oversight

FHFA's Oversight of the Enterprises' Lender-Placed Insurance Costs

Published by the Federal Housing Finance Agency, Office of Inspector General on 2014-06-25.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

          Federal Housing Finance Agency
              Office of Inspector General




     FHFA’s Oversight of the
    Enterprises’ Lender-Placed
         Insurance Costs




Evaluation Report  EVL-2014-009  June 25, 2014
                FHFA’s Oversight of the Enterprises’ Lender-Placed
                Insurance Costs

                Why OIG Did This Report
                Fannie Mae and Freddie Mac (collectively, the Enterprises) require their
                borrowers to maintain hazard insurance on their homes. The insurance
                safeguards the value of the homes in the event of a fire or other covered
 At A           incident, thereby preserving the Enterprises’ interests in them.
Glance          The Enterprises’ mortgage servicers are responsible for ensuring that
   ———          borrowers maintain hazard insurance on their properties. To do so, the
                servicers outsource this task to specialty insurance companies that track the
June 25, 2014   status of borrowers’ insurance policies. When a provider identifies a lapse in
                hazard insurance, it initiates new coverage known as lender-placed insurance
                (LPI).

                Borrowers are responsible for paying LPI premiums but do not always do so.
                Upon foreclosure, the cost of a borrower’s unpaid LPI premiums shifts to the
                Enterprise that owns or guarantees the mortgage. In 2012, the Enterprises paid
                approximately $360 million in LPI premiums.

                In 2012 and 2013, several state insurance regulators determined that LPI rates
                in their respective jurisdictions were excessive. The same regulators also
                found that LPI rates may have been driven up by profit-sharing arrangements
                under which servicers were paid to steer business to LPI providers. Such
                arrangements often took the form of commission structures and reinsurance
                deals.

                We conducted this evaluation to assess the financial impact of LPI on the
                Enterprises and determine whether the Federal Housing Finance Agency
                (FHFA or Agency), in its role as the Enterprises’ conservator, has taken
                sufficient measures to conserve the Enterprises’ assets in this regard.

                OIG Analysis and Finding
                FHFA Has Acted to Restrict Certain Potentially Collusive Practices Employed
                by the Enterprises’ Servicers and LPI Providers

                In November 2013, FHFA sought to mitigate financial harm to the Enterprises
                by directing them to prohibit their servicers from receiving LPI-related
                commissions and entering into reinsurance arrangements with LPI providers.
                Subsequently, both Enterprises issued new, conforming servicing guidelines
                that became effective on June 1, 2014.
                FHFA Has Not Assessed Whether the Enterprises Should Pursue Litigation
                against Servicers and LPI Providers to Recover Potential Damages

                FHFA has yet to complete a thorough assessment regarding the merits of
                potential litigation on behalf of the Enterprises to recover financial damages
                associated with past abuses in the LPI market. Agency officials cited
                competing priorities, such as finalizing other financial settlements, as the
                reason for not completing such an assessment.
 At A
                Our analysis suggests that the Enterprises have suffered considerable financial
Glance          harm in the LPI market. For example, using a methodology similar to that
   ———          utilized by a state insurance regulator, we estimate that—in 2012 alone—the
                Enterprises’ combined financial harm amounted to $158 million due to
June 25, 2014   excessively priced LPI coverage.

                What OIG Recommends
                We recommend that FHFA assess the merits of litigation by the Enterprises
                against their servicers and LPI providers to remedy potential damages caused
                by past abuses in the LPI market and, then, take appropriate action in this
                regard.

                FHFA accepted this recommendation (see Appendix A). As noted in its formal
                response, the Agency will complete its litigation assessment within 12
                months.
TABLE OF CONTENTS ................................................................

FHFA’S OVERSIGHT OF THE ENTERPRISES’ LENDER-PLACED INSURANCE
COSTS .............................................................................................................................................2

TABLE OF CONTENTS .................................................................................................................4

ABBREVIATIONS .........................................................................................................................6

PREFACE ........................................................................................................................................7

CONTEXT .......................................................................................................................................8
      The Enterprise that Holds the Mortgage Is Liable for a Borrower’s Unpaid LPI
      Premiums after Foreclosure ......................................................................................................8
      Several State Insurance Regulators Have Found LPI Premium Rates to Be Excessive ...........9
      Some Mortgage Borrowers Have Recovered a Portion of Their LPI Premiums after
      Initiating Litigation against Servicers and LPI Providers.......................................................13
      FHFA Has Acted to Restrict Certain Potentially Collusive Practices Employed by
      Servicers and LPI Providers ...................................................................................................14

FINDING .......................................................................................................................................15
      FHFA Has Not Assessed Whether the Enterprises Should Pursue Litigation against
      Servicers and LPI Providers to Recover Damages .................................................................15
              FHFA Has Not Assessed the Potential for LPI-Related Financial Recoveries ..............15
              Recent State Regulatory Findings and Borrower Class Action Settlements May
              Inform FHFA’s Assessment of LPI-Related Litigation ..................................................15
              The Enterprises May Be Able to Secure Financial Recoveries through LPI-
              Related Litigation against Some Servicers and LPI Providers .......................................17

CONCLUSIONS............................................................................................................................18

RECOMMENDATION .................................................................................................................18

OBJECTIVE, SCOPE, AND METHODOLOGY .........................................................................19
      Methodology for our Estimate of the Harm that the Enterprises Suffered Due to
      Excessive LPI Premium Rates in 2012 ...................................................................................19
              Methodological Limitations ............................................................................................21



                                              OIG  EVL-2014-009  June 25, 2014                                                                  4
APPENDIX A ................................................................................................................................23
      FHFA’s Comments on FHFA-OIG’s Findings and Recommendation ..................................23

ADDITIONAL INFORMATION AND COPIES .........................................................................24




                                            OIG  EVL-2014-009  June 25, 2014                                                              5
ABBREVIATIONS .......................................................................

