Many of the major US banks such as Bank of America (BAC), Wells Fargo (WFC) and JP Morgan Chase (JPM) are currently challenging an initiative by Fannie Mae (FNMA.OB) to reduce the costs of secondary homeowners insurance policies, better known as "forced policies".
What is a "forced policy" and how is such a policy applied to the homeowner? When a homeowner purchases a brand new home by way of a mortgage loan they are required to obtain and maintain a homeowner's insurance policy. If at any point such a policy lapses or is discontinued by the homeowner prior to the mortgage being paid off, a "forced" policy may be applied by the bank.
These types are policies are intended for borrowers with sub-par credit histories and higher-than-normal debt-to-income ratios. In most cases these types of policies are primarily issued by Assurant Inc. (AIZ) and QBE Insurance Group Ltd. (QBEIF.PK) of Australia.
Making a Case for Fannie Mae
Over the past several months Fannie Mae has sought the approval of the Federal Housing Finance Agency, to use a pre-existing list of insurers and as a result, continues to face some serious scrutiny and backlash from not only the bigger banks but many of their association-based counterparts as well. According to Alan Zibel of the Wall Street Journal, "a number of groups including the American Bankers Association, Mortgage Bankers Association and Financial Services Roundtable have argued that Fannie Mae is working to secretly push through changes that could eventually hurt consumers".
Even though there is a good chance Fannie Mae will get stuck with a portion of these unpaid premiums, the expansion of the proverbial 'playing field' would allow the company to shop around and potentially reduce such premiums. Its force-placed costs have been running about $500 million annually, and the proposed changes could save around $150 million, or 30%, a year.
Banks' commissions on the force-placed policies frequently top more than 10% and in some cases even 15% of the homeowners' annual premiums of about $2,000, according to regulators. In a letter from the American Bankers Association dated January 2nd, it was noted that Fannie Mae continues to "pick winners and losers among lender-placed insurers" and therefore would alter various types of administration operations due the fact commissions would essentially be reduced.
Fannie Mae's proposed system would require bigger banks to use insurers from the pool currently established by Fannie Mae and led by Zurich. A number of these insurers currently offer premiums that are 30%-40% less than the current rates being charged by Assurant and QBE. If such measures are approved by the FHFA the impact on the company's earnings could be significant as expenses associated with "forced policies" would be reduced. In terms of its cost-cutting efforts and for the nine months ending September 30, 2012 vs. the nine months ending September 30th 2011 Fannie Mae has managed to reduce its overall expenses by 13.69% ($2.715 billion in 2012 vs. 3.146 billion in 2011). A further reduction in expenses could occur if Fannie Mae is granted the approval for use of its pre-established pool of insurers.
Regulatory Impact: In May of last year, the New York Department of Financial Services held hearings which had raised some serious "red flags and concerns" about the state of the force-placed insurance market. According to a press release issued by the New York Department of Financial Services, "Among other things, the hearings detailed a lack of competition, as only two companies, Assurant, Inc. and QBE Insurance, control about 90% of the force-placed insurance market. That monopoly, together with the fact that force-placed insurance has become a major profit center for both banks and insurers, and the "tight relationships between banks, their subsidiaries and insurers," were among the factors seen as driving the excessive rates homeowners are being charged for force-placed insurance". Although seemingly small when millions are compared to billions, the long-term effects of such a breakup, via regulatory intervention, could be much bigger.
For those looking to establish a position in Fannie Mae, now may be a great time to establish a position in the company as I believe the chances for a favorable ruling by the FHFA are pretty good. Since the commissions many of the bigger banks have received as a result of these transactions have been brought into question by several state regulators, including New York, we may in fact see begin to see a sense of transparency, just not the kind many of the bigger banks are looking for.