Lender-Placed Insurance: More Robust Data Could Improve Oversight
Published: 2015-09-08T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Mortgage servicers use LPI to protect the collateral on mortgages when borrower-purchased homeowners or flood insurance coverage lapses. The 2007-2009 financial crisis resulted in an increased prevalence of LPI. Because LPI premiums are generally higher than those for borrower-purchased coverage, state insurance regulators and consumer groups have raised concerns about costs to consumers.
This report addresses (1) the extent to which LPI is used; (2) stakeholder views on the cost of LPI; and (3) state and federal oversight of LPI. GAO examined documentation, studies, and laws and regulations related to LPI, and interviewed stakeholders including state insurance and federal financial regulators, consumer advocates, insurers, servicers, and industry associations. GAO selected interviewees based on their involvement in the LPI market and other factors to obtain a diverse range of perspectives. GAO selected the seven state insurance regulators to interview based on a number of factors including LPI premium volume and involvement in the LPI market.
section_title: What GAO Found
paragraphs: Mortgage servicers purchase lender-placed insurance (LPI) for mortgages whose borrower-purchased insurance coverage lapses, most often because of nonpayment by the borrower or cancellation or nonrenewal by the original insurer. The limited information available indicates that LPI generally affects 1 percent to 2 percent of all mortgaged properties annually and has become less prevalent since the 2007-2009 financial crisis as foreclosures have declined. Although used more often when borrowers without escrow accounts (about 25 percent to 40 percent of borrowers) stop paying their insurance premiums, servicers also use LPI when an insurer declines to renew a policy. LPI insurers often provide services such as tracking properties to help servicers identify those without insurance and confirming coverage. LPI insurers said they must refund premiums if a borrower provides evidence of coverage, which occurs on about 10 percent of policies. The Federal Emergency Management Agency offers flood LPI, but industry officials said most servicers prefer private coverage because of more comprehensive coverage and lower rates, among other things.
LPI premium rates are higher than rates for borrower-purchased insurance, and stakeholders disagreed about whether the difference is justified. Insurers pointed out that they provide coverage for any property in a servicer's portfolio without a rigorous underwriting process, and the limited information requires higher rates. They added that LPI properties tended to have higher risk characteristics, such as higher-risk locations (along the coast) and higher vacancy rates because of foreclosures. But some consumer advocates and state regulators said that the factors that insurers cite for higher rates, as well as the insurers' limited loss histories, do not justify the magnitude of the premium differences. They also said borrowers have little influence over the price of LPI and that some insurers competed for the servicers' business by providing commissions to the servicer that passed the costs on to the borrower through higher premium rates. Insurers, however, said that LPI premium rates were filed with and approved by state regulators and that commissions were a standard industry practice, but their use had decreased.
State insurance regulators have primary responsibility for overseeing LPI insurers, but federal financial regulators generally oversee the servicers that purchase LPI coverage for their portfolios. However, a lack of comprehensive data at the state and national levels limits effective oversight of the LPI industry. For example, regulators lack reliable data that would allow them to evaluate the cost of LPI or the appropriateness of its use. The National Association of Insurance Commissioners (NAIC), which helps coordinate state insurance regulation, requires insurers to annually submit state-level LPI data, but the data were incomplete and unreliable. NAIC provides guidance for the reporting of these data and shares responsibility with state regulators for reviewing and analyzing the data, but neither has developed policies and procedures sufficient for ensuring their reliability. State and federal regulators have coordinated to collect more detailed national data to better understand the LPI industry, but insurers failed to provide them all of the requested information, and whether and when they will is unknown. Without more comprehensive and reliable data, state and federal regulators lack an important tool to fully evaluate LPI premium rates and industry practices and ensure that consumers are adequately protected.
section_title: What GAO Recommends
paragraphs: GAO recommends that NAIC work with state insurance regulators to collect sufficient, reliable data to oversee the LPI market. This includes working with state insurance regulators to develop and implement more robust policies and procedures for LPI data collected annually from insurers and to complete efforts to obtain more detailed national data from insurers. NAIC said it would consider the recommendations as part of its ongoing work in the area.

section_title: Letter
paragraphs: Homeowners insurance and flood insurance help protect both borrowers  and lenders from the financial losses that can arise when homes are  damaged. If a borrower allows coverage to lapse or otherwise become  inadequate or loses coverage and does not respond to the servicer’s  requests to provide proof of sufficient coverage, the mortgage loan  documents allow the servicer to protect the mortgage holder’s interest in  the property by purchasing insurance to cover the collateral on the  mortgage loan and charge the borrower for the premium. Servicers’ use  of this type of insurance, known as lender-placed insurance (LPI), peaked  during the 2007-2009 financial crisis as an increasing percentage of  borrowers fell behind on their mortgage and insurance payments.  According to officials from the National Association of Insurance  Commissioners (NAIC), LPI accounted for about $3 billion in premiums in  2014. Although this amount represents only about 0.1 percent of the  overall U.S. insurance industry, LPI can have a significant impact on  affected consumers because it is often more expensive than the  borrower-purchased coverage it replaces.
Questions have grown about LPI’s financial effect on consumers during  and since the 2007-2009 financial crisis. In particular, state insurance  regulators and consumer groups have raised questions about the high  cost of LPI, citing investigations and studies saying that the amount of  claims that LPI insurers pay does not justify the premium rates. These  groups also expressed concerns that borrowers had little influence over  the price of LPI because the lender selects the insurer. Further, they said  that some insurers might compete for the servicers’ business by providing  commissions to the servicer and passing the costs on to the borrower  through higher premium rates. Additionally, industry officials noted that  LPI is more common for mortgages that are delinquent or in foreclosure.  As a result, borrowers may pay higher premiums when they are already in  financial distress. Insurers, however, have said that LPI policies have a  number of risk characteristics that justify their higher premium rates and  that they have rigorous processes to notify borrowers of the need to buy  less expensive replacement coverage.
Because state law governs the business of insurance, state regulators  have had the responsibility for overseeing homeowners LPI. In recent  years, three states have reviewed LPI premium rates and related  activities and reached agreements with insurers on LPI practices aimed at  ensuring premium rates are appropriate. Further, the Dodd-Frank Wall  Street Reform and Consumer Protection Act (Dodd-Frank Act), among  other things, amended the Real Estate Settlement Procedures Act  (RESPA) to establish requirements for mortgage servicers on borrower  notification before charging for homeowners LPI, termination of  homeowners LPI, and refunding premiums paid by the borrower for  homeowners LPI while the borrower maintained borrower-purchased  coverage, among other things. In 2013, the Consumer Financial  Protection Bureau (CFPB) amended Regulation X to implement RESPA’s  LPI provisions added by the Dodd-Frank Act. CFPB’s amendments to  Regulation X became effective in 2014.
You requested that we review the LPI industry and the role of federal and  state regulators in monitoring LPI practices. This report (1) describes the  extent to which LPI is used, (2) discusses stakeholder views on the cost  of LPI, and (3) describes state and federal oversight of LPI. To address  these objectives, we reviewed LPI laws and regulations, agency  guidance, settlements involving LPI, hearings, and studies, as well as  past GAO reports on homeowners, flood, and title insurance. We  interviewed officials from 10 relevant federal agencies, including financial  institution regulators, as well as a selection of state regulators, LPI  insurers, bank and nonbank servicers, industry associations, and  consumer advocates. We selected interviewees based on their  involvement in the LPI market and other factors to obtain a diverse and  wide range of perspectives. To understand states’ oversight of LPI, we  interviewed insurance regulators from California, Florida, Illinois, New  Jersey, New York, Ohio, and Texas and reviewed their states’ laws and  regulations. We selected these states based on the volume of LPI  premiums, rate filing processes, and LPI regulatory activity. This selection  of states is not generalizable to all states. We also reviewed aggregated  financial data that LPI insurers report annually to state regulators to  compare premiums and claims data for LPI to that of borrower-purchased  insurance, but we determined that the data were unreliable for our  purposes. Finally, we obtained and reviewed policy- and servicer-level  LPI data collected through an interagency data call to understand  characteristics of the LPI market and assess LPI premium rates, but we  limited our analysis to geographical data because the data were  incomplete. We discuss data issues more fully later in this report.