Assurant                  Assurant, Inc.

Enterprises               Fannie Mae and Freddie Mac

Fannie Mae                Federal National Mortgage Association

FHFA or Agency            Federal Housing Finance Agency

FIRREA                    Financial Institutions Reform, Recovery, and Enforcement Act

Freddie Mac               Federal Home Loan Mortgage Corporation

LPI                       Lender-Placed Insurance

NAIC                      National Association of Insurance Commissioners

NYDFS                     New York Department of Financial Services

OIG                       Federal Housing Finance Agency Office of Inspector General

QBE                       QBE Holdings, Inc.




                           OIG  EVL-2014-009  June 25, 2014                            6
PREFACE ...................................................................................

FHFA has been the conservator of the Enterprises since September 2008.1 Pursuant to federal
law, FHFA may act as necessary to maintain the Enterprises in a solvent condition. It is also
statutorily charged with conserving and preserving their assets, which are substantial;
together, the Enterprises own or guarantee about $4.8 trillion in mortgages.2

The Enterprises’ servicers are required to ensure that borrowers maintain hazard insurance
on their homes to protect the Enterprises’ financial interests. If a borrower fails to maintain
adequate hazard insurance, then it becomes the servicer’s obligation to obtain such coverage.

The cost of a new policy, which is referred to as lender-placed insurance (LPI),3 is initially
billed to the borrower.4 Upon foreclosure, however, the cost of a borrower’s unpaid LPI
premiums is shifted to the Enterprise that owns or guarantees the mortgage. In 2012, the
Enterprises paid approximately $360 million in such LPI premiums.

We conducted this evaluation to determine the financial impact of the LPI market upon the
Enterprises. We also sought to determine whether FHFA, in its role as the Enterprises’
conservator, should undertake additional LPI-related actions.

This evaluation was led by Brian Harris, Investigative Counsel, assisted by Angela Choy,
Director of Operations and Program Oversight, and Bruce McWilliams, Senior Investigative
Evaluator. The report has been distributed to Congress, the Office of Management and
Budget, and others, and it will be posted on OIG’s website, www.fhfaoig.gov.




Richard Parker
Deputy Inspector General for Evaluations




1
 On September 6, 2008, FHFA placed the Enterprises into conservatorships as authorized by the Housing and
Economic Recovery Act of 2008. See Pub. L. 110-289, § 1145, 122 Stat. 2734-35 (2008).
2
    Fannie Mae, 2013 Form 10-K, at 175 (Feb. 21, 2014); Freddie Mac, 2013 Form 10-K, at 94 (Feb. 27, 2014).
3
    Lender-placed insurance is also known as, and synonymous with, force-placed insurance.
4
 The servicer may bill the borrower for the entire amount or seek reimbursement according to an amortization
schedule.



                                      OIG  EVL-2014-009  June 25, 2014                                       7
CONTEXT ..................................................................................

The Enterprise that Holds the Mortgage Is Liable for a Borrower’s Unpaid LPI
Premiums after Foreclosure

The Enterprises contract with servicers to ensure the homes that secure their mortgages are
covered continuously by hazard insurance.5 Generally, servicers outsource this task to
specialty insurance companies—LPI providers. As depicted in Figure 1 below, the LPI
providers:

        Track hazard insurance coverage on the mortgaged properties; and
        Place hazard insurance on properties whose coverage has become deficient.
Two LPI providers and their subsidiaries do most of this work for the Enterprises’ servicers.
The companies are Assurant, Inc. (Assurant) and QBE Holdings, Inc. (QBE).6 Collectively,
Assurant and QBE subsidiaries write more than 90% of the nation’s LPI coverage, according
to industry observers.

                   FIGURE 1. ENTERPRISE, SERVICER, AND LPI PROVIDER RELATIONSHIP

                            Defines
                            Servicer                                Outsources
                         Responsibilities                         Responsibilities

        Enterprise                               Servicer                               LPI Provider



                                                                            1. Tracks borrowers’ hazard
                         Borrower           Borrower        Borrower           insurance compliance
                                                                            2. Provides hazard insurance
                         servicer           servicer        servicer           coverage if a borrower’s
                                                                               policy is inadequate or has
                                                                               lapsed



5
 These obligations are outlined in the Enterprises’ servicing guides. Fannie Mae, Fannie Mae Single Family
2012 Servicing Guide, at Part II, Chapter 2, § 201 (Mar. 14, 2012) (online at
www.fanniemae.com/content/guide/svc031412.pdf); Freddie Mac, Single-Family Seller/Servicer Guide, at
Volume 2, Chapter 58, § 12 (Dec. 18, 2013) (online at
www.freddiemac.com/singlefamily/guide/bulletins/pdf/2013Guide.pdf).
6
 Both Assurant and QBE are holding companies that own subsidiary insurance companies. These subsidiaries
are the LPI providers that write the LPI coverage discussed in this evaluation report.



