policy, but by that time, there had already been $10k premium incurred before the borrower even knew to go out and get the coverage.

I’m oversimplifying, but the point I want to make is that it’s certainly reasonable for the servicer to charge for retroactive premium, but only with notice to the borrower to the borrower has the opportunity to purchase voluntary coverage.

DFS: The borrowers say they don’t see it until they get a lawyer, but the servicers say they tell them 8-15 times. What’s the disconnect?

Bernie: One possible explanation is when servicers monitor the performance of LPI vendors, a lot of that is probably done through reports for standards. It’s probably data driven, false placement and call answering rates, whatever. The servicer might see 99% done well. Well that leaves 1%, and if you have a portfolio of 10 million people, 1% is 100k customers. That’s a lot. They may not be strong enough.

Another explanation might be that the servicers aren’t really doing a great job in monitoring the performance of the vendors and relying on the vendors to self audit instead of really auditing.

DFS: (whispering) In your 80-85% minimum Loss Ratio, how does it encompass cat?

Bernie: It would include all claim related costs. That provision for catastrophe claims might be a reinsurance in lieu of the cats or a cat model. For example, you had 80-85% and out of that 20% is for cat claims. What you would expect is 65% loss ratios on non cat claims and then 100%. But you wouldn’t expect a rate increase after because it’s included in the rate.

That’s important. Your work is important. Not only are we talking about 10’s of thousands of NY consumers, but you’re on the forefront across the country. The work you do will have a profound influence on regulators across the country. It will create a precedent and imperative, but no pressure.

 DFS: ok, well we thank you very much for your testimony. We’re going to take a 5 minute break and then have our next panel.