Pace Harmon an outsourcing advisory services firm, has prepared a memorandum for its clients suggesting strategies to manage forced placed insurance (FPI) coverage. The memo is in response to recent actions on the part of the Federal Housing Finance Agency (FHFA) and Fannie Mae and heightened scrutiny by Congress and financial regulators on the relationship between servicers and FPI providers. Fannie Mae had proposed contracting with an agent for a consortium of insurers to provide FPI for Fannie Mae's home mortgage portfolio. Servicers would have been able to purchase FPI (which replaces hazard insurance where the homeowner has failed to keep his own policy in place) at rates significantly below the current market for such services.
In mid-February the FHFA announced it was shelving the proposed Fannie Mae program and instead would gather further data and solicit broader industry participation before taking action. In March Acting FHFA Director Edward DeMarco told the House Committee on Financial Services that while the problems with FPI are well known, including the costs, limitations on coverage, and consumer protections, any narrowly focused approach that would contain costs for Fannie Mae and Freddie Mac such as self-insurance or a direct procurement of insurance coverage would do little to address the needs of a future mortgage market without them.
Fannie Mae's initiative heightened awareness about the high price of FPI, which has already resulted in rate re-filings in several states. This regulator focus will probably result in additional downward price pressure on both FPI providers and servicers that currently profit from FPI.
Pace Harmon says that it is clear there is significant value available to providers by expanding participation in the marketplace, creating transparency by decoupling insurance from tracking, and pricing each service on a stand-alone basis.
Servicers must gain a firm grasp of their current operations and cost structures and further consider new and innovative approaches for FPI management. High FPI costs will remain an issue for servicers and state regulators, consumer groups, and congressional leaders are also concerned about the issue; some are pressuring banks to address perceived conflicts of interest in the FPI marketplace.
These downward pricing pressures will likely reduce margins for companies that profit from FPI and it is likely that the focus on eliminating commissions and non-value-added services will persist. Servicer commissions for FPI placement have long been a focus of regulators and consumer groups since they are alleged to inflate FPI costs while requiring little to no sales effort or other "value-added" work on the part of Servicers.
Pace-Harmon said that servicer commissions may be eliminated but servicers can provide other value-added services that will benefit both the payers of FPI (GSEs and homeowners) as well as the companies that service their mortgages. These value added services include:
- Participating in the bearing of risk
- Considering alternative approaches to insurance tracking (e.g., unbundling tracking from insurance, insourcing tracking)
- Leveraging market competition to reduce FPI premiums
The new FPI opportunities are especially relevant given the FHFA's announced plan for creating a new company to securitize Fannie Mae and Freddie Mac home loans and eventually privatizing their securitization operations. This shift to private label Mortgage Backed Securities (MBS) will shift many foreclosure- related costs, including FPI, from the GSEs and homeowners to the private market. Servicers will likely be faced both with losing commissions and finding ways to lower their FPI costs.
In order to take advantage of the opportunities that may be available servicers need first to gather data to assess their current contracts, benchmark the rates, and determine both appropriate premiums and tracking costs for their servicing portfolios. They should also analyze the risk bearing opportunity and current loss ratios on their portfolios and conduct their own risk analysis to determine the costs and benefits of bearing a portion of the risk being underwritten.
Servicers that face external pressure to reduce costs or change the manner in which FPI is managed can learn from the Fannie Mae approach. Armed with contract, pricing and loss data, Servicers will be well-positioned to unlock value and apply the lessons learned, as described below.
They can first unbundle insurance from tracking. The two largest FPI providers, QBE and Assurant, often provide insurance and tracking as a bundled service, making the pricing difficult to untangle and thereby limiting risk management strategies to reduce premiums. The bundling of services also increases insurance switching costs for servicers, as the tracking is highly integrated with current servicing platforms.
Decoupling the pricing of the insurance and tracking services will allow Servicers to evaluate and benchmark their insurance costs and achieve appropriate pricing for the risk. While the marketplace for FPI is actually quite competitive, many FPI providers are unable to effectively compete on a level playing field for the Servicers' business since QBE and Assurant's tracking services are so intertwined with the Servicers' businesses so servicers should consider obtaining market quotes for FPI on a stand-alone basis.
In addition to lowering premium costs, there will be continued pressure in the industry to reduce or eliminate servicer commissions. Since FPI is automatically placed when a lapse in coverage is detected, there is a wide perception in the market that there is little to no sales effort required on the part of Servicers to earn these commissions and they are seen by the regulators as contributing to higher premiums and the overall volume of FPI placements. FHFA and the GSEs are likely to continue to work to eliminate such commissions and payments for non-value added services.
However, servicers that provide value added services and find creative ways to bear risk and earn commensurate returns are in a good position to benefit from some of the recent changes. Depending on a servicer's current premium cost structure, there is a potential for a "win-win," where premiums can be reduced and servicers can continue to derive FPI revenue by underwriting a certain portion of the risk themselves. For example, a servicer could pay for the first $10k in losses in exchange for a portion of the written premium. The premiums collected and the level of risk assumed are based at loan level or in the aggregate and on the premium and loss history of the servicer's portfolio. They could also be based on more sophisticated arrangements where different tranches of risk are identified and priced accordingly.
The memo concludes with the suggestion that there will likely be continued pressure on servicers to find new and creative ways to reduce costs and change the manner in which FPI is managed. Although commissions for non-value added services are likely to be reduced, if not removed entirely over time, the current environment demands new thinking on how risk is assessed, allocated and priced. As in any rapidly changing industry, companies that seize the moment and proactively drive the changes-rather than react to them-will be better positioned to differentiate themselves from their competition.