                                    OIG  EVL-2014-009  June 25, 2014                                       8
Under this arrangement, the Enterprises’ servicers are responsible for negotiating and
purchasing insurance from LPI providers;7 however, the borrowers and Enterprises are
ultimately liable for the premiums.8 For example, when an LPI provider determines that a
mortgaged home is not covered adequately by hazard insurance, it places coverage on it and
bills the Enterprise’s servicer.9 The servicer then advances the premium to the LPI provider
and charges the borrower for that expense.10 In the event of foreclosure, the Enterprise that
holds the mortgage reimburses the servicer for the borrower’s unpaid LPI premiums.
According to the Enterprises, they reimbursed servicers approximately $360 million for LPI
premiums in 2012 and $327 million in 2013.11

Several State Insurance Regulators Have Found LPI Premium Rates to Be Excessive

Over the last two years, insurance regulators in three large states—New York, Florida, and
California12—determined that Assurant, QBE, and their subsidiaries charged excessive rates
for LPI.13 The state regulators also found that, in certain cases, LPI rates may have been
driven up, in part, by profit-sharing arrangements entered into by the servicers and the LPI
providers. The regulators have employed a variety of enforcement techniques to reduce LPI
rates within their respective jurisdictions and prevent further abuses. The details of the state
insurance regulators’ enforcement actions are set forth below.

7
 LPI is often sold as a group insurance master policy. Essentially, the policy covers a predetermined group of
mortgaged homes rather than just a single home. LPI coverage is usually priced as a fixed dollar amount per
$100 of coverage.
8
  On average, LPI premiums are approximately 1.9 to 2.3 times more expensive than a borrower’s voluntary
hazard insurance premiums. LPI providers have advanced a variety of reasons for this phenomenon, including
the fact that they incur the risks associated with insuring most residences sight unseen. Other industry
observers note that this risk is offset by other factors and, therefore, it should not drive up the price of LPI.
The offsets include the fact that LPI is generally less comprehensive than regular hazard insurance. For
example, it usually does not cover personal property within the residence. Moreover, LPI has less overhead
connected with it. As the LPI providers note, most policies are not produced through individual underwriting.
9
    Technically, the LPI provider issues a certificate of coverage under the group insurance master policy.
10
  After it is placed, an LPI policy remains in effect until the borrower acquires adequate hazard insurance on
the mortgaged home or the home is foreclosed upon.
11
     The Enterprises reimbursed their servicers approximately $587 million from 2009 to 2011.
12
  Significantly, 48% of earned LPI premiums nationwide were attributed to homes in New York, Florida, and
California in 2012.
13
  State insurance regulators exercise jurisdiction over insurance companies operating in their respective states.
They promulgate regulations and bring enforcement actions to protect consumers against abusive insurance
practices. State insurance regulators also protect consumers whose mortgages are owned or guaranteed by
the Enterprises and other creditors, such as commercial banks.
The state regulators’ factual findings regarding LPI providers, discussed herein, were primarily issued to
protect individual borrowers, and not the Enterprises. Nevertheless, these findings may be informative because
the Enterprises, like the borrowers, consume LPI. That is, they assume liability for individual borrowers’
unpaid LPI premiums upon foreclosure.



                                       OIG  EVL-2014-009  June 25, 2014                                           9
New York. In spring 2013, the New York Department
of Financial Services (NYDFS) found that subsidiaries                        Loss ratio is the percentage of
                                                                             collected premiums that an insurer
of Assurant and QBE violated New York’s insurance
                                                                             returns to its policy holders as
laws by charging excessive LPI rates.14 NYDFS came                           insurance claims (see Figure 2). A
to this conclusion by examining the subsidiaries’ loss                       high loss ratio indicates that the
ratios. It found that the LPI providers’ actual loss                         insurer has returned to its insured,
ratios were particularly low in comparison with the                          through the payment of claims, a
expected loss ratios they filed with the state.15 The                        large portion of the premiums it
regulator concluded that the disparity between LPI                           has collected. Conversely, a low
                                                                             loss ratio indicates that the insurer
providers’ actual and expected loss ratios indicated that
                                                                             has retained a large portion of the
the LPI providers were retaining a relatively large                          premiums it has collected.
amount of insurance premiums (see Figure 3 below).
                                                                             For example, a loss ratio of 60%
                                                      16                     signifies that that, on average, an
             FIGURE 2. LOSS RATIO EQUATION
                                                                             insurer returned $60 to its insured
       LPI Provider’s                    Claims Paid                         for every $100 it collected in
                              =                                              premiums. The insurer retains the
         Loss Ratio                   Premiums Collected
                                                                             remaining 40%, or $40 in this
                                                                             example, to cover administrative
                                                                             costs, taxes, and profits.




14
  The Insurance Division within NYDFS “supervises all insurance companies that do business in New York.
The Insurance Division oversees nearly 1,700 insurance companies with assets exceeding $4.2 trillion.”
NYDFS website. Accessed Apr. 8, 2014, at www.dfs.ny.gov/about/dfs_about.htm.
15
  Approximately half of the states’ insurance regulators require the insurance providers operating within their
jurisdictions to file rates and obtain approval for them. Expected loss ratios are typically a part of these filings.
16
   The loss ratios in this evaluation report generally account for any changes in claim and premium reserves in
a reported period.



                                       OIG  EVL-2014-009  June 25, 2014                                               10
     FIGURE 3. LOSS RATIO DATA FOR SUBSIDIARIES OF ASSURANT AND QBE IN THE STATE OF NEW YORK
     Assurant Subsidiary17                                               QBE Subsidiary18

                                    Expected Loss                                                   Expected Loss
     Year        Loss Ratio          Ratio on File                       Year        Loss Ratio      Ratio on File
     2006          24.7%                58.1%                            2006          20.7%            55.0%
     2007          19.4%                58.1%                            2007          18.6%            55.0%
     2008          17.3%                58.1%                            2008          29.0%            55.0%
     2009          22.8%                58.1%                            2009          18.2%            55.0%
     2010          24.3%                58.1%                            2010          18.5%            55.0%
     2011          24.7%                58.1%                            2011          13.5%            55.0%
     2012          42.8%                58.1%                            2012          45.3%            55.0%

Source: NYDFS Consent Order with Assurant, at 5 (Mar. 21, 2013) (online at
www.dfs.ny.gov/about/press2013/assur-order-130321.pdf); NYDFS Consent Order with QBE, at 6-7 (Apr. 18,
2014) (online at www.dfs.ny.gov/about/ea/ea_201304181_qbe.pdf).

