Mortgage Scams Involving Force-Placed Insurance
Most victims of force-placed insurance scams don’t even know they’ve been defrauded.
By Zachariah B. Parry, attorney at Pickard Parry Pfau.
In recent years it has become increasingly common to hear about the devious and illegal ways mortgage companies, lenders, and loan servicers use to increase their profit margins at the borrower’s expense—often with the use of unwanted and unnecessary insurance. With growing frequency, these sophisticated and interrelated entities are being accused of fraud, conspiracy, and one or more violations of federal statute. As one federal court put it, mortgage-related insurance practices “have spawned a great deal of litigation in recent years.”
The purpose of insurance is to help a consumer manage risks that are relatively rare, but that can be expensive, like car accidents, fires, and death. Because an individual’s actions (or inactions) may put others at risk, there are often statutory requirements mandating the purchase of insurance. For example, most Nevadans are aware that it is against the law to operate a motor vehicle without automobile insurance.
Homeowners’ insurance (often called hazard insurance) covers everything from loss due to theft, falling objects, water damage, and any of a number of other losses, the specifics of which are contained in the homeowners’ respective policies. Unlike automobile insurance, homeowners’ insurance is not statutorily mandated—there are no laws in Nevada requiring the purchase of homeowners’ insurance.
However, because mortgage lenders secure their loans with the property, and they want to protect the collateral on their loans, they invariably require borrowers to purchase homeowners’ insurance as a condition to financing the purchase of the home. As a practical matter, most homeowners’ policies are purchased as a contractual requirement for home loans.
Lenders, who typically dictate the terms of the loan documents, often include a provision requiring that an escrow account be established, from which the lender will pay recurring expenses, including property taxes and insurance premiums. This way, the borrower makes one monthly deposit into the escrow account, and the lender, in turn, ensures that there is always insurance coverage protecting its investment.
Also very common is a lender’s practice of selling the home loan to other lenders or loan servicers. This can occur immediately after the loan is completed and can take place many times over the life of the loan.
Borrowers are often frustrated when their lenders sell the loan, particularly because the borrowers have no say in the matter. Legally, the terms of the original loan remain the same, but in practice the effects of a loan purchase can result in real harm to the borrower.
For instance, sometimes the lender will stop making premium payments for the homeowners’ insurance, which result in a lapse in coverage. Usually the homeowners are not even aware of any lapse in coverage because the lender handles the transactions. Moreover, because the homeowners have been making monthly escrow deposits, they assume the lender is using those deposits as directed in the contract.
The matter becomes more complicated when the lender, who has allowed the insurance coverage to lapse, sells the loan to a loan servicer. The loan servicer, upon assumption of the loan, discovers that the homeowners have no insurance coverage, and notifies the homeowners that they are in breach of the agreement and must purchase homeowners’ insurance. The alternative, homeowners are told, is that the loan servicer will purchase insurance for them and then increase the homeowners’ monthly payment.
At this point the homeowners are confused because they have been making their monthly payment, part of which is earmarked for insurance. However, when they try to speak to a representative of the loan servicer, they experience an endless maze of phone options, wait on hold while a looped recording tells them how valued they are as a customer, and then ultimately talk to someone who has little interest in helping them, has little information at their disposal, and even less authority to do anything about it. Attempts to contact the prior lender are met with similar disinterest and less success, as the prior lender no longer wants anything to do with a loan it has already sold.
Many homeowners at this point will throw in the towel, deciding that it is not worth the hassle to try and deal with ignorant “customer service” representatives who answer phones all day but don’t provide any actual service to customers. Additionally, the homeowners don’t quite understand the problem themselves because they can’t get any information from the entities that do.
After all this, the homeowners will usually do one of two things. They might purchase insurance privately even though they are continuing to make their monthly escrow deposit, which already includes an insurance premium contribution. That means the portion of the escrow deposit earmarked for insurance doesn’t get used for insurance. One can only imagine what the loan servicer uses it for.
The other option is for the homeowners to give up after making numerous phone calls and sending numerous letters to no avail. If the homeowners take this route, the insurance company will purchase insurance on their behalf then increase the monthly escrow payment.
This is called force-placed insurance. There are at least three features of force-placed insurance that distinguish it from other types of insurance. First, it is much more expensive. Force-placed insurance usually costs between double and ten times as much as private insurance for the same home. Second, force-placed insurance provides much less coverage. Whereas private insurance will usually include liability, medical, and property damage coverage, force-placed insurance coverage does not. Third, force-placed insurance is often applied retroactively.
The combination of these three characteristics of force-placed insurance makes it a big moneymaker. Because it is purchased without the homeowner’s permission, the premiums can be outrageously priced while still affording only just enough coverage to protect the lender.
What is more concerning is that nowhere else in the insurance industry can insurance be purchased retroactively—and for good reason. Imagine if a driver could purchase insurance only if she had been in an accident. There would be no reason to ever maintain coverage, and insurance companies could not stay in business.
With force-placed insurance, the loan servicers purchase insurance retroactively that covers only the value of the loan. The insurers are happy to provide retroactive coverage in this case because they know there has been no loss in the past “covered” months. And because it means collecting months’, sometimes years’ worth of backdated “coverage,” the insurers are further enriched.
The homeowners are the ones who have to pay the premiums. If the homeowners do not pay for the force-placed insurance, the loan servicer stops applying the monthly escrow payments to the loan and then forecloses on the home.
In some cases, the lender either owns the insurance company, or receives a kickback for every force-placed policy referred to the insurance company. And in an industry where loan servicers make an average of $51 per loan per year, getting a few thousand dollars in a kickback from an insurance company increases their profit margin exponentially, which provides a considerable financial incentive to continue this practice.
Recognizing the prevalence of these abusive practices, Congress passed legislation in 2010 that mandates, among other things, that charges for force-placed insurance be “bona fide and reasonable.” It also prohibits kickbacks and unearned fees.
However, this may be an instance where the financial incentive is much stronger than the deterrent effect of the law. Some sources say that for at least one insurance company, “the unit handling force-placed insurance has accounted for $811 million of its $879 million in profits during the last two years.”
The good news is that no matter how labyrinthine their phone options, how indignant their customer service representatives, or how unbearable their hold music, loan servicers and force-placed insurers cannot avoid homeowners indefinitely: they have no choice but to respond when an attorney files a lawsuit.
If your monthly payments have inexplicably increased, or you know you’re paying for force-placed insurance against your will, you should speak with a knowledgeable and experienced attorney.
Zachariah B. Parry is a founding partner of the civil litigation law firm, Pickard Parry Pfau. He regularly litigates against parties with deep pockets like labor unions, racketeering enterprises, and insurance companies. He has experienced success on both sides of the table, including multiple multi-million dollar judgments on behalf of plaintiffs in fraud cases and zero-dollar defense verdicts for his clients who were unjustly sued. In addition to litigating, Zach also teaches torts, contracts and Nevada practice and procedure at UNLV’s paralegal program.
Zach can be reached at email@example.com, 702-910-4300, or through his firm’s website at www.pickardparry.com.
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