Mortgage insurance is a type of credit insurance where a mortgage lender is insured against a loss from a default by the borrower. There are several mortgage insurers still in the market today, and all are currently feeling the effect of the mortgage crisis with higher loss ratios and reductions to capital. Accordingly, now more than ever, mortgage insurers are relying on certain policy provisions and exclusions to deny coverage or, at the very least, reduce the claims amount. In some instances, it appears that mortgage insurers are overzealously interpreting and applying these provisions to reduce their claims exposure and salvage capital.
One of the more overly asserted provisions that has arisen recently between lenders and mortgage insurers involves mortgage loan modifications. Most mortgage insurance policies contain a "loan modifications" provision, which requires the policyholder to obtain advance written approval from a mortgage insurer before making any changes in the terms of a loan. A typical loan modifications provision, in pertinent part, provides:
"Unless advance written approval is obtained from the company, the Insured shall not make any change in the terms of the loan, including, but not limited to, the principal amount borrowed, the property securing the loan, the interest rate, payment terms or amortization schedule of the loan."
Given the downturn in the economy and push by the federal government and mortgage lenders to restructure certain types of loans, the loan modification provision contained in most, if not all, mortgage insurance policies is increasingly becoming a hot topic of dispute between policyholders and their mortgage insurers.
Mortgage insurers have not flinched to terminate coverage where the policyholder has changed the terms of a loan and failed to obtain advance written approval before doing so. Such conduct in the face of government-mandated changes in the mortgages seems particularly egregious and unfair. That fact is bolstered by the reality that lenders are actually reducing the risk faced by mortgage insurers through the loan modifications.
After the deterioration of the U.S. economy beginning in or around mid-2007, the federal government and mortgage lenders took steps to prevent mortgage defaults. In March 2009, the U.S. Department of the Treasury announced details of the Home Affordable Modification Program (HAMP), a loan modification program designed to reduce delinquent and at-risk borrowers' monthly mortgage payments. In addition to HAMP, mortgage lenders have implemented pilot programs designed to lower the actual principal of mortgages for homeowners whose homes are underwater.
Certain government-sponsored enterprises have obtained blanket delegations of authority from most, but not all, mortgage insurers so that mortgage servicers can more efficiently process modifications without having to obtain the mortgage insurer's approval for individual mortgage loans.
However, in an abundance of caution, and in order to prevent a coverage dispute down the line, policyholders should, before making any loan modifications, consult their mortgage insurers for specific processes related to the reporting of modified terms, payment of premiums, payment of claims, and other operational matters in connection with mortgage loans modified under HAMP or any other voluntary or mandatory modification program. Coverage may depend on it.
Even under policies that do not expressly require advance "written" approval, the policyholder should, as a prudent risk management exercise, obtain the mortgage insurer's written approval before making any loan modifications.
Policyholders should be mindful that, while mortgage insurance may be essential, insurance coverage problems frequently develop upon the default of a borrower. Especially given the current state of the economy and housing market, mortgage insurers now, more than ever, will battle their policyholders in an effort to reduce insurance coverage for sizeable claims. By developing a fundamental understanding of their mortgage insurance policies and the typical coverage disputes that arise with mortgage insurers, policyholders can enhance their position to secure insurance coverage.
DOUGLAS CAMERON is a partner and practice group leader of the firmwide Insurance Recovery Group at Reed Smith.
March 29, 2011
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