We conducted this performance audit from March 2014 to September  2015 in accordance with generally accepted government auditing  standards. Those standards require that we plan and perform the audit to  obtain sufficient, appropriate evidence to provide a reasonable basis for  our findings and conclusions based on our audit objectives. We believe  that the evidence obtained provides a reasonable basis for our findings  and conclusions based on our audit objectives.
subsections: section_title: Background
paragraphs: LPI, also known as “force-placed” or “creditor-placed” insurance, is an  insurance policy purchased by a mortgage servicer on a home to ensure  continuous coverage when the borrower’s homeowners or flood  insurance lapses or otherwise becomes inadequate. Most investors, such  as Fannie Mae and Freddie Mac, require continuous homeowners  insurance coverage on properties that serve as collateral for loans, and  mortgage contracts usually require that borrowers maintain continuous  coverage to protect the investor’s financial interest in the property.  Regulated lending institutions are also required to ensure that borrowers  obtain and maintain flood insurance for properties in special flood hazard  areas. If a borrower does not maintain continuous coverage as required  by the mortgage contract, the servicer is required to purchase LPI and  may charge the borrower for the associated premiums and costs. As a  result, LPI allows servicers to meet these requirements and protect the  mortgage holder’s financial interest in the property. A distribution of LPI  policies in 2013 can be seen in figure 1.
subsections: section_title: The LPI Process
paragraphs: Servicers generally contract with LPI providers to cover all the mortgages  in their portfolios from the date any borrower-purchased coverage lapses,  regardless of when the coverage lapse is discovered. According to  industry officials, most servicers outsource tracking and notification  services—that is, monitoring of the mortgages’ insurance policies for  possible lapses in coverage and communicating to borrowers that LPI will  be placed unless the borrower provides proof of insurance—to LPI  insurers or managing general agents. Because LPI insurers are  responsible for losses that occur during coverage lapses, some of the  larger insurers perform these services themselves. Industry officials said  that some smaller LPI insurers use a managing general agent to perform  some or all of the tracking services, usually because setting up these  services requires a large upfront investment, but generally continue to  perform the notification services directly. Insurers typically factor the  expenses associated with such activity into the LPI premium rates, which  are based on the value of the underlying properties. When the servicer  places an LPI policy, it pays the premium to the LPI insurer and  reimburses itself with funds from the borrower’s escrow account or by  adding the premium amount to the mortgage’s principal balance. In some  cases, the insurer may pay a commission to the servicer or servicer’s  agent for the business and can also use a portion of its premium revenue  to purchase reinsurance to hedge its risk of loss (see fig. 2). Also in some  cases, the company providing reinsurance to the LPI insurer could be  affiliated with the servicer who placed the LPI policy.
section_title: Differences between LPI and Borrower- Purchased Insurance
paragraphs: LPI differs from borrower-purchased homeowners insurance in several  ways. First, with borrower-purchased insurance, insurers evaluate the  risks for individual properties and decide whether to cover a property and  how much to charge. Because LPI covers all mortgages in a servicer’s  portfolio, insurers do not underwrite properties individually. Instead, they  provide coverage without assessing the condition of individual properties  and provide coverage for a broader range of risks, including defaults and  vacancies. Second, industry officials said that the servicer rather than the  borrower is typically the named insured on the LPI policy, although in  some cases, borrowers can be additional insureds who have the right to  file a claim in the event of a loss, and their interest is included in any  settlement. Third, servicers rather than insurers are responsible for  determining the amount of coverage. Most servicers purchase the same  amount of coverage that was available under the lapsed borrower- purchased policy. This amount approximates the replacement value of  the home and protects the borrower’s financial interest and the servicer  should the property be damaged. However, in some situations the  servicer may not know the amount of coverage under the previous policy  and may instead use the mortgage’s unpaid principal balance. Finally, LPI  coverage may differ from the coverage provided by borrower-purchased  insurance. Industry officials said that LPI policies typically insure the  dwelling and other related structures on a property but often do not  include the borrower’s belongings or liability risks, as borrower-purchased  policies do. However, one industry official said that LPI policies typically  provide broader structural coverage, insure against vandalism, and  continue coverage in the event of vacancy.
section_title: Role of State Insurance Regulators
paragraphs: Like borrower-purchased insurance, LPI is subject to state insurance  regulation, including rate and form reviews and approvals where  applicable. The McCarran-Ferguson Act provides that state law governs  the business of insurance and is not superseded by federal law unless a  federal law specifically relates to the business of insurance. State  regulators license agents; review insurance products and premium rates,  including LPI products and rates where applicable; and routinely examine  insurers’ financial solvency. State regulators also generally perform  market examinations in response to specific consumer complaints or  regulatory concerns and monitor the resolution of consumer complaints  against insurers.
NAIC is a voluntary association of the heads of insurance departments  from the 50 states, the District of Columbia, and five U.S. territories. While  NAIC does not regulate insurers, it provides services to make certain  interactions between insurers and state regulators more efficient. These  services include providing detailed insurance data to help regulators  understand insurance sales and practices; maintaining a range of  databases useful to regulators; and coordinating state regulatory efforts  by providing guidance, model laws and regulation, and information- sharing tools. NAIC has coordinated state regulatory efforts on LPI by  developing a model law for LPI and holding public hearings on LPI. In  1996, NAIC developed the Creditor-Placed Insurance Model Act, which  serves as a guide for state legislation on LPI for personal property, such  as automobiles. Additionally, in August 2012, NAIC held a public  hearing to discuss the use of LPI for mortgages and the effect of the  practice on consumers.
section_title: Role of Federal Regulators
paragraphs: Although the business of insurance is regulated by the states, federal  regulators generally have authority over regulated lenders’ and their  servicers’ activities related to flood insurance, including flood LPI. The  Board of Governors of the Federal Reserve System (Federal Reserve),  Farm Credit Administration (FCA), Federal Deposit Insurance Corporation  (FDIC), Office of the Comptroller of the Currency (OCC), and National  Credit Union Administration (NCUA) are the regulators responsible for  overseeing the mandatory flood insurance purchase requirement for their  institutions (see table 1). Since the passage of the Flood Disaster  Protection Act of 1973, flood insurance has been mandatory for certain  properties in special flood hazard areas within communities participating  in the National Flood Insurance Program (NFIP), and federal regulators  have been responsible for enforcing compliance with this mandatory  purchase requirement. In 1994, the enactment of the National Flood  Insurance Reform Act required a regulated lending institution or a servicer  acting on its behalf to notify borrowers of lapsed coverage, and if the  borrower did not purchase coverage within 45 days of the notice, to  purchase flood LPI. The act clarified that servicers could charge the  borrower for the cost of premiums and fees for flood LPI. It also required  regulators to issue civil money penalties against regulated lending  institutions for a pattern or practice of mandatory flood insurance  purchase requirement violations, including LPI requirements. In 2012, the  Biggert-Waters Flood Insurance Reform Act (Biggert-Waters Act) clarified  that servicers could charge for flood LPI from the date of a coverage  lapse or from the beginning date of insufficient coverage and also  required them to issue refunds to borrowers who provided proof of  insurance for any period of duplicate coverage. Each of the federal  regulators has issued regulations to implement flood LPI rules for their  respective institutions.
Federal regulators also have supervision and enforcement authority for  their regulated entities’ activities related to homeowners LPI. In 2010, the  Dodd-Frank Act amended RESPA with specific provisions for  homeowners LPI and granted CFPB rulemaking authority under RESPA.  In 2013, CFPB adopted amendments to Regulation X to implement Dodd- Frank Act amendments to RESPA. CFPB’s amendments to Regulation  X became effective in January 2014. The rules: prohibit servicers from charging borrowers for homeowners LPI unless  they have a reasonable basis for believing that the borrower has not  maintained homeowners insurance as required by the loan contract;  require all charges to be bona fide and reasonable (does not cover  charges subject to state regulation as the “business of insurance” and  those authorized by the Flood Disaster Protection Act);  require servicers to send two notices to borrowers before placing LPI;  specify the content of the notices with model forms; generally prohibit servicers from obtaining homeowners LPI for  borrowers with escrow accounts for the payment of hazard insurance  whose mortgage payments are more than 30 days overdue unless the  servicer is unable to disburse funds from the borrower’s escrow  account to ensure that the borrower’s hazard insurance premiums are  paid on time. The servicer is not considered unable to disburse funds  because the borrower’s escrow account contains insufficient funds or  if the loan payment is overdue. A servicer is considered unable to  disburse funds from a borrower’s escrow account only if the servicer  has a reasonable basis to believe either that the borrower’s insurance  has been canceled (or not renewed) for reasons other than  nonpayment of premium charges or that the property is vacant. The  servicer generally must advance funds through escrow to maintain the  borrower’s coverage; and  specify procedures for terminating LPI and issuing refunds for  duplicative premiums.
