How credit unions protect the items that back their loans.
What happens if a credit union needs to repossess a vehicle, but the vehicle turns out to be damaged or missing? What if a newly mortgaged home catches on fire and suddenly isn't worth the money the CU lent for it?
In a perfect world, members would always carry the proper insurance to protect those assets. But it's not a perfect world. Sometimes, under stress and financial pressure, members make poor risk management decisions and don't renew their coverage. Sometimes (although it's rare) they even skip town or trash the house. How can CUs best protect themselves from loss?
One of the main ways is by purchasing insurance. Collateral protection insurance might not be as well known as general liability or workers' comp, but it's just as necessary.
"I coined the term 'lender asset protection' because my industry is terrible at categorizing this stuff," says Scott Simmonds, CPCU, ARM, an insurance consultant (www. scottsimmonds.com) based in Saco, Maine. "This is insurance against the collateral in a loan transaction."
Passing on the Cost
Insurance on lender assets takes many forms, but one of the most common and basic is tracked collateral protection insurance, also known as lender-placed or forceplaced insurance.
"The way a tracked program works is, the insurance provider gets the loan file from the credit union, matches up insurance to those loans, and any borrowers who do not have insurance would go into some type of notice cycle," explains Jay Morgan, director of product management for collateral protection at CUNA Mutual Group (www.cunamutual. com), a CUES Supplier member in Madison, Wis.
"The provider sends notices on behalf of the credit union to the members, reminding them of the requirement in their loan agreement to have valid insurance. They'll receive a series of notices if they don't provide proof of insurance. Eventually, then, the provider would force-place coverage (put coverage in place and bill the borrower) and a certificate would be issued."
Force-placed insurance is always significantly more expensive than insurance that a home or auto owner would buy on the market. The cost of it is borne by the borrower. Morgan recommends credit unions re-amortize loans when this happens, adding the cost of the insurance onto the monthly payment.
In most cases, because of the amount of time it takes to monitor asset insurance coverage and the expertise it takes to navigate the regulations surrounding it, credit unions outsource this task.
"Most of the medium and large credit unions would look at a tracked solution," which outsources the process of matching insurance to see which members do or don't have valid coverage, Morgan says. "If they do any kind of volume, it's just more efficient for them to contract with a provider to do all of this."
He says when shopping for a provider, credit unions should look for experts in collateral protection, find out which insurance company or companies they work with, and make sure they'll be able to integrate with the CU's core system.
"I would also evaluate how that company would treat their (credit union's) members," he says. "How are the notices worded, and how are phone calls handled? Can the credit union listen to those phone calls? Many of the best providers will record phone calls and let clients listen to them on demand. CUs differentiate themselves on relationships with their members, so that's a critical piece."
It's also possible for a credit union itself to decide when to place insurance on a car, home, or other asset. It's called an immediate-issue program.
"This is a situation where the credit union would be identifying which loans or which members do or don't have insurance," explains Morgan. "If they identify someone who's uninsured, they could order a certificate to be force-placed specifically in that situation and on that loan. Then the cost of that insurance is added to the borrower's loan, just like in a tracked program. But with an immediate-issue program, it's the credit union determining where they need to place coverage, as opposed to having a provider do all that tracking and matching of insurance to the loan file."
Similarly, Simmonds mentions that there's specialty insurance for foreclosed properties and vehicles. It's insurance that is placed on loan collateral by the financial institution after a foreclosure, to protect its interest in the property that is now in their possession. (Read more in this article: cues. org/061014insurancequestions.)
Home vs. Car Loans
Brad Young, chief operating officer of the financial institution group at SWBC (www. swbc.com), a San Antonio-based company that provides insurance tracking, policy placement, and collections services, says recently there have been several major litigation settlements in the industry regarding lender-placed mortgage insurance. Every large commercial bank has been touched by these settlements.
The problem was, historically, insurers paid commissions to lenders that forceplaced loan asset insurance. They also gave the lenders free tracking services. But the Consumer Financial Protection Bureau (www.cfpb.gov) and several state attorneys general ruled that financial institutions can't require borrowers to carry expensive premiums for lender-placed insurance and receive free services on the borrowers' dime.
