Lender Placed Insurance Surge: 4 Key Considerations
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Higher interest rates and a tough insurance market have translated into financial institutions issuing more lender placed insurance. But some lenders might not be prepared for the growth. Here’s what you need to know to protect your real estate portfolios.
Over the past decade, lender placed insurance programs have usually been an afterthought for financial institutions: Delinquency rates on real estate loans were at historic lows 1 and borrowers could easily obtain affordable insurance coverage to satisfy real estate loan terms.
Lender placed insurance protects lenders if a borrower fails to obtain sufficient coverage under their loan agreement. Most financial institutions haven’t had to issue lender placed insurance to protect their asset portfolios because there hasn’t been a widespread need.
Until now.
Interest rate hikes and tighter credit conditions are increasing loan costs, which has resulted in rising delinquencies. And rising delinquencies suggest financial institutions are issuing more lender placed insurance.
A Difficult Insurance Market Means More Lender Placed Insurance
Due to several factors, insurance rates have been rising the past few years, and in some cases, those increases have been dramatic. As a result, borrowers may cut back on insurance or delay paying premiums in order to cut costs.
What’s more, there have been insurers abandoning some markets en masse, citing their inability to stay profitable in the face of increased catastrophes. That often leaves real estate owners unable to secure coverage at an affordable rate.
In a challenging insurance market, rising premiums and insurer withdrawals are making it harder for borrowers to maintain coverage, often leading them to reduce or delay payments. As insurers exit high-risk areas, lenders and servicers increasingly rely on lender placed insurance to protect assets when traditional policies lapse or become unaffordable.
In these cases, lenders and servicers have no choice but to apply lender-placed insurance on borrowers.
Lender Placed Insurance Program Considerations
Lender-placed insurance programs help protect financial institutions from otherwise uninsured collateral losses and comply with secondary market requirements. Here are four characteristics of a strong lender-placed insurance program:
- Adequate policy limits and deductibles. Policy limits should be sufficient to cover most collateral. For example, $1 million in per property limits that were secured for a program three years ago may no longer be enough for current property values and rebuilding costs. In addition, lender-placed insurance programs need adequate deductibles that meet requirements of secondary markets like Fannie Mae and Freddie Mac.
- Monoline coverage capabilities. It’s important for a lender-placed insurance program to place a single coverage line, such as wind, fire or earthquake, if a borrower is unable to find that specific coverage elsewhere. The alternative to monoline placement could create situations in which wider-ranging lender-placed fire and extended coverage would have to cover a single peril, such as wind.
- The right operational systems. Lenders and servicers need operational systems sufficient to manage the collateral verification process. For instance, financial institutions must notify borrowers when lender-placed insurance is in effect and issue certificates of insurance to other relevant entities. Superior lender-placed insurance programs have technology and processes to deliver on these mandates.
- Matched risk profile and risk management processes. The lender-placed insurance program should be part of a financial institution’s overall collateral risk management process. Lenders can work with insurance brokers to develop a lender-placed insurance program that matches their risk profile.
Contact HUB International’s financial institutions insurance team for more information on securing the best lender-placed insurance program to protect your real estate portfolio.
References
1 National Mortgage Professional, “Overall Mortgage Delinquency Rate Hit All-Time Low In March,” May 25, 2023.
2 CNN, “Commercial and multifamily mortgage delinquencies rose in the first part of 2023,” June 2, 2023.
Frequently Asked Questions about the Surge in Lender-Placed Insurance
What is lender-placed insurance?
Lender-placed insurance, also known as force-placed insurance, is a policy that financial institutions obtain to protect their interests when a borrower fails to maintain the required insurance coverage on collateral, such as real estate. This ensures that the lender’s assets are safeguarded against potential losses due to uninsured events.
Why is there a recent increase in lender-placed insurance?
The surge in lender-placed insurance is primarily due to rising interest rates and a challenging insurance market. Higher loan costs have led to increased delinquencies, and many borrowers are either reducing their insurance coverage or delaying premium payments to cut costs. Additionally, some insurers are exiting certain markets due to profitability concerns, leaving property owners without affordable coverage options. In these situations, lenders are compelled to implement lender-placed insurance to protect their assets.
What should financial institutions consider when implementing a lender-placed insurance program?
When establishing a lender-placed insurance program, financial institutions should focus on:
Adequate Policy Limits and Deductibles: Ensuring that coverage limits are sufficient to protect the collateral’s current value and that deductibles meet secondary market requirements.
Monoline Coverage Capabilities: Offering single-peril coverage options, such as wind or fire, especially when borrowers cannot secure specific coverages independently.
Operational Systems: Maintaining robust systems to manage collateral verification, notify borrowers of policy placements, and issue necessary insurance certificates efficiently.
Aligned Risk Profile and Management Processes: Integrating the insurance program into the institution’s overall risk management strategy to ensure cohesive and effective protection.
How do rising insurance rates affect borrowers and lenders?
Escalating insurance premiums can strain borrowers’ finances, leading them to reduce coverage or miss payments. This lapse in coverage exposes lenders to potential losses from uninsured collateral. Consequently, lenders must proactively monitor insurance statuses and be prepared to implement lender-placed insurance to mitigate these risks.
How can financial institutions ensure compliance with secondary market requirements when using lender-placed insurance?
To comply with secondary market standards, such as those set by Fannie Mae and Freddie Mac, institutions should:
Regularly Review and Adjust Policy Limits: Align coverage with current property values and rebuilding costs.
Set Appropriate Deductibles: Ensure deductibles meet or exceed the thresholds established by secondary markets.
Maintain Detailed Documentation: Keep accurate records of all communications, policy placements, and borrower notifications related to lender-placed insurance.
By adhering to these practices, lenders can effectively manage their portfolios and remain compliant with industry regulations.
Understanding and addressing the factors contributing to the rise in lender-placed insurance enables financial institutions to protect their assets and navigate the evolving insurance landscape effectively.