Notably, the Assurant subsidiary’s loss ratio was below 25% in six of the seven years
reported. The LPI provider’s expected loss ratio on file during that time was approximately
58%. NYDFS observed that the LPI provider’s loss ratio elevated to just 42.8% in 2012—a
year in which the state was hit by a severe storm. Similarly, the QBE subsidiary’s loss ratio
was below 30% in six of the seven years reported while its expected loss ratio was 55%.19

Additionally, NYDFS found that the LPI providers employed several mechanisms through
which they shared their profits with the servicers who steered business to them. First, the LPI
providers paid commissions to the servicers’ insurance agency affiliates, which ranged from
10% to 20% of the LPI premiums purchased. NYDFS found that these servicer affiliates “do
little or no work for the commissions.”20 Second, NYDFS found that the Assurant subsidiary
shared its profits with servicers using reinsurance arrangements.21 Under these arrangements,
the LPI provider shared a set percentage of its earned premiums and claims paid—known as a
quota share basis—with affiliates of the servicer. NYDFS concluded that both commissions
and reinsurance arrangements tend to incent servicers to purchase higher priced LPI.


17
     American Security Insurance Company.
18
  The table reflects Empire Fire and Marine Insurance Company data from 2006 to 2008. In December 2008,
QBE acquired ZC Sterling Corporation and assumed Empire Fire and Marine Insurance Company’s New York
LPI market share. The data from 2009 to 2012 reflect QBE Insurance Corporation’s loss ratios.
19
  Low loss ratios were not unique to New York during this period. From 2004 to 2012, respectively, the
nationwide LPI average loss ratios were: 33.1%, 53.5%, 29.0%, 20.5%, 23.3%, 20.7%, 17.3%, 24.7%, and
30.8%. The LPI average loss ratio for all nine years was 25.3%.
20
     NYDFS Consent Order with Assurant, at 5; NYDFS Consent Order with QBE, at 7.
21
     Reinsurance allows an insurance provider to share a portion of its risk with another entity.



                                        OIG  EVL-2014-009  June 25, 2014                                           11
Ultimately, the two LPI providers entered into consent orders under which they were required
to pay $24 million in civil penalties and provide restitution to affected borrowers.22 They
were also required to refrain from remitting commissions to servicers or entering into
reinsurance arrangements with them. Finally they were required to set new LPI rates that
would support an expected loss ratio of 62% or greater.

Florida. In August 2012, the Florida Office of Insurance Regulation23 found that a QBE
subsidiary’s LPI rates were excessive and did not comply with Florida law.24 Six months
later, the LPI provider agreed to reduce its rates by 18.8%.25 Furthermore, in October 2013,
the Florida Office of Insurance Regulation entered into a consent order with the Assurant
subsidiary that then had the largest LPI market share in Florida.26 Under the order, the LPI
provider was required to reduce its rates by 10%. Moreover, both LPI providers were
required to cease paying commissions to servicers or entering into reinsurance agreements
with them.

California. In March 2012, the California Department of Insurance observed low loss ratios
during a review of LPI providers’ rate filings;27 it later determined that the LPI rates were
excessive. The insurance commissioner directed the largest LPI providers in the state to
resubmit their filings at lower rates. Subsequently, an Assurant subsidiary reduced its rates by
30.5%28 and a QBE subsidiary reduced its rates in the state by 35%.29



22
 NYDFS’ investigations resulted in consent orders with Assurant, QBE, Balboa Insurance Company, and
American Modern Home Insurance Company. This evaluation report focuses upon the findings in the
Assurant and QBE consent orders because those two LPI providers write at least 90% of LPI nationwide.
23
  The Florida Office of Insurance Regulation ensures “that insurance companies licensed to do business in
Florida are financially viable; operating within the laws and regulations governing the insurance industry; and
offering insurance policy products at fair and adequate rates which do not unfairly discriminate against the
buying public.” Florida Office of Insurance Regulation website. Accessed Apr. 8, 2014, at
www.floir.com/Office/MissionStatement.aspx.
24
 Florida Office of Insurance Regulation, Notice of Intent to Disapprove (Aug. 10, 2012) (online at
www.floir.com/siteDocuments/PraetorianNOI12-07860.pdf).
25
 Florida Office of Insurance Regulation, Press Release (Feb. 11, 2013) (online at
www.floir.com/pressreleases/viewmediarelease.aspx?id=2000).
26
  Florida Office of Insurance Regulation Consent Order with American Security Insurance Company (Oct. 7,
2013) (online at www.floir.com/siteDocuments/AmericanSecurity141841-13-CO.pdf).
27
  The California Department of Insurance ensures “vibrant markets where insurers keep their promises and the
health and economic security of individuals, families, and businesses are protected.” California Department of
Insurance website. Accessed Apr. 8, 2014, at www.insurance.ca.gov/0500-about-us/.
28
  California Department of Insurance, Press Release (Oct. 22, 2012) (online at www.insurance.ca.gov/0400-
news/0100-press-releases/2012/release149-12.cfm).
29
  California Department of Insurance, Press Release (Jan. 31, 2013) (online at www.insurance.ca.gov/0400-
news/0100-press-releases/2013/release010-13.cfm).