"Consequently, the industry has responded by charging for the services, lowering the premiums dramatically, and no longer paying commission," Young explains. "So the credit unions and banks are bearing those additional costs now."
CFPB has been much slower to respond on the auto insurance side, and has not issued any regulations regarding force-placed auto loans. Young says many credit unions are still receiving compensation from insurers for force-placing auto policies, and the policies they're placing are expensive ones that cover everything from repossession expenses to mechanics' liens (an interest in the title to property for the benefit of those who have supplied labor or materials that improve the property). He believes that's illadvised-that they should not be getting a kickback, and that lower-premium policies may help both member and institution.
"We're not only advising our customers that it's best to not take commission, but we're also recommending they go to a more pared-down policy that's physical damage and theft only and costs significantly less," Young says. "[With the older, more expensive policies], you had all these benefits on one hand, but on the other hand you created a problem because of the huge premium you were adding to the loan balance. You underwrote him for a $400 car payment and now he's paying $600. When you do that, you force him into voluntary repossession, and now you're looking down the barrel at a $6,500 to $7,000 deficiency balance loss," the remaining amount due a lender after the collateral securing a loan is sold for less than the outstanding loan balance.
Just in Case
But what do smaller credit unions do if they can't afford to hire the expertise needed for loan tracking and insurance placement? Morgan says many opt for blanket insurance.
"They pay an annual premium to the insurance company, and the blanket policy covers their entire loan portfolio," he explains. "So with a blanket program, the insurance provider, the carrier, is not tracking which members do or do not have insurance. They're not sending notices or force-placing on individual loans. The credit union just pays an annual premium."
With smaller loan volumes, these CUs tend to be able to afford blanket policies with more ease. Some smaller institutions are also very protective of their members and don't want outside companies dealing with them, Morgan suggests, and this approach fixes that problem as well.
Blanket coverage can have many names. Simmonds calls it mortgage impairment coverage in the case of a home loan, and lender's single interest coverage in the case of an auto loan.
"The mortgage impairment coverage is a coverage on the portfolio of loans," he explains. "The idea is, if I've got 1,000 loans, at any one point, 10 of them don't have insurance on them. I just don't know which 10. This is coverage protecting the financial institution's interest."
Morgan says in some cases, a credit union may have both a blanket policy and an immediate-issue policy. Those can be used together on both mortgages and consumer auto loans. For example, the CU may discover that a member doesn't have car insurance and force-place insurance on that vehicle to help control its loss ratio and reduce the amount of claims that will need to be submitted under the blanket program.
Blanket policies are a good backup for individual policies that may not be placed in time, Simmonds notes.
"Mortgage impairment takes care of the risk that a financial institution faces when the customer has not bought insurance, then there's a loss, then the credit union figures out there's no insurance," he says. "It's a problem of timing. Had the credit union known that the coverage was canceled, they would have force-placed the coverage. The classic example would be a customer who calls the credit union and says, 'I've got some bad news and some worse news. The bad news is my house burned. The really bad news is my insurance was canceled last week and I didn't tell you.'"
Just a Mouse Click Away
It may seem strange that lender asset protection works this way. Isn't there some technology that alerts CUs to lapses in insurance right when they happen? Simmonds says he's not aware of any such tech for home insurance.
"There's no central repository of information that's updated when State Farm cancels an insurance policy," he says. "What's supposed to happen is that if an insurance company has a mortgage clause on a homeowner's insurance policy, they're supposed to notify the financial institution. That almost never seems to happen."
There is plenty of other technology in the automobile lending sector, on the other hand. Most of it has to do with locating, disabling, or acquiring vehicles that must be repossessed. Starter interrupt, for example, is increasingly used in the car sales business to shut down cars whose owners have stopped making payments. But it hasn't gotten deep roots in the credit union world. Morgan says CUNA Mutual and its partners don't use it.
Young explains: "Those technologies really haven't taken hold in the credit union space to date, primarily because credit unions are not nearand subprime lenders," he says. 'Your typical credit union [auto loan] is going to be A and maybe some B quality paper, and you're not typically adding starter interrupt devices to members' cars. Think of it this way: It's a competitive industry. If you go out and get a car loan and they say, 'You've got to go by this shop to install a starter interrupt device,' you probably would take exception to that."