In addition to homeowners LPI provisions, amendments to Regulation X  included new provisions related to escrow payments; error resolution and  information requests; general servicing policies, procedures, and  requirements; loss mitigation activities; and mortgage servicing transfers.  Mortgage servicers that service loans for investors in mortgage-backed  securities must also comply with LPI rules required by their investors,  particularly from Fannie Mae and Freddie Mac. In November 2013, the  Federal Housing Finance Agency (FHFA), which oversees these entities,  directed Fannie Mae and Freddie Mac to issue guidance to their servicers  on LPI. In December 2013, the entities issued corresponding guidance,  prohibiting their servicers and affiliated entities from receiving  commissions or similar incentive-based compensation from LPI insurers  and servicers’ affiliated companies from providing LPI insurance,  including any reinsurance arrangements. See figure 3 for a summary of  these and other key events related to LPI oversight.
section_title: Few Mortgages Receive LPI, and Those That Do Usually Receive It Due to Premium Nonpayment by the Borrower or Coverage Cancelation by the Original Insurer
paragraphs: Mortgage servicers and LPI insurers use tracking and notification  processes to determine when required coverage lapses and LPI is  necessary. They ultimately place LPI on about 1 percent to 2 percent of  mortgages in their portfolios, usually resulting from borrowers not paying  their insurance premiums or the original insurers canceling or not  renewing coverage. Servicers and insurers said that they use the tracking  and notification systems to ensure that LPI placement is as accurate as  possible, but that they must refund premiums when the borrower provides  proof of coverage, which occurs on about 10 percent of policies. Finally,  the Federal Emergency Management Agency (FEMA) offers flood LPI  through its Mortgage Portfolio Protection Program (MPPP), but servicers  generally said that they prefer private flood LPI coverage for a number of  reasons, including more comprehensive coverage and lower premium  rates.
subsections: section_title: Tracking and Notification Processes Identify a Small Percentage of Mortgages Requiring LPI
paragraphs: Mortgage servicers place LPI on a small percentage of mortgages when  required coverage lapses, usually as a result of nonpayment by the  borrower or cancelation or nonrenewal by the insurer. According to  industry officials, mortgage servicers ultimately place homeowners LPI  coverage on 1 percent to 2 percent of the mortgages in their portfolio.  They said that placement rates were often under 2 percent prior to the  2007-2009 financial crisis but peaked at about 3 percent at the height of  the crisis due to increased delinquencies. Industry officials said that  placement rates increased as borrowers stopped paying their  homeowners or flood insurance premiums along with their mortgage  payments. One consumer advocate said that LPI placement rates were  much higher for subprime lenders and may have peaked at 15 percent to  20 percent for some of them. Industry officials also said that placement  rates were much higher for mortgages that were delinquent or in  foreclosure. For example, one official said that its company’s placement  rate was 0.6 percent for current loans, compared with 17 percent for  noncurrent loans. Industry officials said that even as the housing market  has improved, properties can remain in foreclosure for an extended  period of time in some states, keeping the placement rate above its pre- crisis level. However, they said that they expected the rate to continue to  decline as older foreclosures were resolved.
As discussed earlier, some LPI insurers perform tracking and notification  services for servicers both to manage their exposure and to meet the  needs of servicers. As part of the tracking process, the insurer (or  insurer’s agent) monitors mortgages on behalf of the servicer for possible  lapses in borrower-purchased coverage—for example, when coverage  has been canceled or is about to expire. One industry official said that this  process involves obtaining and reviewing millions of insurance documents  each year, many of which are in hard copy and not in a standardized  format, and updating the servicers’ records accordingly. Industry officials  said that within about 2 weeks of a borrower-purchased policy’s expected  renewal date, the insurer generally receives renewal documentation on  behalf of the servicer, and at this point, they have confirmed coverage for  all but about 14 percent of mortgages (see fig. 4). If the insurer does not  receive this documentation, it contacts borrowers’ insurers, their agents,  and the borrowers themselves for proof of coverage. This process  typically reduces the number of mortgages whose coverage status is  unknown to about 9 percent around the expiration date. If renewal  documentation does not arrive and the renewal date passes, the insurer  sends a first letter to the borrower asking for proof of coverage. If the  borrower does not provide proof of coverage, the insurer must send a  second letter at least 15 days before charging the borrower for LPI (and  at least 30 days after sending the first notice), this time with the cost or a  reasonable estimate of the LPI policy’s premium. This second letter is  sent to about 3 percent of loans whose coverage status has not yet been  confirmed. Industry officials said that insurers had such notification  procedures in place prior to the CFPB regulations, but noted that the  regulations had helped standardize and clarify the notification letters.
By the end of this process, the insurer is generally able to confirm  borrower-purchased coverage for most of the mortgages in a servicer’s  portfolio, but servicers ultimately place new coverage on the  approximately 1 percent to 2 percent of borrowers who do not respond to  the notifications. Industry officials said that because CFPB regulations  require servicers to complete the 45-day notification process before  charging for LPI coverage, most LPI policies are not issued until at least  60 days after the borrower’s insurance lapses. However, they said that  most LPI policies are retroactive to the date of the insurance lapse.  Industry officials said that LPI policies had a 1-year term but that most  were canceled before the policy expired because borrowers eventually  obtained the required borrower-purchased coverage to replace the LPI  policy.
section_title: LPI Is Most Often Placed on Non-Escrowed Mortgages When Borrowers Stop Paying Required Homeowners Insurance Premiums
paragraphs: According to industry officials and consumer advocates with whom we  spoke, most LPI policies are placed on mortgages without escrow  accounts when borrowers stop paying premiums on their required  homeowners insurance policies. Industry officials said that mortgages  with escrow accounts require LPI less often, because Regulation X  requires mortgage servicers to use escrow funds to maintain borrower- purchased coverage—even when the escrow funds are insufficient.  Industry officials noted that these regulations had had little effect on the  LPI industry because servicers already maintained coverage for  escrowed borrowers, including when escrow funds were insufficient.  Additionally, industry officials with whom we spoke also estimated that 60  percent to 75 percent of U.S. mortgages had escrow accounts. Industry  officials said that mortgages without escrow accounts are more likely to  require LPI because servicers do not have escrow accounts to draw on to  continue paying borrower-purchased insurance premiums.
However, CFPB regulations do not require servicers to maintain  borrower-purchased coverage for mortgages with escrow accounts if they  believe the property is vacant or that the borrower-purchased coverage  was canceled or not renewed for reasons other than nonpayment.  Regulatory and industry officials said that, as a result, LPI placement on  escrowed mortgages primarily occurred when the previous insurer  canceled or declined to renew coverage. Regulatory and industry officials  said that cancelation or nonrenewal happens for a number of reasons,  most commonly because of a change in occupancy status, especially  vacancy, often in connection with a foreclosure. They also cited other  reasons, including a history of large losses on the property, a change in  the condition or risk of the property, the borrower’s failure to maintain or  repair the property, a misrepresentation of the property’s characteristics  on the insurance application or other violations of the insurance contract,  or a desire by the insurer to limit their concentration of risk in a particular  high-risk geographic area. Even state residual insurance programs, which  are designed to be insurers of last resort, may refuse to insure some  high-risk properties, particularly those that are vacant. In addition,  industry officials said that high risks in some areas could make borrower- purchased coverage difficult to obtain—for example, parts of the Gulf  Coast and especially Florida—and result in placement of LPI. Industry  officials said that a much less frequent cause of LPI placement was  administrative errors that occurred, for instance, when a mortgage was  transferred to a new servicer and the insurer was not notified. Industry  officials said these errors were rare, but they did not provide more specific  data.
section_title: Insurers Said They Refund Premiums on about 10 Percent of Policies
paragraphs: LPI insurers with whom we spoke said that they used the tracking and  notification process to ensure that flood and homeowners LPI placement  was as accurate as possible. However, industry officials and a consumer  advocate said that insurers generally determined that placement was  unnecessary for about 10 percent of the LPI policies they issued. Industry  officials said that this unnecessary placement usually occurs because the  borrower does not provide proof of coverage until after the LPI policy is  placed, despite multiple requests from the servicer. CFPB regulations  require the insurer to cancel the LPI and refund all homeowners LPI  premiums and related fees for any overlapping coverage within 15 days  of receiving proof of coverage.
