Force-Placed Insurance

Force-placed insurance is hazard insurance that a mortgage servicer buys to protect a home securing a loan, without the borrower choosing it, after the borrower's own policy has lapsed, been canceled or failed to meet the loan's requirements. Regulation X defines it as "hazard insurance obtained by a servicer on behalf of the owner or assignee of a mortgage loan that insures the property securing such loan." The industry also calls it lender-placed insurance, and the National Association of Insurance Commissioners' glossary calls the same product creditor-placed insurance.

The premium is charged to the borrower, for example through the escrow account. The policy is bought to protect the lender's collateral, and federal rules require the servicer to warn the borrower, before charging for it, that it may cost more and cover less than the borrower's own policy.

Why it costs more and covers less. The NAIC glossary describes creditor-placed coverage on a home as insurance "purchased unilaterally by the creditor, who is the named insured," providing coverage against loss to property that would impair the creditor's stake or the value of the collateral. It can be single-interest, protecting only the lender, or dual-interest. Either way the borrower did not shop for it, and nothing in that design requires it to cover the borrower's belongings or personal liability, which an ordinary homeowners policy does. Regulation X makes the servicer put this in the notice itself: the insurance it buys "May cost significantly more than hazard insurance purchased by the borrower" and may "Not provide as much coverage."

The federal protections, in order.

• A reasonable basis. No charge may be assessed unless the servicer "has a reasonable basis to believe that the borrower has failed to comply with the mortgage loan contract's requirement to maintain hazard insurance."
• Two notices. The first goes out at least 45 days before any charge. A reminder follows at least 30 days after the first and at least 15 days before the charge, stating the cost or a reasonable estimate of it.
• A last chance. If, by the end of the 15 days after the reminder, the borrower shows continuous coverage, the servicer may not charge.
• Cancel and refund. Within 15 days of receiving evidence that compliant coverage was in place, the servicer must cancel the force-placed policy, refund charges for any overlapping period, and remove them from the account.
• Reasonable charges. Charges must be "bona fide and reasonable," except charges that state insurance law regulates as the business of insurance and charges authorized by the Flood Disaster Protection Act of 1973.

The escrow rule. For a borrower who pays hazard insurance through escrow and is more than 30 days behind on the mortgage, a servicer "may not purchase force-placed insurance" unless it is unable to pay the borrower's premium from escrow, which the rule limits to a reasonable belief that the policy was canceled for reasons other than nonpayment or that the property is vacant. A shortfall in the escrow account does not count; the servicer has to advance the money and may seek repayment. A small servicer may instead force-place coverage if it costs the borrower less than paying the borrower's own premium from escrow would.

What it is not. Flood insurance required under the Flood Disaster Protection Act of 1973 is outside the Regulation X definition and has its own rules. So is a borrower's own policy that the servicer simply renews from escrow. Car lenders can also place insurance on a financed vehicle when the borrower's physical damage coverage lapses; that is governed by the loan contract and state law, not by Regulation X.

1. The servicer sees no proof of coverage when a policy expires, is canceled or does not meet the loan's requirements.
2. It sends the first notice at least 45 days before charging, asking for proof of insurance.
3. It sends a reminder no sooner than 30 days after the first notice and at least 15 days before charging, with the cost of the coverage.
4. If no proof arrives, it charges for the force-placed policy, typically through escrow.
5. When proof arrives, it unwinds. Within 15 days the servicer must cancel the policy and refund the charges for any period in which the borrower's own coverage was also in force.

Take an example: a servicer mails the first notice on March 1. The reminder cannot go out before March 31, and no charge can be assessed before April 15, which is 45 days after the first notice and 15 days after a reminder sent on March 31. The borrower's insurer had in fact renewed the policy but sent it to the wrong address. The borrower forwards proof on May 1, showing coverage without a gap. If the force-placed policy cost $5,475 a year, its charge for the 16 days from April 15 to May 1 is $5,475 / 365 x 16 = $240, and by May 16 the servicer must cancel the policy and refund that $240.

Pros

• It keeps the home insured when the borrower's coverage lapses, which protects the collateral behind the loan.
• Regulation X gives the borrower two notices, a chance to show coverage before any charge, and a refund of overlapping charges.
• A borrower who escrows insurance is largely protected from it, because the servicer must keep paying the borrower's own policy.

Cons

• It may cost significantly more than a policy the homeowner would buy, as the required notice itself warns, and may cover only the structure, not belongings or personal liability.
• The borrower pays for a policy chosen by someone else, often through a higher escrow payment.
• Charges regulated as insurance under state law are outside Regulation X's "bona fide and reasonable" test.