Understanding the Differences: Narrow and Broad Form Mortgage Impairment
Make sure you’re protecting the balance sheet against mortgage origination and servicing oversights (for all real property secured notes). HUB Financial Services answers the most frequently asked questions about loan portfolio risk, origination / operational risk and secondary market compliance.
A homeowner cancels their insurance policy days before their home burns to the ground in a fire. A commercial borrower on the coast inadvertently fails to secure flood or wind coverage before a major hurricane hits. You fail to properly advance borrower insurance escrow payments resulting in a borrower’s policy being cancelled right before they suffer a physical damage loss. And the worst of it…. your financial institution holds the mortgages and servicing rights. Inevitably, borrower oversights and internal servicing errors or omissions can lead to lender risk, some which might not be covered by lender placed automatic coverage provisions.
How do you ensure that the value of the loan is protected when your customer doesn’t secure the appropriate coverage? Or, that your borrower insurance tracking operations are protected against mistakes? For these missteps and more mortgage lender risks, there is Mortgage Impairment (MI) insurance.
To minimize the risk associated with originating, selling, and servicing Mortgage Impairment insurance stands behind financial institutions to protect the lender’s or servicer’s interest should certain situations occur. Knowing which type to secure and what’s best for the portfolio of mortgages your institution holds or services is where it gets tricky. To be sure, ask yourself these questions:
FAQ #1: Which type of Mortgage Impairment insurance do you need? Narrow Form vs. Broad Form – What’s the difference?
Mortgage Impairment insurance, or mortgagee errors and omissions (E&O) coverage, generally comes in two forms. Narrow Form coverage is mortgagee E&O in its most basic form. It’s what financial institutions are required to have in order to comply with secondary markets regulations (and certain safety and soundness issues) and will cover a limited set of situations.
Broad Form is significantly enhanced mortgagee E&O coverage. The Broad Form coverage is effectively two types of insurance married together:
1. Extra E&O. Covers lenders for certain servicing-related operation failures resulting in demands from third parties.
2. Balance of perils. Covers lender’s loss from perils NOT required of a borrower that are not excluded by the mortgage impairment insurance policy. For example, a house destroyed by an earthquake when the borrower was not required to carry earthquake insurance.
Secondary Market MI requirements are based on a sliding scale that directly correlates to the size of a financial institution’s portfolio of owned and serviced mortgages. Keep in mind these requirements are a bare minimum and may not provide adequate coverage for a big claim or multiple claims in one calendar year. These calculations can be found in the agency guides.
Community banks and credit unions will sometimes carry Narrow Form coverage, but limits are often inadequate when it comes to backing the complete scope of a financial institution’s properties. For financial institutions concerned about risk management, a Broad Form policy with one or both endorsements will provide the most complete coverage possible.
FAQ #2: How should you buy your Mortgage Impairment insurance coverage? Should you choose stand-alone vs. packaged – What’s the difference?
Stand-alone Mortgage Impairment insurance coverage, in Narrow or Broad Form, can be independently negotiated to meet the needs of any financial institution, including desired premiums, limits and endorsements.
Lenders might also consider packaged Mortgage E&O insurance coverage, which will come in one of two forms: a Financial Institution Bond (FIB) that bundles mortgagee E&O as well as bond coverage. A packaged policy will feature mortgagee E&O coverage attached to the master property policy, which in of itself has benefits and drawbacks.
FAQ #3: What’s best for your financial institution?
Base your decision as to which Mortgage Impairment insurance coverage is best for your business on a thorough analysis of your portfolio, systemic risk, origination/servicing operations and risk tolerance. Working with a broker to analyze these key data points will both get you to the right policy and will provide your risk manager with a road map of how the decision was made and why. This analysis will serve you beyond your institution’s initial purchase, as a backup should the risk manager be called upon to support the financial institution’s decision.
FAQ #4: Who can help us find the right coverage we need?
Contact your HUB Financial Institutions specialist for more information about safeguarding your mortgage impairment risk.