It’s a little like handing a cement lifejacket to a drowning man.
The practice is called “force-placed” insurance, and it’s an example of big financial institutions profiting from the misfortune of struggling homeowners. Recently, two major insurance companies agreed to pay millions in penalties for doing it. Here’s how it works:
A mortgage borrower stops making payments on his or her homeowners insurance, so the policy lapses. The bank that collects payments on the mortgage wants to protect the mortgage investors, so it forces the borrower to buy new insurance.
Problem is the new insurance costs up to 10 times what a voluntary policy would cost and provides little coverage. Even worse, the banks collect fees and commissions of about 15 percent for forcing the overpriced insurance on homeowners.
The penalties against the insurance companies resulted from cases in New York, where the state’s Department of Financial Services cited "reverse competition." Rather than competing by offering lower prices, the insurers competed by sharing profits with banks, raising the price of force-placed insurance by creating incentives for banks to buy policies with high premiums, the state said.
“It’s a rip-off,” said Bill Cree, a real estate agent in Felton who worked for 15 years as an insurance agent, handling homeowners insurance. “People forced to buy these policies paid exorbitant fees for minimal coverage.”
The issue is important to Fannie Mae and Freddie Mac, the government sponsored enterprises that back most of the nation’s mortgages. They end up paying for much of the unpaid insurance costs, according to the Wall Street Journal.
A Scotts Valley Realtor who specializes in distressed properties, Kurt Useldinger, says forced insurance isn’t so much a rip-off of homeowners as it is of Fannie and Freddie.
He says many homeowners who owe more than their houses are worth, stop making their mortgage payments. When their homeowner’s insurance bill comes, they don’t pay it. That’s when the mortgage servicer forces the new insurance on the homeowner.
“If your old insurance cost $2,000 a year, your new insurance might be $8,000,” Useldinger said. “And it’s inferior insurance, just to cover the structure. If you have water damage that wrecks your furniture, that won’t be covered.”
“Usually, the homeowner doesn’t pay for the insurance anyway,” he said, “because he’s going to let the house be sold in a short sale,” where the bank agrees to let the borrower walk away as the house is sold for less than is owed on it.
That’s when Fannie and Freddie, financed by taxpayers, get stuck with the bill.
In a small number of cases, the struggling homeowner comes up with the missed mortgage payments in a last-ditch effort to save his home, Useldinger said, and that’s when the homeowner would have to pay for the forced insurance.
If a homeowner's insurance policy lapses, he or she can avoid paying high rates for forced insurance by having their original policy reinstated or shopping around with other insurers for a new policy, said Cree, the former insurance agent.
Better yet, maybe the penalties paid by insurance companies in New York will finally put an end to overpriced forced insurance.
- Mark Rosenberg is an investment consultant for Financial West Group in Scotts Valley, a member of FINRA and SIPC. He can be reached at 831-439-9910 or firstname.lastname@example.org