Industry officials told us that insurers had no incentive to place LPI  unnecessarily, because doing so generated administrative expenses  without a corresponding receipt of premium. For example, insurers incur  expenses for corresponding with borrowers through calls and letters,  issuing the policy, processing the cancelation, and issuing the premium  refund. In addition to avoiding unnecessary expenses, industry officials  said that insurers also want to avoid exposing their clients (the servicers)  to borrower dissatisfaction and complaints. However, consumer  advocates have cited unnecessary placements as an issue that needs to  be addressed. While borrowers eventually receive a full refund of any  unnecessary premiums, they may also be inconvenienced by having to  initially pay the premium and go through the process of getting the policy  canceled. One consumer advocate also cited concerns about  unnecessary placement of flood LPI, particularly that borrowers incurred  costs, such as hiring surveyors, to refute the servicer’s determination that  flood insurance was necessary.
section_title: FEMA Offers Flood LPI, but Servicers Prefer Private Coverage
paragraphs: LPI is also used when mandatory flood insurance policies lapse. The  Flood Disaster Protection Act of 1973 requires flood insurance for  properties in special flood hazard areas located in communities  participating in NFIP that secure mortgages from federally regulated  lenders. FEMA offers flood LPI coverage through MPPP, but most  servicers obtain coverage through private insurers. FEMA officials said  that as of March 2015, MPPP had about 800 policies, a small number  compared with the approximately 5.2 million policies in its National Flood  Insurance Program, the primary provider of borrower-purchased flood  coverage. Industry officials told us that MPPP was mostly used by smaller  servicers that did not have access to LPI insurers that offer flood LPI.
Industry officials cited a number of reasons that servicers preferred to do  business with private flood LPI insurers rather than FEMA’s MPPP. First,  industry officials said that private insurers would provide coverage from  the date of lapse. Industry officials said that MPPP policies, in contrast,  do not allow for automatic coverage upon lapse of borrowers’ policies,  resulting in the possibility of short periods with no coverage in place, while  investors require the servicer to ensure continuous coverage. Second,  industry officials said that private flood LPI rates are lower than MPPP  rates, although they are still higher than rates for borrower-purchased  flood insurance. For example, some told us that MPPP policies were  about 4 times more expensive than private LPI flood policies, making  MPPP a less attractive option. Further, some industry officials said that  using MPPP for flood LPI would require servicers to have two insurers,  one for homeowners LPI and one for flood, but that most servicers  preferred to have the same insurer for both lines.
section_title: Stakeholders’ Views on LPI Rates and Practices Were Mixed
subsections: section_title: Industry Officials Provided a Number of Reasons for LPI’s Higher Premium Rates
paragraphs: According to one actuary who works with LPI, premium rates are  determined by looking at expected losses (both catastrophic and  noncatastrophic), expected other expenses, and target profit  commensurate with the exposure and risk. Several industry officials said  that some of the ways that LPI insurance differs from typical homeowners  insurance can make LPI rates higher than borrower-purchased insurance.  These differences include the following:
Covering all properties regardless of associated risk: LPI insurers  do not underwrite individual properties, but instead agree to cover all  properties in a servicer’s mortgage portfolio and cannot reject  coverage for high-risk borrowers. Insurers told us previously that to  manage risk, they need the ability to accept and reject applicants as  necessary. Some industry officials told us that because of the lack of  information on the risks associated with the covered properties,  insurers set LPI premium rates higher than rates for fully underwritten  borrower-purchased insurance.
Higher geographical concentrations of high-risk properties:  Some industry officials told us that the inability to reject coverage for  high-risk borrowers resulted in LPI insurance portfolios having large  concentrations of high-risk properties—including in coastal states  prone to catastrophic damage—that did not generally exist in  borrower-purchased insurance portfolios. For example, one LPI  insurer said that approximately 70 percent of its premiums in 2014  were in what it considered to be hurricane-exposed states.
Higher concentrations of delinquent mortgages: Several industry  officials said that LPI policies were more likely than borrower- purchased insurance policies to cover mortgages that were in  delinquency and foreclosure. According to one insurer, 30 percent to  35 percent of its LPI policies as of March 2015 were on mortgages  that had been delinquent for at least 90 days. Several industry  officials said that properties in foreclosure are often vacant and  inadequately maintained, increasing the risk and therefore the  potential cost to the insurer.
Additional administrative costs: Several industry officials also told  us that LPI policies carried additional administrative costs. These  costs can include tracking mortgages, obtaining reinsurance, and  notifying homeowners of potential lapses. According to one LPI  insurer, these efforts require significant and ongoing investments in  technology that help effectively manage risk exposure and lower  unnecessary placements. Further, several insurers said they also  incur costs for communicating with borrowers during the notification  process and when LPI is placed unnecessarily.
Several industry officials also pointed out that investors and servicers  bore at least some of the cost of LPI, especially on delinquent mortgages.  One LPI insurer said that based on its own calculations, 35 percent of LPI  premiums were paid by someone other than the borrower, usually the  investor, and that this percentage had decreased in recent years.  According to industry officials, when borrowers do not recover from  delinquencies, investors—which could include Fannie Mae and Freddie  Mac—typically reimburse servicers for the cost of LPI premiums once the  foreclosure process is complete, which in some cases can take years.
section_title: Stakeholders’ Views Differed on the Appropriateness of LPI Premium Rates
paragraphs: According to several consumer advocates and state regulators, some LPI  premiums were higher than they should be. NAIC’s general principles for  determining premium rates state that they should not be inadequate,  excessive, or unfairly discriminatory. Some of the advocates and  regulators cited low loss ratios—claims and adjustment expenses as a  percentage of premiums—as evidence that the policies were priced too  highly. For example, one study by a consumer advocate examined loss  ratios from 2004 through 2012 and found that the average LPI loss ratio  was 25.3 percent, compared with 63 percent for borrower-purchased  insurance. Further, it found that the LPI loss ratio was lower than the  borrower-purchased loss ratio in each of the 9 years in that time period.
Industry officials responded to these assertions by noting that LPI claims  were highly volatile and needed to be examined over much longer loss  histories. They said that insurers set rates prospectively using models to  estimate the full range of expected losses before they occurred and that  these rates were reviewed by most state regulators as part of the rate  filing process. They added that a loss ratio analysis, instead, is a  retrospective process because it examines rates after the losses have  occurred and is only one of many factors that state regulators consider  when conducting an actuarial review of the filed rates.
Some insurers also said that the potential for catastrophic losses in some  years requires rates that may exceed losses in other years. For example,  some LPI insurers have said that LPI may have lower losses in many  years but significantly higher losses in catastrophic years, offsetting the  profits from lower loss years. However, California and New York required  insurers in their states to resubmit rate filings with lower rates because,  based on their review of some insurers’ loss histories in recent years,  they did not see the pattern of profits from lower loss years offsetting  significantly higher losses in catastrophic years.
section_title: Some Consumer Advocates and State Regulators Said Several Factors Resulted in Higher Rates and Other Practices That Harmed Consumers, but Industry Officials Disagreed
paragraphs: Consumer advocates said that the primary cause of higher LPI rates was  reverse competition—a market structure that drives up prices for  consumers because insurers compete for mortgage servicers’ business  rather than consumers’ business—by providing financial incentives to the  servicer. They said that borrowers had little or no influence over the price  of the insurance because the servicer was responsible for selecting it and  that the costs of the financial considerations were passed on to the  borrower. They also said that some insurers have paid commissions to  servicers or servicers’ agents and that the servicers and agents did little  work to justify them. They said that these commissions contribute to  higher premium rates. One industry official, however, said that  commissions were a standard industry practice and that their costs were  within reasonable ranges. After reviewing proposals from Fannie Mae and  Freddie Mac on reducing expenditures related to LPI, FHFA in November  2013 instructed the enterprises—i.e., Fannie Mae and Freddie Mac—to  prohibit servicers from receiving commissions paid for LPI. FHFA, as well  as an insurer and a servicer with whom we spoke, told us that the use of  commissions had decreased since then.