                                     OIG  EVL-2014-009  June 25, 2014                                           12
Some Mortgage Borrowers Have Recovered a Portion of Their LPI Premiums after
Initiating Litigation against Servicers and LPI Providers

As early as 2011, some mortgage borrowers began filing class action lawsuits against their
servicers30 and LPI providers.31 The borrowers sought, among other things, damages
stemming from a variety of LPI-related charges. Specifically, the borrowers alleged that their
servicers:

          Breached their contract with the borrowers by charging LPI rates that included
           unearned commissions and lucrative reinsurance premiums;
          Violated the covenant of good faith and fair dealing that is implied in every contract
           when they manipulated the LPI marketplace to benefit themselves;32
          Colluded with LPI providers to artificially inflate premiums, thereby unjustly
           enriching the servicers and the LPI providers at the expense of the borrowers; and
          Breached the fiduciary duty they owed the borrowers by charging unnecessary
           premiums.

Several of these lawsuits have settled33 out of court for substantial sums of money—a total of
at least $674 million to date. For example, Wells Fargo and QBE settled with a class of
Florida borrowers for $19 million in May 2013.34 They agreed to reimburse or credit affected
borrowers 25% of any LPI premium they assessed. In September 2013, JPMorgan Chase and
Assurant settled with a nationwide class of borrowers for $300 million.35 The defendants
agreed to reimburse or credit affected borrowers 12.5% of any LPI premium they assessed.
Finally, in February 2014, Citibank and a class of borrowers agreed to a $95 million




30
  We use the words “servicers” and “lenders” synonymously in our discussion of these lawsuits because, in all
of them, the borrower’s lender and the servicer were closely affiliated with each other.
31
  Many of these borrowers’ mortgages may have been owned or guaranteed by the Enterprises. See Finding
section below for a discussion of the lawsuits’ potential applicability to the Enterprises.
32
  Every contract imposes upon each party a duty of good faith and fair dealing in its performance and its
enforcement. Restatement (Second) of Contracts § 205 (1981).
33
  Because these lawsuits have resulted in settlements, there have been no judicial findings of fact concerning
the borrowers’ allegations listed above.
34
     See Williams v. Wells Fargo Bank, N.A, No. 1:11-cv-21233 (S.D. Fla. 2013).
35
     See Herrick v. JPMorgan Chase Bank, N.A., No. 1:13-cv-21107 (S.D. Fla. 2014).



                                      OIG  EVL-2014-009  June 25, 2014                                         13
settlement36 in which Citibank would also refund 12.5% of the LPI premiums it billed to
borrowers.37,38

FHFA Has Acted to Restrict Certain Potentially Collusive Practices Employed by
Servicers and LPI Providers

FHFA has used its conservatorship authority to restrict certain profit-sharing practices
between the servicers and LPI providers in an effort to mitigate financial harm to the
Enterprises. In March 2013, FHFA published a notice in the Federal Register requesting
public input on proposals to prohibit certain commissions and reinsurance arrangements.39
Then, in April 2013, FHFA established a regulatory working group to ensure that federal and
state regulators, as well as industry stakeholders, were actively engaged in the reform
process.40

That summer, before finalizing the LPI proposals, FHFA considered the views of the
regulatory working group and reviewed more than 30 replies to its notice in the Federal
Register. In November 2013, FHFA directed the Enterprises to restrict servicer commissions
and reinsurance arrangements. In December 2013, the Enterprises released updated servicing
guidelines that included the new restrictions. They became effective on June 1, 2014.

Generally, the new guidelines prohibit servicers and their affiliates from receiving any form
of commission or incentive-based compensation from LPI providers. They also explicitly
restrict any type of reinsurance arrangement between a servicer’s affiliate and an LPI
provider. Finally, they give the Enterprises the right to inspect any contractual documents
between servicers and LPI providers to ensure compliance.




36
  See Coonan v. Citibank, N.A., No: 1:13-cv-00353 (N.D.N.Y filed Mar. 27, 2013) (consolidated with Casey v.
Citibank, N.A., No. 5:12-cv-00820 (N.D.N.Y. filed May 17, 2012)).
37
  Citibank also agreed to refund borrowers 8%—or about $15 million total—of any paid or charged lender-
placed flood or stand-alone wind insurance premiums.
38
   Since February 2014, several other borrower class action lawsuits are moving toward settlement. In LPI
litigation against Bank of America and QBE, borrowers have agreed to a settlement of $228 million. See Hall
v. Bank of America, N.A., No. 1:12-cv-22700 (S.D. Fla. filed July 24, 2012). In LPI litigation against HSBC
and Assurant, borrowers have agreed to a settlement valued at $32 million. See Lopez v. HSBC Bank USA,
N.A., No. 1:13-cv-21104 (S.D. Fla. filed Mar. 28, 2013).
39
     78 Fed. Reg. 19263 (Mar. 29, 2013).
40
     The working group is comprised of seven federal regulators and fourteen state regulators.



                                       OIG  EVL-2014-009  June 25, 2014                                     14
FINDING ...................................................................................

FHFA Has Not Assessed Whether the Enterprises Should Pursue Litigation against
Servicers and LPI Providers to Recover Damages

FHFA is statutorily obligated to preserve and conserve the Enterprises’ assets while they are
in conservatorship. As set forth above, the Agency has taken some steps to prevent the
Enterprises from being harmed further by their servicers and LPI providers. However, it has
not determined whether the Enterprises should pursue litigation to recover damages caused by
their servicers’ and the LPI providers’ past practices. Our analysis indicates that such
litigation could result in financial recoveries for the Enterprises.