On the other hand, license plate recognition is a big deal all across the auto lending world, and it doesn't require tampering with a member's vehicle. Young says more and more tow truck drivers in the United States have installed cameras on their trucks. When they're not actively towing vehicles, they cruise parking lots, airports, and neighborhoods, snapping pictures of millions of license plates per month.
"What happens is, the repossession companies load up all their VINs (vehicle identification numbers) into this system, and the license plate recognition company converts those VINs into license plate numbers," Young says. "When the tow truck drives by a car that's in the database, bells go off in the truck. The driver's laptop lets them know the car is out for repossession and gives them a number to call to validate. And then they'll turn around and tow the car."
Young says one of his colleagues can personally vouch for the efficacy of the technology. Recently, she was demonstrating the system for a client and typed in her own VIN. The company SWBC works with to consign repossessions didn't note that it was a demonstration. Soon after, a tow truck drove down her street, picked up her license plate, backed up and towed her car away.
"So it does work!" laughs Young.
In many cases, though, the first and best technological investment a CU can make to secure its lending portfolio is to use an outsourced system that can communicate with the CU's data processor, automating the monitoring process. If a CU is big enough to consider advanced repossession technologies, it's probably also big enough to have a sophisticated insurance placement system for its collateral.
"If the CPI provider can integrate with your core processor, your staff can be more efficient in how they perform their collections role and in how they interact with the collateral protection program," says Morgan.
"If I'm going to provide some outsourced collection services, I've got to have some kind of two-way communication with the core," he says. "The same way with the lending side, [where we talk] with their loan origination system. Creating that integration is expensive and time-consuming, but once you accomplish it, it's a pretty efficient way to work."
For small CUs with tiny loan portfolios, simply carrying a blanket insurance policy on collateral sounds like an appealing option. That way, you don't have to devote precious human resources to tracking your members' insurance coverage, right?
Well, almost. Flood insurance is the exception. For homeowners in flood zones, the Federal Emergency Management Agency's National Flood Insurance Program (www.fema.gov/national-flood-insurance-program) requires lenders to track flood insurance, notify the borrower if there is a cancellation or expiration, and place coverage.
"Right now, there are no financial institutions that do not track flood insurance," says insurance consultant Scott Simmonds, CPCU, ARM, an insurance consultant (www.scottsimmonds.com) based in Saco, Maine. "They have to. The federal government has made the responsibility of making sure that flood-prone properties are insured" belong to the mortgage holder.
Flood insurance also has public relations implications for credit unions. About five years ago, FEMA started redrawing flood zone lines because of an increase in flooding of properties that hadn't previously been considered susceptible.
Hurricane Sandy exacerbated the issue, says Simmonds. At least half the properties that were flooded were not in flood zones. So FEMA realized its interests were served by larger and larger flood zones. The agency feels the heat when homes that are not in a flood zone are damaged, but no one criticizes it when homes flood inside the flood zone.
When members' houses are newly designated flood-prone and they receive a letter from the credit union requiring them to purchase flood insurance, they can become irate, Simmonds says.
"Same house, same mortgage, but now the owner has to spend $1,500 a year buying flood insurance," he explains. "And if he doesn't, the credit union is forced to force-place flood insurance, and they are forced to add the premium for the flood insurance onto the homeowner's mortgage."
Unless the CU has a delicate touch and invests in a bit of education, it can be a bitter pill.
"Who's getting blamed for this?" Simmonds asks. "The credit union. Nobody goes to the cocktail party and says 'FEMA made me buy flood insurance.' They're going to the cocktail party and saying 'ABC Credit Union is making me buy flood insurance."'
Download the "Insurance Assurance Toolbox" by Scott Simmonds, a do-ityourself guide to credit union insurance at cues.org/insuranceassurance.
Find free articles about CU insurance by Scott Simmonds at cumanagement. org/archive. Search for "Insurance Matters." Also read two articles by Simmonds about force-placed insurance. Search for "placed insurance."
Read CU Management articles about starter-interrupt devices at http://tinyurl. com/s tarterin terrup t.
Read an article by CUNA Mutual on flood insurance at cues.org/102413 oncompliance.
Jamie Swedberg is a freelance writer based in New Jersey.