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If you've never heard of force-placed homeowner's insurance, your ignorance will most likely be rectified very soon. The state of New York recently held hearings on an industry that is supposed to provide protection for homeowners and investors as well as the mortgage holder, but most often protects only the interests of insurance companies and banks.

Problems with the industry have been brewing for years. The logic behind the product makes perfect sense: When a borrower's homeowner's insurance lapses for any reason, the bank secures coverage and places it on the property, thereby protecting the bank's investment. So far, so good. But the new coverage often costs many times what the homeowner's original premiums did; according to Bloomberg, premiums on these policies have risen more than threefold since 2004, and most of it is profit. The increased payments have even resulted in many foreclosures.

The vast majority of New York's force-placed policies are handled by only two companies -- Assurant (NYSE: AIZ  ) and Balboa Insurance, formerly a subsidiary of Bank of America (NYSE: BAC  ) . The state says that not only were premiums too high, but that claims were hardly ever paid out, despite arguments to the contrary by the insurance company representatives. Sweetheart deals abound in this industry as well. JPMorgan Chase (NYSE: JPM  ) receives commissions from insurers including Assurant for funneling work its way, and it collects huge fees when Assurant reinsures through a subsidiary company belonging to JPMorgan. When Bank of America sold Balboa to QBE, part of the deal was to continue providing the insurer with its force-placed business. Citigroup (NYSE: C  ) was subpoenaed in January regarding its relationship with Assurant as well, and the bank certainly didn't inspire confidence when it complained that evidence requested predated Dodd-Frank. The bank's CitiMortgage arm has been accused of instituting policy premiums that raised some homeowners' monthly payments by as much as 50%.

Other big banks are riding this gravy train, too. Earlier this year, a federal judge gave the nod to a class action suit against Wells Fargo (NYSE: WFC  ) and QBE in Florida. The court action specifically addresses the collusion between the companies, resulting in large commissions funded by the customers. The judge also accused Wells Fargo of retaliation against the plaintiffs, adding even more drama to the case.

Fool's Take
Concerns about this sketchy activity is not new, and calls to look into the practice have been resonating for some time. Assurant's stock plunged when California's insurance commissioner demanded that all of that state's insurance carriers lower the premiums charged for force-placed insurance, and an article from late 2010 in American Banker lays out many of the corrupt practices that New York is now investigating.

There is no question that banks have a right to protect their investment. But paying kickbacks, charging for backdated policies, and other dishonest and possibly illegal practices put homeowners, mortgage loans, and investors' money at risk, for no other reason than pure unadulterated greed. If there was ever a scenario crying out for the regulator's touch, force-placed insurance is a prime example.

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Fool contributor Amanda Alix owns no shares in the companies mentioned above. The Motley Fool owns shares of Bank of America, Citigroup, Wells Fargo, and JPMorgan Chase and has created a covered strangle position in Wells Fargo. Motley Fool newsletter services have recommended buying shares of Wells Fargo. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Read/Post Comments (1) | Recommend This Article (3)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 25, 2012, at 10:57 AM, SpaceVegetable wrote:

    It's not just mortgage companies who do this. Places that offer car loans do the same thing. I had it happen to me after a payment snafu. The policy they wanted to charge me for cost three times what my normal policy did. Luckily I was able to get it cancelled once I proved it was the insurance company's error and lot a lapse on my part.

    It's quite a racket. I'm not opposed to banks protecting themselves or making a profit, but there's no need for these policies to be so outrageously expensive.

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