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Insurance Kickbacks Highlight Big-Bank Idiocy

NEW YORK (TheStreet) -- Force-placed insurance is back in the headlines, with Citigroup (C - Get Report) agreeing to settle a class action lawsuit by refunding $110 million to thousands mortgage loan borrowers.

Reuters reported the story, and the lead sentence in the report says Citi had to pay the refunds to "thousands of homeowners who were forcibly charged expensive property insurance premiums."

The problem was not the force-placement of the insurance; it was the higher costs being passed to the borrowers because of the kickbacks Citigroup was receiving from insurance providers. According to the Reuters report, the court filing indicated Citi was receiving 15% commissions from insurance providers who placed hazard insurance premiums.

""We are pleased to have reached an agreement to conclude this claim and anticipate approval by the court," Citigroup said in a statement.

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A Citigroup spokesman confirmed in an email exchange, "We no longer accept commissions on lender-placed hazard insurance. We never accepted commissions on lender-placed flood insurance."

Force-Placed Insurance Is a Required Risk-Management Tool

Making sure collateral properties are covered by insurance is a major part of the loan servicing business. Residential mortgage loan borrowers sign agreements saying they will provide proof of hazard insurance coverage for their homes, with flood insurance also required if the home is in a special flood hazard area, as determined by FEMA.

Most first-lien mortgage loans are escrowed for insurance, so the loan servicer -- which can be the lender, or might be another company -- collects some additional money each month as part of the loan payment in order to pay the insurance premium each year. The servicer is responsible to make the payment and to contact the insurance agent if a bill is not received, and to contact the borrower if necessary, if there is no longer an insurance policy.

For non-escrowed mortgage loans, or for home equity loans, the borrower is required to provide proof of insurance each year. If the borrower fails to provide the proof of insurance, the servicer will contact the insurance agent to try to obtain an insurance declaration, and/or contact the borrower making the same request.

It can take a great deal of effort on the part of the servicer to obtain the proof of insurance, but that's part of the servicer's job.

If the borrower cannot be contacted or refuses to provide the proof of insurance he or she agreed to, the loan servicer will get a force-placed insurance policy to cover the home, and if necessary set up an escrow account for the borrower in order to collect the money (in arrears) to pay the premium.

All this effort may seem silly, but it is critically important for a lender to protect its interest in the collateral, especially in areas that see high levels of hurricanes, floods or tornado activity. Bank examiners look very closely at banks' insurance monitoring, especially for flood insurance.

Consumers' Mistrust of Big Banks

From my own experience in loan servicing at a community bank in Florida, I learned just how challenging it could be to obtain proof of insurance, and how important it could be to have the coverage when being hit by multiple hurricanes.

At the bank where I worked, we would send a reminder notice to a non-escrowed insurance customer 45 days before the current insurance policy was due to expire. Then if proof of insurance wasn't received, we would call the agent for the expired policy and request proof if insurance be sent directly to the bank. If that wasn't immediately successful, we would send another notice to the borrower demanding proof of insurance within 30 days. We would then call the borrower to make the same request.

I would even, on occasion, personally visit insurance agents to get the proof of insurance, if we were unable to receive it by fax, email or by regular mail. If we were still unable to obtain proof of insurance, we would force-place a policy, which was nearly always more expensive than the previous policy.

The force-placed insurance policies were often cancelled rather quickly, when customers responded by providing proof of insurance, or by going out and getting new insurance policies. These customers received full refunds within the first month or pro-rated refunds thereafter.

The bank I worked for received no commissions or kick-backs from the force-placed insurance broker.

But some of the largest U.S. banks did, including Citigroup and JPMorgan Chase (JPM - Get Report), which in September agreed to a $300 million settlement to resolve accusations it had entered into a kickback scheme with Assurant (AIZ). Bank of America (BAC), Wells Fargo (WFC) and HSBC (HSBC) were also sued over similar practices.

Considering that a force-placed insurance policy can easily cost twice as much as a regular policy and that a borrower failing to provide proof of insurance may be having financial difficulty, it would seems the banks were especially tone-deaf in setting up force-placed insurance commission schemes.

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