It is always interesting to listen to the owners of mortgage companies who share their view of Mortgagee's Errors and Omissions, Professional Liability, and Fidelity Bond policies. Many have a perceived notion that there is complete coverage for things like repurchases or indemnification requests. There are others who have the view that "It doesn't cover anything. I would get rid of it if I could." These owners consider the purchase of such coverage forms as the cost of doing business. A ticket to do business you might say. Lastly, there are a few who utilize the coverage forms as an effective risk management tool.
So what does it cover? Why do we have it? Let's do a little insurance 101.
Why do you need these coverages? Freddie Mac, Fannie Mae, Ginnie Mae, private investors, warehouse lenders and some wholesale lenders all require the Fidelity Bond and, Mortgagee's Errors and Omissions coverage forms. Each of the aforementioned has their own specific limit and coverage requirements (which can be a daunting task for any insurance agent who does not specialize in these lines of coverage). Professional Liability is not required but most lenders purchase the coverage to protect the company.
Take a look at the details of each...
Errors & Omissions coverage provides protection for lenders from losses to mortgaged properties. Protects against claims alleging:
- The mortgage interest portion protects mortgagee or owner interest in under-insured properties against physical damage losses from "required" perils.
- Mortgagee's errors and omissions covers liability for accidental failure to maintain certain required insurance coverages or guarantees on mortgaged properties.
- Failure to determine a property is in a flood zone.
- Failure to arrange for hazard and/or flood insurance, FHA insurance; VA guarantee and PMI.
- Liability to investors and to mortgagors when losses occur due to certain accidental errors and omissions during the warehouse period.
You will notice it does not cover any general error and not one which is tied to a repurchase demand. Again, you must have this coverage to meet the requirements of Fannie Mae, Freddie Mac, Ginnie Mae and other mortgage investors and not all insurance products meet these requirements.
Fidelity Bonds protect mortgage bankers from loss due to employee dishonesty. Depending on the insurance coverage acquired, it may also extend to attorneys, or other loan closing agents, performing loan-closing services on a loan originated or acquired by the business. Insurance carriers have their own definition of "employee dishonesty" and a general definition for it is "dishonest or fraudulent acts committed by an employee acting alone or in collusion with others". These acts must be committed by the employee with the manifest intent to cause the lender to sustain a loss and/or to obtain a financial benefit for the employee or another person or entity. The definition specifically states that "financial benefit" does not include things such as salary, fees, commissions, bonuses, etc.
Fidelity Bond coverage may protect against claims alleging loss from:
- From employee dishonesty as well as from any closing agent; can also cover third party originators and/or servicing contractors.
- Theft of mortgage investor's money or collateral as required by Fannie Mae, Freddie Mac or Ginnie Mae, satisfying industry standards and most mortgage investors' requirements.
- A loss of property, including real estate documents, on premise or in-transit, check forgery and electronic or computer crime.
- Forged original documents.
- Also includes coverage for robbery, misplacement, counterfeiting, fraudulent documents and fraudulent real property mortgages.
One big misconception is that the fidelity bond covers third party fraud. It does not.
Professional Liability covers the legal liability for claims brought by a third party in the rendering of (or the failure to render) professional services. Areas of coverage may include origination, counseling, underwriting, processing, marketing, warehousing, closing, selling, or servicing. A Professional Liability policy may protect lenders against claims alleging:
- Misrepresentations of the terms of a loan to a borrower
- Non-compliance with TILA
- Non-compliance with RESPA
- Negligent acts, errors, or omissions in the performance of your professional services
- Wrongful foreclosure and eviction
- Wrongful acts of third party originators (Mortgage Brokers/Originators/Correspondents) or others considered as independent contractors
- Non-compliance with the Fair Housing Act (typically defense sub-limit only)
- Non-compliance with the Equal Credit Opportunity Act (typically defense sub-limit only)
- Wrongful loan application counseling
This is not a required coverage but purchased by nearly all lenders. The reason is that it can protect a firms balance sheet by potentially providing legal defense and paying settlements/losses arising out of third party claims. Again, no coverage if tied to a repurchase demand.