     FHFA Has Not Assessed the Potential for LPI-Related Financial Recoveries

During this evaluation, we asked FHFA’s Office of General Counsel if it had conducted an
assessment to determine whether the Enterprises should pursue LPI-related litigation against
their servicers or LPI providers. An official from that office said that it had not yet done so,
citing competing priorities, such as finalizing pending legal claims. The official said,
however, that FHFA’s Office of General Counsel would consider undertaking such an
assessment.

     Recent State Regulatory Findings and Borrower Class Action Settlements May Inform
     FHFA’s Assessment of LPI-Related Litigation

We believe that the Enterprises may be able to benefit from LPI-related litigation. As
noted above, several state insurance regulators have documented abusive practices by some
servicers and LPI providers. Consequently, these state regulators required LPI providers to
substantially lower their premiums. Further, in some cases, regulators and LPI providers have
mutually agreed to provide restitution to affected borrowers, implying that the borrowers were
financially harmed by potentially collusive industry practices. As large consumers of LPI, the
Enterprises have likely sustained similar financial harm as a result of these practices.41

Additionally, there are key similarities between the Enterprises and the borrowers who have
recently settled class action lawsuits with servicers and LPI providers. Specifically:




41
  FHFA has explicitly acknowledged that certain servicer and LPI provider practices may have resulted in
potential losses to the Enterprises.



                                    OIG  EVL-2014-009  June 25, 2014                                     15
          The Enterprises reimbursed their servicers for the cost of borrowers’ unpaid LPI
           premiums after foreclosure;
          The Enterprises’ servicers include some of the same servicers that were defendants in
           the borrowers’ class action lawsuits; and
          The Enterprises’ servicers purchased LPI coverage from the same LPI providers that
           were defendants in the borrower class action lawsuits.

Accordingly, the Enterprises may have been harmed in the same manner as the borrowers
who settled the class action lawsuits described above. That is, the Enterprises’ servicers may
have breached their contractual obligations to the Enterprises if they charged them for
excessively priced LPI coverage and then shared in the resulting profits. Therefore, like the
borrowers, the Enterprises may be able to secure similar financial recoveries.42,43

We acknowledge that the servicers and LPI providers would raise defenses to any such claims
asserted by the Enterprises. For example, the servicers might claim that they never expressly
breached a contract. Rather, they may argue that the LPI coverage at issue was purchased in
compliance with the Enterprises’ servicing guidelines and, thus, there is no claim.44

This is similar to a defense that the servicers advanced in the borrower class action lawsuits.
There, the servicers sought dismissals claiming that, notwithstanding the higher cost of LPI,
they were contractually required to purchase it.45 Moreover, they noted that the borrowers’
mortgage contracts themselves expressly stated that the cost of LPI could “significantly
exceed” the cost of the borrower’s previous policy.46 However, the servicers’ motions to
dismiss were denied by the courts that ruled upon them.47

42
     One of the Enterprises has recognized the legitimacy of this line of reasoning.
43
  The Enterprises may also consider causes of action sounding in breach of the implied covenant of good faith
and fair dealing, breach of fiduciary duty, and unjust enrichment. Additionally, given that the Enterprises are
currently in federal conservatorship, the Department of Justice may be able to utilize causes of action that have
their basis in statutes reserved to the United States. This may include, for example, claims brought under the
Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA), 12 U.S.C. § 1833a (2012),
or the False Claims Act, 31 U.S.C. §§ 3729–3733 (2012).
44
  Both Enterprises’ servicing guides require their servicers to procure LPI if the borrower fails to maintain
adequate hazard insurance. Fannie Mae’s servicing guide acknowledges that LPI coverage may cost more than
voluntary homeowner’s insurance. Fannie Mae Single Family 2012 Servicing Guide, at 206-1.
45
  HSBC argued that the borrower’s mortgage contract did not prohibit the servicer from earning profits in
procuring LPI, and that HSBC complied with the terms of the contract. See HSBC’s Motion to Dismiss at 11,
Lopez v. HSBC, ECF No. 11; see also JPMorgan Chase’s Motion to Dismiss at 7, Herrick v. JPMorgan Chase,
ECF No. 35.
46
     See, e.g., Bank of America’s Motion to Dismiss at 3, Hall v. Bank of America, ECF No. 192.
47
  In the Wells Fargo, Citibank, and Bank of America litigation, the courts denied the servicers’ motions to
dismiss—which argued there was no basis for the borrowers’ breach of contract claims—at least once prior to
settlement.


                                        OIG  EVL-2014-009  June 25, 2014                                          16
Regardless, we do not believe potential defenses should deter FHFA from assessing whether
the Enterprises should pursue LPI-related litigation against their servicers or LPI providers.

      The Enterprises May Be Able to Secure Financial Recoveries through LPI-Related
      Litigation against Some Servicers and LPI Providers

In deciding whether to pursue LPI-related litigation, FHFA should balance the expected cost
of such litigation against the expected recovery.48 Our analysis suggests that the Enterprises
likely suffered significant financial harm due to excessive LPI rates in recent years and,
therefore, the potential recovery from LPI-related litigation may outweigh its costs.

We estimate that, in 2012 alone, the Enterprises suffered $158 million in financial harm as a
result of reimbursing their servicers for excessively priced LPI coverage. This estimate is
based on a methodology similar to that utilized by NYDFS in its recent enforcement actions
against subsidiaries of Assurant and QBE. As depicted in Figure 4, below, the $158 million
is the difference between the amount that the Enterprises actually paid in premiums—$360
million—and a reasonable price for such coverage—$202 million. In other words, our
retrospective analysis suggests that in 2012 the Enterprises paid LPI premiums that were
priced nearly 79% greater than was reasonable for the LPI providers to charge in order to
cover their claims.