Some state regulators noted that some insurers provided tracking and  other services for free or below cost, benefitting the servicer, but included  the costs of such services in what they charge consumers. One regulator  and a consumer advocate said that some LPI insurers have purchased  reinsurance at inflated prices from reinsurers owned by the lender. They  said this overpayment to the reinsurer affiliated with the servicer could be  a benefit to the servicer for purchasing LPI coverage from the insurer.  One insurer and an industry official with whom we spoke commented that  the use of affiliated reinsurers had decreased in recent years, with the  industry official adding that this was at least in part due to the enterprises’  guidance, which also prohibited their servicers from entering into  reinsurance arrangements with LPI providers.
Some consumer advocates also said that the concentrated LPI market  further contributed to high premiums. Two insurers account for most of  the LPI market, with estimates of their market share ranging from 70  percent to 90 percent. Industry officials said that the two largest insurers  had extensive systems to track large servicers’ mortgage portfolios, and  one consumer advocate said that the expense of setting up such systems  could be a barrier to entry for smaller insurers that must often outsource  tracking services to independent agents. Some industry officials said that  recent state and federal actions—for example, state actions establishing  minimum loss ratio requirements—could have the unintended  consequence of forcing smaller insurers out of the market because of  increased compliance costs. This limited competition, they said, could  contribute to higher premium rates. One insurer said that there were at  least 10 major LPI insurers in the United States in 1992. The insurer said  that since then, catastrophic losses—notably Hurricane Andrew in 1992— and other related factors have resulted in the majority of them choosing to  exit the market. The insurer told us that most insurance companies were  not willing to assume the level of risk involved in LPI.
Finally, consumer advocates and some state regulators said that LPI had  other negative effects on consumers in addition to the financial hardship  of higher premiums. For example, they said LPI offers more limited  coverage than borrower-purchased insurance. In particular, the policies  purchased by the servicer for the borrower to protect the mortgage holder  do not cover contents (personal property), liability, or additional living  expenses. The servicer, not the borrower, is typically the primary insured  party on an LPI policy and therefore determines the amount of coverage.  Some state regulators said that as a result, the servicer may, in some  cases, select coverage for the mortgage’s unpaid principal balance, which  would not cover the property’s replacement cost. Some industry officials,  however, said that servicers prefer to use the coverage amount the  borrower had in place for the lapsed policy when it is known.
section_title: Some State and Federal Regulators Have Taken Actions Related to LPI, but Incomplete Data Limit Oversight
subsections: section_title: State Oversight of LPI Varies
paragraphs: Oversight of homeowners LPI varied across selected states in terms of  requirements, reviews of LPI practices, and the rate filing process. NAIC  does not have a model law or guidelines to address LPI for real  property. We found variations in the regulatory treatment of LPI among  the seven states we reviewed. For example, of the states we reviewed,  only New York had adopted regulatory requirements applicable to LPI  insurer practices. New York’s LPI regulations applicable to insurers  include requirements for insurers and affiliates to notify the borrower  before issuing LPI and for renewing or replacing LPI. Additionally, the  New York LPI regulations prohibit the amount of LPI coverage from  exceeding the last known coverage amount and prohibit insurers from  engaging in several practices, including issuing LPI on property serviced  by affiliated servicers, paying commissions, and providing insurance  tracking to a servicer or affiliate for free or reduced charge. Six of the  states (California, Florida, Illinois, Ohio, New Jersey, and Texas) did not  have statutory or regulatory requirements specifically for LPI insurers in  connection with mortgages (see table 2).
Some states had LPI laws and regulations for mortgage servicers in  addition to what the federal regulators required, as the following examples  illustrate.
The Texas Finance Code includes a chapter on LPI, which requires  that the creditor (servicer) notify the debtor (borrower) no later than 31  days after the LPI is charged to the debtor. It also provides that a  creditor may obtain LPI that will cover either the replacement cost of  improvements or the amount of the unpaid indebtedness. The debtor  is obligated to reimburse the creditor for the premium, the finance  charge, and any other charges incurred by the creditor in connection  with the placement of insurance.
Illinois has a law that applies to servicers using LPI. Specifically, the  law requires that notification forms include language similar to the  “Notice of Placement of Insurance” forms set out in the act. The notice  must be provided within 30 days following the purchase of the  insurance. In 2014, the Illinois Collateral Protection Act was amended  to provide that a servicer subject to Regulation X that places LPI in  substantial compliance with Regulation X would be deemed in  compliance with the Illinois law.
New York has emergency regulations setting out business conduct  rules for mortgage loan servicers. Servicers are prohibited from  placing homeowners or flood insurance on the mortgaged property  when the servicer knows or has reason to know that the borrower has  an effective insurance policy. Servicers also must provide written  notice to a borrower on taking action to place LPI on a property.
LPI premium rates are subject to different levels of review across states.  In most states, LPI is considered commercial lines coverage—that is, the  policy is considered to cover the interests of a business (the servicer)  rather than a consumer. NAIC officials stated that LPI is usually  considered commercial lines coverage because insurers typically sell LPI  to the servicer as a commercial product. States can use different rate  review systems for commercial insurance, and some states may not have  a rate review system for all commercial lines.
According to NAIC officials, state regulators generally review every rate  filing for personal lines coverage but may review only some rate filings for  commercial lines. The officials told us that state insurance regulators  often decided how to allocate resources for rate reviews based on  consumer complaints, and personal lines typically generated more  complaints than commercial lines. The seven states we selected all  considered LPI to be commercial insurance but varied in whether they  conducted rate reviews, how they conducted rate reviews, and how often  rates were reviewed (see table 2), as the following examples illustrate.
In New Jersey, commercial lines are subject to the use and file  system—that is, the insurers can begin using new rates before filing  but must file within a specified period. However, New Jersey does not  require insurers to file LPI rates because the state considers it to be a  deregulated product.
In Ohio and Texas, commercial lines are subject to the file and use  system, which, unlike use and file, generally allows them to begin  using rates as soon as they are filed while the state regulator reviews  the filing.
In Florida, commercial lines and LPI are subject to the file and use  system, which as previously noted, requires approval before the rates  can be used, or use and file, which allows insurers to use rates as  soon as they are filed as long as they are filed no later than 30 days  after implementation, subject to refunds if the rates are determined to  be excessive. Additionally, Florida requires annual rate filings from  its top two LPI insurers.
In California, commercial lines are subject to the prior approval  system, which requires insurers to get state approval before using  new rates. For example, after the first filing, California requires  property-casualty insurers, including LPI insurers, to refile whenever  their rates become inadequate or excessive.
New York uses the file and use rating system for commercial lines.
New York also requires LPI insurers to file rates that reflect loss ratios  of at least 62 percent and to refile rates following any year in which  the actual loss ratio falls below 40 percent. As of 2015, New York  required LPI insurers to file rates at least every 3 years.
Illinois does not have a rate filing system for all commercial lines.
