When a loan is secured by collateral such as a home or auto, consumers are required to insure the property against hazards causing physical damage or total loss. In the event that the consumer fails to have auto or homeowner’s insurance on the property while they are paying off a loan, the lender is permitted to obtain replacement insurance to protect the property. Collateral Protection Products are a suite of insurance services that enable consumer lending by providing hazard insurance for collateral securing loans, whether real estate, auto, or other personal property. The suite is comprised of two core product sets to help lenders mitigate loan risk: blanket insurance and individually-placed insurance.
Product Description
Blanket physical damage insurance is a business-to-business group insurance policy procured by the lender. Blanket insurance protects the lender’s entire eligible loan portfolio for physical damage. The lender is the master policyholder. Blanket products are characterized by no consumer-level coverage placement. Rather, the entire eligible loan portfolio is automatically covered, without regard to whether any one individual borrower lapses on their primary physical damage insurance. In addition, the claims process is lender-insurer direct: no consumer-level involvement.
Blanket vendor single interest (“VSI”) is a form of blanket insurance available in the auto lending market enabling lenders to recoup a nominal portion of their blanket policy costs. Under VSI, a lender may charge all borrowers the same one-time, nominal fee disclosed and assessed at loan closing. The fee is charged to all borrowers regardless of loan amount or likelihood of insurance lapse.
Lender-placed insurance (“LPI”) is individually-placed auto or homeowners insurance which a lender requires a consumer pay for when they fail to purchase their own insurance while they are paying off the loan for the auto or home. The lender arranges with an insurer through a group master policy for the insurer to provide the auto or homeowners policy for the consumer who then pays for the policy with their loan payments.
Value of Product
The Collateral Protection Product suite fundamentally enables lending for auto and home purchases nationwide. Without such insurance, lenders would be exposed to direct collateral loss and/or increased defaults. Inevitably, interest rates would rise for all borrowers as lenders would need to increase their loan loss reserves for expected uninsured losses. Since GSEs like Fannie Mae and Freddie Mac require continuous coverage on mortgage loans, LPI for real estate also assures such requirements are met, thereby helping ensure a smoothly functioning secondary market for mortgages.
The suite also helps borrowers more directly by: (1) helping them avoid loan contractual default (maintaining insurance is a condition of their loan agreement), and (2) helping them avoid loan payment default which could very likely occur if they sustained an uninsured loss to the collateral.
Regulation
Blanket physical damage insurance, VSI and LPI are regulated through the state departments of insurance. Since VSI involves a nominal fee at point-of-loan, the VSI fee is also governed by The Truth in Lending Act and Regulation Z.
Mortgage servicers play a key role in the proper administration of the real estate lending market. As such, the Consumer Financial Protection Bureau (“CFPB”), Fannie Mae and Freddie Mac regulate LPI for real estate. The CFPB addresses LPI for real estate through Regulation X, while Fannie and Freddie each have published servicer requirements.
Consumer Protections
Remember the Collateral Protection Product suite primarily helps lenders mitigate their loan risk. Through the loan agreement, borrowers are expected to fulfill their contractual obligations by maintaining physical damage insurance on the collateral securing their loan(s). Pricing and any requisite consumer forms are regulated by the state insurance departments. Specific to LPI products, federal agencies and some states stipulate requirements for notices to consumers when they fail to maintain hazard insurance and claims handling.