       FIGURE 4. ESTIMATE OF ENTERPRISES’ FINANCIAL HARM DUE TO EXCESSIVE LPI RATES IN 2012
     Enterprise Reimbursements for         Estimate of Reasonable Price for
              LPI Premiums                     Equivalent LPI Coverage                Estimate of Financial Harm
               $360 million                          $202 million                            $158 million

Note: See the Objectives, Scope, and Methodology section of this report for a description of the methodology by
which we arrived at this estimate and its limitations.

This calculation serves to demonstrate how severely the Enterprises were harmed by their
payment of excessively priced LPI premiums; and how important it is that FHFA evaluate the
merits of litigation intended to recover damages from certain servicers and LPI providers.49




48
  LPI-related litigation costs would include attorney fees and other litigation-related expenses. Further, there
could be certain indirect costs, such as the negative impact litigation may have on the Enterprises’ relationships
with the servicers whom they employ to manage borrower accounts. The potential recovery would include
proceeds that result from a judgment or settlement.
49
  We do not necessarily expect FHFA and the Enterprises to pursue or recover damages in this amount—
actual damages may be higher or lower. For example, the amount could be higher if they pursue recoveries for
multiple years rather than just 2012. Conversely, it could be lower if they employ a different methodology.



                                     OIG  EVL-2014-009  June 25, 2014                                              17
CONCLUSIONS ..........................................................................

We conclude that FHFA has taken some steps to prevent the Enterprises’ servicers and LPI
providers from inflicting further financial harm upon them. However, FHFA has not yet
completed its assessment regarding the merits of litigation by the Enterprises against their
servicers and LPI providers to remedy damages caused by past abuses in the LPI market. We
believe that FHFA—as the Enterprises’ conservator—has a responsibility to conduct such an
assessment because the failure to do so could result in potentially forgoing significant
financial recoveries.




RECOMMENDATION .................................................................

We recommend that FHFA assess the merits of litigation by the Enterprises against their
servicers and LPI providers to remedy potential damages caused by past abuses in the LPI
market and, then, take appropriate action in this regard.

FHFA accepted this recommendation (see Appendix A). As noted in its formal response, the
Agency will complete its litigation assessment within 12 months.




                              OIG  EVL-2014-009  June 25, 2014                               18
OBJECTIVE, SCOPE, AND METHODOLOGY .................................

The objectives of this evaluation were to: (1) assess the financial impact of the LPI market
upon the Enterprises; and (2) determine whether FHFA, in its role as the Enterprises’
conservator, should undertake additional LPI-related actions.

To address these objectives generally, we interviewed FHFA officials in the Division of
Housing Mission and Goals, the Division of Enterprise Regulation, and the Office of General
Counsel. We also interviewed officials at both Enterprises responsible for their business
dealings with servicers and LPI providers. Additionally, we reviewed Enterprise LPI-related
financial data, such as annual premiums paid, and reviewed numerous FHFA and Enterprise
documents that contain LPI analyses. Finally, we reviewed testimony from industry experts
and various other topical, publicly available documents.

Methodology for our Estimate of the Harm that the Enterprises Suffered Due to
Excessive LPI Premium Rates in 2012

We estimated the harm the Enterprises suffered due to excessive LPI rates by utilizing a
methodology similar to that employed by the NYDFS in recent enforcement actions against
subsidiaries of Assurant and QBE. Specifically, using 2012 data, we calculated the difference
between (1) the actual amount the Enterprises reimbursed the servicers for LPI coverage, and
(2) an estimate of the reasonable price for the coverage. We acknowledge limitations in our
methodology, and they are disclosed at the end of this section.

We took the following steps to develop our estimate of the financial harm suffered by the
Enterprises:

Step 1: Determine the amount the Enterprises reimbursed the servicers for LPI premiums in
        2012

According to the Enterprises, they reimbursed their servicers $360 million for LPI-related
premiums in 2012.

Step 2: Estimate the Enterprises’ actual LPI proceeds in 2012, i.e., the payments the
        Enterprises received as a result of claims submitted for their LPI-related losses

Data regarding the amount of proceeds the Enterprises received from their servicers for LPI-
related claims was not readily available. Accordingly, we could not precisely calculate their
actual loss ratio. Therefore, we used the 2012 nationwide average loss ratio for LPI
providers, which we derived from data compiled by the National Association of Insurance



                               OIG  EVL-2014-009  June 25, 2014                               19
Commissioners (NAIC).50 This figure—30.8%—served as a proxy for the Enterprises’ actual
LPI-related loss ratio in 2012.51

We estimated that the Enterprises received $111 million in LPI proceeds in 2012, as depicted
in Figure 5 below.

        FIGURE 5. ESTIMATE OF THE AMOUNT OF LPI PROCEEDS THE ENTERPRISES RECEIVED IN 2012

 Loss             Insurance Proceeds                                      X
            =                                        30.8% =                                    X = $111 million
 Ratio                 Premiums                                     $360 million

Step 3: Estimate how much the Enterprises should have reasonably paid for receiving $111
        million in LPI proceeds

Next, as depicted in Figure 6, below, we estimated how much the Enterprises should have
reasonably paid for LPI coverage under the assumption that they received $111 million in
insurance proceeds from LPI providers in 2012. To do so, we used a 55% loss ratio, which
was the expected LPI loss ratio QBE’s subsidiary had on file with the state of New York prior
to the NYDFS investigation.