As with reviews of rate filings, reviews of LPI insurer practices also  differed across states. Of the states we selected, those with the highest  incidence of LPI were generally the most active in overseeing LPI.  According to 2012 NAIC data, California, Florida, New York, and Texas  were the top four states in LPI premium volume. Since 2011, three of  them—California, Florida, and New York—have reviewed LPI practices in  their states in response to increased attention from consumer advocates  and NAIC. For example, the New York State Department of Financial  Services (NYDFS) took several steps to review LPI practices in its state,  which resulted in development of regulations on the LPI activities of  insurers and servicers. According to NYDFS officials, the department  began an investigation of LPI in October 2011 after receiving complaints  from consumer advocates that LPI loss ratios were significantly lower  than loss ratios for borrower-purchased insurance. In May 2012, NYDFS  subpoenaed LPI insurers and servicers and held public hearings on LPI  premiums and the financial relationship between servicers and insurers.  In March, April, and May 2013, when NYDFS reached settlements with  the four largest LPI insurers, the agency noted in its findings that  payments of commissions to affiliated servicers and reinsurance  agreements could have led to the high premium rates. The settlements  required the LPI insurers to refile premium rates with a permissible loss  ratio of 62 percent; to refile rates every 3 years; to annually refile any  rates that have an actual loss ratio of less than 40 percent; to have  separate rates for LPI and borrower-purchased insurance; and prohibited  certain practices, including the payment of commissions. The settlements  also required the four LPI insurers to pay restitutions to eligible claimants  and pay a combined total of $25 million in civil money penalties to  NYDFS. Additionally, four other LPI insurers agreed to sign codes of  conduct implementing New York’s LPI reforms. As noted earlier, effective  February 2015, New York regulations began addressing several  practices, including the use of affiliated insurers, commissions, tracking  services, loss ratios, and borrower notification. NYDFS officials stated  that since these hearings and settlements, LPI insurers had reduced their  rates in New York.
California’s and Florida’s actions did not result in revised regulations, but  both states did require reduced LPI rates. Officials from the California  Department of Insurance said that in March 2012, they contacted LPI  insurers and ultimately required four of them to refile their LPI rates. They  said that after examining the insurers’ annual financial statement data,  they found that the insurers’ loss ratios were low, and required four  insurers to lower their rate schedules. The officials said that these  refilings resulted in rate reductions ranging from about 21 percent to 35  percent. Similarly, officials from the Florida Office of Insurance Regulation  said that the New York settlements, NAIC hearing, and information from  consumer advocates on LPI prompted them to review LPI practices. In  July 2012 and May 2013, it held public rate hearings on two of its LPI  insurers. Both hearings resulted in orders for the insurers to reduce rates  and other reforms, including a prohibition on payment of commissions to  the mortgage servicer, borrower notification requirements, and annual  rate filings. Florida officials said that the annual rate filings have resulted  in rate reductions of about 14 percent and 22 percent for the two insurers.  In a 2014 filing, a third LPI insurer agreed to reduce its rates by 4 percent.
According to NAIC data, Illinois, New Jersey, Ohio, and Texas were  among the seven states with the highest market share of LPI premiums,  but officials from these states stated they have not taken specific actions  regarding LPI. Illinois officials stated that although they had not taken  actions related to LPI, their market conduct unit was conducting  examinations of three LPI insurers and planned to publish the findings in  2015. New Jersey officials stated that in the past 2 years they had  received one consumer complaint related to LPI. They added that in  general when they receive consumer complaints about any issue, they  conduct market examinations and consider regulatory changes if the  issue is widespread. Ohio officials said that they had not received  consumer complaints related to LPI or identified any issues related to LPI  in their state.
section_title: Federal Regulators Have Long-standing Procedures for Overseeing Servicers’ Flood LPI Activities and Are Implementing Recent Regulatory Changes for Homeowners LPI
paragraphs: Federal regulators have recently revised regulations related to flood and  homeowners LPI. In 2010, the Dodd-Frank Act amended RESPA to add  provisions on homeowners LPI, which CFPB implemented through  amendments to Regulation X. Federal regulators have monitored  mortgage servicers’ flood LPI activities since the 1994 amendments to  NFIP. The Flood Disaster Protection Act of 1973 made flood insurance  mandatory for properties with mortgages from federally regulated lenders  in special flood hazard areas and in communities participating in NFIP.  Among other things, the Flood Disaster Protection Act required  regulators—including FDIC, the Federal Reserve, NCUA, OCC, the  Federal Home Loan Bank Board (FHLBB), and the Federal Savings and  Loan Insurance Corporation (FSLIC)—to issue regulations prohibiting  lending institutions from approving loans without adequate flood  insurance where available. The National Flood Insurance Reform Act of  1994 (1994 Act) included specific provisions on placement of flood  insurance by lenders. The 1994 Act also replaced the FHLBB and  FSLIC with the Office of Thrift Supervision and added FCA as a regulator  for flood insurance compliance, and required the six regulators to impose  civil money penalties for patterns or practices of violations of the  mandatory flood insurance purchase requirement, including violations of  flood LPI rules. The 1994 Act also required regulated lending institutions  to notify borrowers of a coverage lapse and to purchase flood LPI on their  behalf if the borrower failed to obtain coverage within 45 days after notice.  The 2012 Biggert-Waters Flood Insurance Reform Act (Biggert-Waters  Act) included new requirements for flood LPI, among other items. Like  the Dodd-Frank Act for homeowners insurance, the Biggert-Waters Act  established rules for refunding flood LPI premiums when the borrower  provided proof of existing coverage and clarified that the lender could  charge for flood LPI from the date the borrower-purchased insurance  lapsed. The act also increased the civil money penalty amounts for  violations of flood insurance requirements and eliminated the per year  cap on the amount of civil money penalties for regulated institutions. In  March 2013, the regulators published interagency guidance on  amendments resulting from the Biggert-Waters Act with a section  specifically about flood LPI. In July 2015, the regulators published a joint  final rule implementing the provisions of the Biggert-Waters Act related to  LPI.
Each of the five financial regulators has adopted flood insurance  examination procedures that address flood insurance requirements,  including requirements for LPI. Specifically, the examination procedures  discuss borrower notification regarding the need to purchase an adequate  amount of flood insurance, and as required by statute, provide that if the  borrower does not purchase such coverage within 45 days from  notification, the lender or servicer will purchase insurance on behalf of the  borrower and may charge the borrower for the cost of premiums and fees  incurred in purchasing the insurance. To enforce the flood insurance  requirements, the regulators identify flood insurance-related violations,  including flood LPI violations, through their examinations. These  examinations are risk based, so examiners may not address all policies  and procedures or review flood LPI policies and procedures during every  examination. For example, NCUA’s examiner’s guide states that although  they must review flood compliance in every examination, depending on  scope, an examiner may review one or more of the following: coverage  and internal controls, property determination requirements, LPI  requirements, and flood insurance checklists.
Since the amendments to Regulation X became effective in 2014, the five  financial regulators and CFPB have been responsible for supervising the  regulated entities’ activities related to homeowners LPI. Rule-making  authority for Regulation X, which implements RESPA, was transferred to  CFPB from the Department of Housing and Urban Development under  the Dodd-Frank Act. As discussed earlier, for homeowners LPI,  Regulation X, as amended, requires servicers to send two notices to  borrowers to confirm that the borrowers do not have the required  homeowners insurance before charging the borrower for LPI. Among  other requirements, the regulation also prohibits servicers from obtaining  LPI if the borrower has an escrow account for homeowners insurance,  unless the servicer is unable to disburse funds from the account. Under  the regulations, inability to disburse funds does not exist when the  borrower’s escrow account contains insufficient funds to pay the  premiums, but it exists when the servicer has a reasonable basis to  believe either that the borrower’s coverage has been canceled (or not  renewed) for reasons other than nonpayment of premiums, or that the  borrower’s property is vacant.
Of the five financial regulators and CFPB, CFPB, FCA, FDIC, the Federal  Reserve, and OCC have adopted revised examination procedures for  RESPA compliance, including compliance with homeowners LPI  requirements. NCUA is in the process of updating its examiner’s guide  and related materials to include the new requirements for homeowners  LPI. CFPB’s, FDIC’s, the Federal Reserve’s, and OCC’s manuals discuss  RESPA requirements for escrow accounts, notifying borrowers, and  canceling and renewing LPI, among other requirements. Similar to the  procedures they use for flood LPI, examiners also identify violations of  homeowners LPI through risk-based examinations of financial institutions.
Because Regulation X’s mortgage servicing requirements for  homeowners LPI became effective in January 2014, regulators had  limited data on the servicers’ compliance with them compared to the data  on compliance with flood LPI requirements as of May 2015. CFPB  officials said that because consumers might not know about LPI until their  coverage lapsed, there might be a greater lag in complaint and violations  data than there would be for other housing issues. Of the six regulators  responsible for enforcing homeowners LPI rules, CFPB, FDIC, Federal  Reserve, and OCC had cited violations as of June 2015. The regulators  may also impose civil money penalties for servicer violations of  homeowners LPI requirements under RESPA and Regulation X, but they  stated that as of June 2015 they had not imposed any.
