DIMONT Insights

Vendor management is one of the most import functions in the modern mortgage servicing operation. Much of the work the servicer must do to maintain compliance and to effectively service its portfolio is outsourced to trusted third-parties who perform that work on the servicer’s behalf. Over the past decade, the vendor management function has become much more complex and the corresponding penalties for mistakes have increased in severity.

As a result, vendor managers working within mortgage servicing firms spend a great deal of time determining exactly what functions must be outsourced, evaluating potential partners, contracting with preferred partners, and then managing those relationships – risk management work that must be performed according to a rigorous set of standards and best practices.

The government requires any homeowner with a mortgage to buy flood insurance through the National Flood Insurance Program if the structures on the property fall within the Special Flood Hazard Area (SFHA) of the map. The flood maps are updated periodically; and, it is the servicer’s responsibility to make sure that the properties in its portfolio are properly insured.

In a previous post, we touched on the federal government’s National Flood Insurance Program (NFIP) that requires any property within a Special Flood Hazard Area (SFHA) to carry flood insurance. Determining the sufficient level of insurance coverage for lender placed insurance has presented a problem for some servicers. Failing to insure the property to the correct amount of coverage exposes the servicer to compliance risk.

Federal law requires properties within a flood special hazard area to have a flood insurance policy. The government regulations for determining the correct amount of coverage for lender-placed flood policies are not clear. Over-insuring or under-insuring lender-placed flood policies can cause compliance problems for servicers in addition to having a negative impact on the borrower’s experience.

There are three primary risks for lenders associated with lender-placed flood insurance on properties with multiple structures:

An increasingly important part of the servicing industry is lender placed flood insurance valuation analysis. Accurately assessing the required amount of flood coverage to place on a property is an opportunity that the industry has not responded to in any meaningful way.  This fact is apparent from increased instances of inaccurately insured homes and failed audits. Many of these errors are due to servicers trying to manage flood insurance coverage valuation analysis themselves.  Flood coverage valuation is difficult to do accurately and efficiently; the root cause of this difficulty, for most servicers, is that flood coverage valuation is not part of a servicer’s core competency.

It is the responsibility of financial service companies to manage their compliance burden as effectively as they manage other risks to their enterprise. The compliance burden related to the Nation Flood Insurance Program (NFIP) is an opportunity area for many companies that should not be ignored.

The NFIP has undergone radical changes in the last few years that have resulted in more risk for servicers. The Biggert-Waters Act of 2012 increased the civil monetary penalties (CMP) from $385 to $2,000 per violation and removed the annual cap on the amount of CMP’s that can be assessed against a financial institution. This has increased the potential exposure for mortgage servicers into the tens of millions of dollars if the Office of the Comptroller of the Currency (OCC) determines that a servicer has engaged in a pattern of violations of NFIP regulations.

In recent years, major flooding has occurred due to storms like Katrina and Sandy; and, this flooding has caused devastating property damage. Large flood events and legislative changes have added to mortgage servicers’ workload, as they must analyze mortgage portfolios to ensure they meet the Minimum Flood Insurance Requirement (MFIR) on mortgage loans within their portfolios. In determining the MFIR, the servicer must ascertain the appropriate amount of coverage without over-insuring the property.

Many servicers are attempting to determine the MFIR on their own. The most problematic piece to determining MFIR is calculating a building’s insurable value. While the government has provided some guidance on how to calculate insurable value, not all mortgage servicers are implementing the guidance correctly. Some servicers are still using the appraised value or hazard coverage amounts to determine a building’s insurable value. This is not correct; a cost analysis approach is the only correct way to determine the MFIR. The risk to a servicer who does not use a cost analysis approach is substantial. The most recent flood legislation removed the annual cap on National Flood Insurance Program (NFIP) compliance fines. The cost to a servicer for non-compliance can now run into the millions of dollars.