FIGURE 6. ESTIMATE OF WHAT THE ENTERPRISES’ 2012 LPI PREMIUM REIMBURSEMENTS WOULD HAVE
           BEEN ASSUMING LPI RATES WERE PRICED TO MAINTAIN A LOSS RATIO OF 55%

 Loss             Insurance Proceeds                                $111 million
            =                                         55%     =                                 Y = $202 million
 Ratio                 Premiums                                           Y

Step 4: Calculate the estimated financial harm to the Enterprises

As depicted in Figure 7, below, we estimate that if LPI providers set their rates to produce a
55% loss ratio in 2012, then the Enterprises would have reimbursed their servicers $202
million for LPI premiums—$158 million less than they actually paid in 2012.




50
  NAIC is a voluntary association of the heads of insurance departments from each state, the District of
Columbia, and five U.S. territories. NAIC provides a national forum for addressing and resolving major
insurance issues and for promoting the development of consistent policies among the states. The NAIC
requires LPI providers to submit their previous years’ credit insurance experience data on collateralized real
property. NAIC does not endorse any analysis or conclusions based upon the use of its data.
51
     30.8% represents the ratio of LPI providers’ incurred claims to earned premiums in 2012.



                                       OIG  EVL-2014-009  June 25, 2014                                          20
        FIGURE 7. ESTIMATE OF ENTERPRISES’ FINANCIAL HARM DUE TO EXCESSIVE LPI RATES IN 2012
     Enterprise Reimbursements               Estimate of Reasonable Price for
          for LPI Premiums                       Equivalent LPI Coverage                 Estimate of Financial Harm
            $360 million                              $202 million                             $158 million


       Methodological Limitations

The methodology described above is subject to the following limitations:

          Our estimate assumes that the Enterprises’ actual 2012 LPI loss ratio is similar to the
           nationwide average LPI loss ratio of 30.8%, which we computed using data compiled
           by the NAIC.52 Nevertheless, we believe that the 30.8% figure is conservative in that
           it is higher than the average nationwide LPI actual loss ratio from 2004 to 2012—
           25.3%. Further, internal documents from one of the Enterprises indicate that its
           estimated historical LPI loss ratio was substantially less than 30.8%.
          Our utilization of 55% as a reasonable loss ratio is based upon one state insurance
           regulator’s investigation. Specifically, we examined NYDFS’ consent orders with
           subsidiaries of both Assurant and QBE.53 We chose to use QBE’s expected loss ratio
           of 55% rather than Assurant’s expected loss ratio of 58.1% because it was a more
           conservative estimate. Our estimate is also conservative in that a condition of both
           consent orders with Assurant’s and QBE’s subsidiaries requires them to file new LPI
           rates that produce a minimum expected loss ratio of 62%.54 Additionally, NYDFS has
           recently proposed implementing a new regulation requiring all LPI providers in the
           state to refile their LPI rates so that they produce a minimum expected loss ratio of
           62%.55


52
  LPI providers submit their actual loss ratio data to the NAIC by submitting Part 4 of the Credit Insurance
Experience Exhibit. We used that data to compute the 2012 nationwide LPI provider loss ratio.
Part 4 of the NAIC’s Credit Insurance Experience Exhibit does not distinguish between lender-placed hazard
insurance and lender-placed flood insurance. Lender-placed hazard insurance, however, accounts for the vast
majority of the data. Moreover, the two product lines are sufficiently similar to warrant generalizations,
according to industry experts.
Additionally, through 2012, QBE had not submitted Part 4 of the Credit Insurance Experience Exhibit; rather,
it submitted Part 5, which is titled “Other Credit Insurance.” In calculating our loss ratios we assumed that
QBE’s data on Part 5 of the Credit Insurance Experience Exhibit refers to its LPI portfolio.
53
     Such granular loss ratio data were not readily publicly available from regulators in Florida and California.
54
     NYDFS Consent Order with Assurant, at 8; NYDFS Consent Order with QBE, at 9.
55
  11 NYCRR § 227.7 (Proposed). The proposed regulation was released for public comment in the State
Register on September 25, 2013. As of February 19, 2014, NYDFS was still considering public comments on
the proposed regulation.



                                        OIG  EVL-2014-009  June 25, 2014                                            21
      Either Enterprise may request that a lender repurchase a loan if it finds a defect in
       the loan’s underwriting quality. If the loan has already been liquidated, then the
       Enterprise can request that the lender remit a “make-whole” payment. Theoretically,
       this payment would compensate the Enterprise for any LPI-related cost associated
       with the loan. Our estimations do not include any compensation the Enterprises may
       have received due to repurchase requests.

This study was conducted under the authority of the Inspector General Act and is in
accordance with the Quality Standards for Inspection and Evaluation (January 2012), which
were promulgated by the Council of the Inspectors General on Integrity and Efficiency.
These standards require us to plan and perform an evaluation based upon evidence sufficient
to provide reasonable bases to support its findings and recommendations. We believe that the
findings and recommendation discussed in this report meet these standards.

The performance period for this evaluation was October 2013 to January 2014.




                              OIG  EVL-2014-009  June 25, 2014                               22
APPENDIX A .............................................................................
FHFA’s Comments on FHFA-OIG’s Findings and Recommendation




                            OIG  EVL-2014-009  June 25, 2014                         23
ADDITIONAL INFORMATION AND COPIES .................................


For additional copies of this report:

      Call: 202-730-0880
      Fax: 202-318-0239
      Visit: www.fhfaoig.gov



To report potential fraud, waste, abuse, mismanagement, or any other kind of criminal or
noncriminal misconduct relative to FHFA’s programs or operations:

      Call: 1-800-793-7724
      Fax: 202-318-0358
      Visit: www.fhfaoig.gov/ReportFraud
      Write:
                FHFA Office of Inspector General
                Attn: Office of Investigation – Hotline
                400 Seventh Street, S.W.
                Washington, DC 20024




                                OIG  EVL-2014-009  June 25, 2014                         24