CFPB and several state regulators have reached joint settlements with  some servicers for alleged violations of federal and state laws, including  some violations related to homeowners LPI. In February 2012, 49 states  and the District of Columbia (excepting Oklahoma) and federal  government partners reached a settlement with banks and mortgage  servicers over similar mortgage servicing violations, including LPI,  requiring them to provide $20 billion in consumer relief and $5 billion in  other payments. In December 2013, CFPB, along with 49 states and the  District of Columbia, filed a civil action against a nonbank mortgage  servicer alleging misconduct related to servicing mortgages. The  complaint identified mortgage servicing violations, including the  placement of LPI when the servicers knew or should have known that  borrowers already had adequate coverage. In February 2014, CFPB and  the states reached a settlement with the servicer, requiring the servicer to  pay over $2 billion to borrowers and to follow certain servicing  standards. Additionally, in December 2014, NYDFS reached a  settlement with this servicer over mortgage servicing rules, alleging the  servicer had conflicts of interest related to LPI, among other violations.  CFPB and the same states also reached a joint settlement with another  servicer in September 2014 over similar mortgage servicing violations.
The consent judgment required the servicer to pay $540 million to  borrowers and to follow certain servicing standards.
FHFA has also taken actions to address LPI concerns (as noted earlier).  In November 2013, FHFA instructed Fannie Mae and Freddie Mac to  prohibit their servicers from receiving commissions for LPI and from using  servicer-affiliated entities to insure or reinsure LPI. Effective June 2014,  Freddie Mac prohibits servicers from receiving commissions from LPI  insurers, and Fannie Mae requires servicers to exclude from premiums  charged to borrowers any commissions received from LPI insurers. Also  in June 2014, FHFA’s Office of Inspector General (OIG) published a  report on FHFA’s oversight of LPI and stated that in 2012 the enterprises  paid approximately $360 million in LPI premiums, including, potentially,  an estimated $158 million in excessive LPI rates. The FHFA OIG noted  that during a foreclosure, the enterprise that owns or guarantees the  mortgage is responsible for the cost of the borrower’s unpaid LPI  premiums. The OIG recommended that FHFA assess whether the  enterprises should pursue litigation against their servicers and LPI  insurers to remedy potential damages caused by past abuses in the LPI  market. FHFA accepted the recommendation and stated that they  completed the assessment in June 2015.
section_title: Insurer Data for Assessing the LPI Industry Are Unreliable Despite Efforts to Collect More Complete and Consistent Data
paragraphs: Limited reliable data exist at the state and federal levels to evaluate the  LPI industry and ensure that consumers are being protected. As part of its  efforts to collect financial data on the insurance industry, NAIC updated  its Credit Insurance Experience Exhibit (CIEE) in 2004 to require insurers  to submit data on LPI to NAIC and state regulators. NAIC and state  regulators are responsible for reviewing and analyzing data from insurers,  including the CIEE. The CIEE data include information on premiums,  claims, losses, compensation, and expenses. However, we determined  that these data were unreliable for our purposes. For example, a  number of LPI insurers did not submit data to state regulators for CIEE,  as required. Also, data in some states and for some years were  incomplete. For example, one company reported data for some states but  not for others. NAIC officials stated that another company reported LPI  data in the wrong section of the CIEE. NAIC officials stated that they  performed some basic reviews and tests to identify data errors, such as  significant fluctuation between years related to premiums and claims, and  worked with the state regulators to address such issues. However, they  said that state regulators were responsible for resolving incomplete  submissions, such as ensuring that insurers provided answers for every  field. Each state, for example, determines its own policies and procedures  for reviewing annual statements, including CIEE data, from insurers. As a  result, states may not review and analyze similar levels of LPI data. In  addition, NAIC officials stated that in 2013 they updated their data  submission instructions to request that the insurers report LPI data  separately from the borrower-purchased data. NAIC officials said that  state regulators allocate their resources on what they deem to be the  most cost-effective activities. LPI is a relatively small insurance line,  representing only about 0.1 percent of the overall U.S. insurance industry,  but its relatively high premium rates can have a significant impact on  affected consumers. Given recent state and federal actions regarding the  LPI industry, it has become more important for NAIC and state regulators  to have adequate data to effectively oversee the industry. Without more  comprehensive and reliable data and adequate policies and procedures  to ensure the usefulness of the data, NAIC is limited in its ability to  coordinate LPI regulation nationwide, and state and federal regulators  lack reliable data about the industry. As a result, they are unable to  analyze the relationship between LPI prices and the underlying costs to  make sure premium rates are reasonable and cannot ensure that  consumers are receiving fair and equitable treatment from the LPI  industry.
Recognizing a need to better understand the LPI industry, federal and  state regulators have begun coordinating in recent years to collect more  detailed data about the LPI industry. FHFA and NAIC officials stated that  in 2013 they held discussions about LPI and potential strategies for  collecting data to better understand the LPI industry and evaluate whether  recent concerns raised were valid. These discussions resulted in an  interagency working group, consisting of state and federal regulators, to  discuss LPI. FHFA officials said that in addition to examining the need to  obtain more data on the LPI industry, this working group opened a  dialogue between several entities, including state regulators, insurers,  and servicers. The working group created a template to obtain about 80  LPI industry data variables and tasked a committee with requesting the  LPI data (the data call effort). The 80 variables included the type of loan;  whether the mortgage had an escrow account; the property’s occupancy  status; the reason for the coverage lapse; and the company, premium,  coverage amount, and deductible for the LPI policy as well as the last  known borrower-purchased policy. These data are more granular than  what is collected through the annual CIEE in that they include policy-level  data that would, among other things, allow for a more direct analysis of  LPI premium rates, whereas the CIEE data contain substantially fewer  variables and are aggregated at the state and insurer level.
According to NAIC officials, NAIC tasked the Mississippi Insurance  Department’s Commissioner, chair of NAIC’s Property and Casualty  Committee, to lead the data call effort. Mississippi officials requested that  the top three LPI insurers—which NAIC estimated accounted for about 90  percent of the LPI market—provide the 80 variables. Mississippi officials  requested the data in April 2014 for submission by July 2014. However,  the insurers and servicers did not submit their final data until December  2014. NAIC and Mississippi officials said the delay was due to the need to  clarify data issues with the insurers and correct errors, such as missing  fields and missing and outlier values. But the final data lacked values for  many of the variables, and some insurers and servicers said that certain  information was not available. For example, all three insurers reported  annual LPI premium amounts, but only one insurer reported the premium  amount of the last known borrower-purchased insurance, and only for  some policies. Both of these variables are necessary to determine the  difference in cost between LPI and borrower-purchased insurance and  understand whether premium rates are reasonable. Additionally, only one  insurer reported the lapse date of the borrower-purchased insurance,  which would help determine how quickly insurers and servicers are  identifying coverage lapses, but this insurer did not consistently report the  lapse dates for all policies. According to NAIC and Mississippi officials,  one insurer said it did not maintain much of the requested data itself and  was unable to get approval from many of its servicers to release the data.  As a result, state and federal regulators lack the comprehensive and  reliable data necessary to assess LPI industry practices and premium  rates and their effects on consumers.