You might be thinking you have more exposure than you thought and you are probably right. In mortgage banking, there are a number of major areas of risk that Fidelity Bond, Mortgagee's E&O, and Professional Liability will not provide protection from. Here are the most commonly referenced and tied to repurchase liability:
- Underwriting and eligibility risk
- Fraud and misrepresentation risk
- Collateral risk
- Compliance and regulatory risk
- Interest rate risk
With the rising number of mortgage defaults and declining home prices, mortgage fraud has become one of the most costly expenses associated with mortgage loan origination. More specifically, recent research findings indicate that "fraud for property" - where a borrower misrepresents income, employment, occupancy, assets and/or debts in order to apply for a mortgage loan - is a large contributor to the overall rise of mortgage fraud.
The most commonly referenced frauds in 2009-2011 repurchases were:
- Undisclosed Liabilities
- Property Valuation
- Borrower Authentication
- Employment Status
This is dangerous because regardless of whether the borrower intentionally or unintentionally omits this information, the risk is passed along to you. What's the result? An increasing number of buy-back requests - ending in significant losses. With this in mind there are a few insurance programs many lender have already put in place and perhaps you should consider.
- Borrower Fraud Insurance - As noted above much of the losses the mortgage banking industry has faced, often stemming from repurchases, are tied to borrower fraud. A program, headlined, Quality Lending Insurance, provides protection when you are victimized by the misrepresentation of information in the application by a borrower. Whether the misrepresentation is intentional or not protection is provided.
- Insured Undisclosed Debt Monitoring - Undisclosed debt has been one of the more prevalent types of frauds tied to repurchases in the industry, especially in the last few years. Investors are diligently looking at loans for variations in the credit profile of a borrower. Fannie's LQI requirements clearly show an increased focus in the area. To combat this risk Equifax Mortgage Services developed Undisclosed Debt MonitoringTM which is a system that monitors the "quiet period" between the time of the original credit file pull and the closing of the loan. The platform is "always on" - which means the borrower is continuously monitored and daily alerts are provided to the lender that may represent potential risk associated with mortgage loans in their pipelines. This not only detects potential risks it is a more efficient way to manage your loan pipeline and review credit discrepancy from application to close. While it significantly reduces the exposure to undisclosed debt, Equifax took it a step further to assure their clients have a complete solution and coupled an insurance policy to the program to cover losses should undetected liabilities result in a repurchase demand.
- Appraisal Warranty Insurance - With borrower fraud being covered by or in part by the program referenced above that leaves appraisal risk These programs cover financial loss arising from error, omission, action, failure to act, breach of contract or breach of duty by the Insured (appraisal management co) in the rendering or failure to render their Professional Services. The action must result in the stated value deviation, generally 10%, from the original insured warranted appraisal report.
A number of insurance products are truly mortgage specific. The key to knowing what coverages you need, the right coverage for your business and the right cost is working with someone who knows mortgage banking. Many lenders work with local agents or different agents for various aspects of their insurance portfolio. With some many changes in mortgage banking over the past few years you may want to consider working with someone that specializes in mortgage banking. By working with a specialist in your area of business, you will likely learn of adjustments or changes needed to your current policies, be given an introduction to new products, or participate in the development of new products which can be beneficial to your balance sheet. Often those insurance agents in the "business" have relationships, beyond insurance, that can be beneficial to your business as well.
[I am away from the computer on a daily basis, and will not be returning e-mails until September 10th. In my place are daily commentaries from a series of very knowledgeable mortgage industry people with different backgrounds, and they have been given very little direction about what to write about - the latest is below. Our views may or may not coincide, but I thank them for their time in volunteering and helping out.]
Today's contribution comes from....
Area Senior Vice President
Arthur J. Gallagher, Mortgage Banking Division