Force-placed insurance is a hot topic in today’s mortgage landscape. Across the country, lawsuits have targeted lenders and mortgage servicers that obtain insurance coverage for secured real property and charge the costs of that insurance coverage to the borrower. Recently filed cases have alleged that lenders artificially inflated force-placed insurance costs, imposed force-placed insurance on properties that were allegedly adequately insured, failed to reinstate borrowers’ homeowners policies before force-placing hazard insurance and wrongly imposed force-placed insurance policies that increased borrowers’ monthly payments, thereby causing them to default on their obligations. Plaintiffs’ counsel are actively pursuing class action and individual claims against lenders and mortgage servicers for the force-placement of insurance coverage.
The force-placement of hazard insurance, as opposed to flood insurance, is generally a contractual right of the lender. When taking a security interest in property, lenders often demand insurance against the risk of loss of the secured property. The Federal National Mortgage Association’s uniform mortgage requires that the borrower maintain insurance coverage, the amount of which is to be determined by the lender. If the borrower fails to maintain adequate insurance coverage, the mortgage provides that the lender has a right to obtain hazard insurance and to seek the costs of that insurance coverage from the borrower. This coverage is called “force-placed” hazard insurance. Because underwriting and coverage on force-placed hazard insurance is different from that of traditional homeowners’ policies, force-placed hazard insurance is often more costly and covers different risks than those policies. For example, a force-placed hazard insurance policy may not cover contents, but it also may not have the occupancy requirement of a homeowner’s policy.
In the wake of hurricanes and other natural disasters, lenders have faced lawsuits for failing to force-place hazard insurance or force-placing hazard insurance at an amount less than the amount of the outstanding indebtedness. Conversely, borrowers sometimes allege that lenders force-placed an excessive amount of hazard coverage. Generally courts look to the mortgage documents and, pursuant to the parties’ contract, allow the lender to determine the appropriate amount of force-placed hazard insurance coverage.
Unlike hazard insurance, which is force-placed pursuant to the contract between the borrower and lender, federal law mandates flood insurance for mortgages issued or held by federally regulated entities, federal agency lenders (such as the Veterans’ Administration), Fannie Mae and Freddie Mac. If a borrower fails to maintain mandated flood insurance for secured improved real estate in a designated flood zone and flood insurance is available in that zone, the lender or servicer must force-place flood insurance. Difficulties with borrowers may arise when flood maps are redrawn, rezoning property so as to require flood insurance. Unlike force-placed hazard insurance where the lender determines an appropriate amount of coverage, federal law and regulations require that the amount of force-placed flood insurance must not be less than the outstanding principal balance of the loan or the maximum limit of coverage set out in federal regulations, whichever is less. Courts have generally determined that the federal law creates a floor rather than a ceiling on the amount of flood insurance a lender may require or force-place.
Before force-placing flood insurance, the lender or servicer must send notice to the borrower allowing him 45 days to obtain appropriate flood coverage before force-placing pursuant to federal law. Any flood insurance the borrower obtains must meet the requirements of flood insurance in the National Flood Insurance Program. If it fails to meet these guidelines, then the lender has an obligation under federal law to force-place flood insurance that complies with federal mandates.
The Dodd-Frank Wall Street Reform and Consumer Protection Act has brought changes to many areas of the financial services industry, including force-placed hazard insurance. Under Dodd-Frank, a lender or servicer must have a “reasonable basis” for believing the borrower failed to maintain the required hazard insurance. Lenders and mortgage servicers may develop this reasonable basis by contacting the borrower and requesting documentation of the contractually required hazard insurance. Federal law details the contents of these communications with borrowers.
If the lender or mortgage servicer receives no evidence of adequate hazard insurance coverage from the borrower, it may force-place hazard insurance. However, the borrower may reinstate its lapsed hazard coverage or obtain different yet adequate hazard coverage. If the borrower provides the lender or mortgage servicer written confirmation of existing hazard insurance coverage, the lender must terminate the force-placed hazard insurance policy within 15 days of receipt of notice and reverse any charges to the borrower for time when both the force-placed hazard policy and homeowner’s policy were effective.
In these ways Dodd-Frank strives to ensure that force-placed hazard insurance serves only as a back-stop for a lack of adequate insurance and eliminates coverage that is arguably redundant. The Dodd-Frank requirements governing the forced-placement of hazard insurance will become effective on Jan. 21, 2013, or earlier if the Consumer Financial Protection Bureau publishes regulations.