NAIC and Mississippi officials said that they were surprised that the  insurers were unable to produce some of the requested data because  much of the data seemed necessary for the insurers to maintain. As a  result, NAIC members have opened multistate examinations of the LPI  practices of the top two LPI insurers which, among other things, officials  expected would help produce the remaining data. As of August 2015, 42  jurisdictions—mostly states—had committed to participate in the  examinations, and officials expect to have preliminary findings in the fall  of 2015. NAIC is working to address the issue of missing data through the  multistate examinations, but it is unclear when such data will be available.
section_title: Conclusions
paragraphs: Some state and federal regulators have taken action to improve oversight  of LPI. However, NAIC and state insurance regulators lack  comprehensive and reliable data on LPI premium rates and industry  practices to assess their effects on consumers. For example, NAIC has  attempted to collect some data aggregated at the state and company  levels, but these efforts have yielded incomplete data. Recognizing the  need for more robust data on the LPI industry, NAIC and FHFA have  coordinated to collect policy- and servicer-level data on LPI. However, LPI  insurers and their servicers did not provide all of the requested data.  NAIC was created to coordinate insurance regulation across states, and  the agency needs quality information to evaluate the LPI industry and the  effects of its premium rates and practices on consumers. Although NAIC  is working to obtain the missing data, it is unclear when such data might  be available, or that its efforts will be effective without additional action.  Without more comprehensive and reliable data, state and federal  regulators are lacking an important tool to help them fully evaluate the LPI  industry and ensure that consumers are adequately protected.
section_title: Recommendations for Executive Action
paragraphs: To help ensure that adequate data collection efforts by state insurance  regulators produce sufficient, reliable data to oversee the LPI market, we  recommend that NAIC: work with the state insurance regulators to develop and implement  more robust policies and procedures for the collection of annual data  from LPI insurers to ensure they are complete and reliable; and work with the state insurance regulators to complete efforts to obtain  more detailed national data from LPI insurers.
section_title: Agency Comments
paragraphs: We provided a draft of this report to NAIC, as well as CFPB, FCA, FDIC,  Federal Reserve, FEMA, FHFA, FIO, FTC, NCUA, and OCC for their  review and comment. NCUA provided written comments that we reprinted  in appendix II. CFPB, FCA, FDIC, Federal Reserve, FHFA, NAIC, NCUA,  and OCC provided technical comments that were incorporated, as  appropriate. NAIC officials said they understand the importance of  ensuring reliable data and will consider the recommendations as part of  NAIC’s continuing work in the area, which includes multistate  examinations and potential revisions to model laws.
We are sending copies of this report to the appropriate congressional  committees and the agencies listed above. In addition, the report is  available at no charge on the GAO website at http://www.gao.gov.
If you have any questions about this report, please contact me at (202)  512-8678 or cackleya@gao.gov. Contact points for our Offices of  Congressional Relations and Public Affairs may be found on the last page  of this report. GAO staff who made key contributions to this report are  listed in appendix III.
section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: We were asked to review the lender-placed insurance (LPI) industry and  the role of federal and state regulators in monitoring LPI practices. This  report (1) describes the extent to which LPI is used, (2) discusses  stakeholder views on the cost of LPI, and (3) describes state and federal  oversight of LPI.
To address these objectives, we reviewed relevant laws and regulations  on lender-placed insurance. We conducted a literature review and  reviewed relevant articles, hearings, settlements, and agency guidance  on the LPI industry. We also reviewed past GAO reports on homeowners  and flood insurance. We interviewed officials from federal agencies,  including the Board of Governors of the Federal Reserve System,  Consumer Financial Protection Bureau, Department of the Treasury’s  Federal Insurance Office, Farm Credit Administration, Federal Deposit  Insurance Corporation, Federal Emergency Management Agency  (FEMA), Federal Housing Finance Agency (FHFA), Federal Trade  Commission, National Credit Union Administration, and Office of the  Comptroller of the Currency. We selected these agencies because they  regulate mortgage servicers’ LPI activities or might have an interest in LPI  issues. Further, we interviewed officials from the National Association of  Insurance Commissioners (NAIC) as well as officials from seven state  insurance regulators—California, Florida, Illinois, New Jersey, New York,  Ohio, and Texas. We selected these states because they had higher LPI  premium volumes and some had taken regulatory action in LPI. In  selecting states, we also reviewed publicly available information as well  as LPI laws and regulations, whether they had adopted NAIC’s model law  for personal property LPI and adapted it to real property LPI, whether they  had separate banking and insurance offices, and rate approval methods.  This selection of states is not generalizable to all states. In addition to the  selected states, we met with officials from Mississippi’s insurance  department to discuss their involvement in NAIC’s LPI data request.  Finally, we met with four LPI insurance providers of varying sizes, as well  as four mortgage servicers, four industry associations, and two consumer  advocates. We selected these stakeholders based on their level of  involvement in the LPI industry and mortgage servicers to get a mix of  bank and nonbank servicers with large and mid-sized mortgage volume.  When we refer to “industry officials” in this report we mean officials of the  insurance industry associations, insurance companies, and bank and  nonbank mortgage servicing companies we interviewed.
To describe the extent to which LPI is used, we reviewed studies,  testimonies, and public comments on related regulations to obtain a wide  variety of views on how LPI operates. We interviewed the same  consumer advocates, industry associations, and a selection of state  insurance regulators, insurers, and mortgage servicers to better  understand how each party is involved in LPI and the circumstances  surrounding its use. Specifically, we interviewed insurers and servicers to  understand their processes for tracking mortgage portfolios, notifying  borrowers, and placing LPI. We also interviewed FEMA to understand its  flood LPI program—the Mortgage Portfolio Protection Program—and the  reasons servicers might choose it versus private flood LPI coverage.
To discuss stakeholder views on the cost of LPI, we interviewed state  insurance regulators, consumer advocates, and industry officials about  their opinions on the reasons for differences in premium rates between  LPI and borrower-purchased insurance and their opinions on the effects  on consumers. We reviewed studies, testimonies, and public comments  on proposed regulations on flood and homeowners LPI. We obtained  premiums and claims data for LPI and borrower-purchased insurance so  that these might be compared. We first reviewed NAIC’s Credit Insurance  Experience Exhibit (CIEE) database—financial data collected annually  from insurers that are aggregated at the state and company levels—with  the intended purpose of comparing LPI premiums to those of borrower- purchased insurance. However, we determined that these data were  unreliable for our purposes. For example, a number of LPI insurers did  not submit CIEE data, and there appeared to be missing data in some  years. Further, NAIC officials said that they perform some basic tests on  the CIEE data to identify data errors but that state regulators are  responsible for resolving incomplete data submissions. We discuss these  data issues in greater detail in the report. We also obtained and reviewed  data from a data call effort coordinated by NAIC and FHFA that requested  policy- and servicer-level data from what they believed to be the top three  LPI insurers to get a better understanding of the LPI industry. NAIC and  FHFA estimated that these three insurers represented 90 percent of LPI  premium revenue in the U.S. However, the total number of LPI insurers  as well as the total LPI premium volume are unclear because of a lack of  comprehensive national data on the LPI industry. Further, we cannot  assume that these three insurers are representative of the other insurers  in the industry. Moreover, most of the variables were incomplete for one  or more of the insurers. To address these omissions, we limited our  analysis to high-level figures summarizing variables that were at least 90  percent complete for each of the top two insurers. We determined that  variables where more than 10 percent of the values were missing could  produce invalid results. Because of the missing data, we were unable to  analyze most of the variables, including those that could have compared  LPI premiums to the premiums of the last-known borrower-purchased  policies.
To describe state and federal oversight of LPI, we reviewed and  summarized federal laws, regulations, and policies and procedures  relating to agencies’ enforcement of LPI-related requirements. Further,  we interviewed federal agency officials, including examiners and  enforcement officials, on flood and homeowners LPI monitoring and  enforcement activities. We interviewed insurers, mortgage servicers, and  lenders for their perspectives on federal regulations and their  enforcement. We reviewed and summarized selected state laws and  regulations related to LPI, particularly those related to rate setting, and  interviewed NAIC officials and selected state insurance regulatory officials  on LPI oversight activities.
We conducted this performance audit from March 2014 to September  2015 in accordance with generally accepted government auditing  standards. Those standards require that we plan and perform the audit to  obtain sufficient, appropriate evidence to provide a reasonable basis for  our findings and conclusions based on our audit objectives. We believe  that the evidence obtained provides a reasonable basis for our findings  and conclusions based on our audit objectives.
section_title: Appendix II: Comments from the National Credit Union Administration
section_title: Appendix III: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Staff Acknowledgments
paragraphs: In addition to the contact named above, Patrick Ward (Assistant Director);  Christopher Forys (Analyst-in-Charge); Abby Brown; Emily Chalmers;  William Chatlos; Juliann Gorse; Camille Keith Jennings; John Karikari;  John Mingus; Patricia Moye; Jena Sinkfield; and Heneng Yu made key  contributions to this report.