MBA (6/29/2007 ) Ochoa, Stephanie
(Stephanie Ochoa is owner of Ochoa and Associates, Irvine, Calif., and also serves as chair of the Mortgage Bankers Association’s State Legislative & Regulatory Committee.
 Nearly two years after Hurricanes Katrina and Rita, policymakers continue to debate the best approaches to resolve gaps in insurance coverage and other issues. However, for those of us in the industry, as well as consumers, action—not talk—is needed.
Congress this month revisited flood insurance and flood insurance reform in the continued wake of the devastation and recovery in New Orleans and the Gulf Coast. The House Financial Services subcommittee on Housing and Community Opportunity recently held a hearing on H.R. 1682, the Flood Insurance Reform and Modernization Act of 2007. Additionally, the House Financial Services subcommittee on Oversight and Investigations and the Homeland Security Management subcommittee on Investigations and Oversight held a joint hearing on flood insurance issues exposed by Rita and Katrina.
Both hearings also examined the National Flood Insurance Program and its interaction with private insurers and the allocation of insurance claims. The House Financial Services Committee is expected to mark up H.R. 1682 later this summer and bring the bill to the House floor.
On the litigation front, major insurance companies are involved in preliminary arguments in a lawsuit filed by policyholders, who allege that insurers underpaid Katrina claims by colluding with a software manufacturer to keep property replacement costs artificially low. The suit alleges that insurers, through the software manufacturer, quoted prices for building materials that were “substantially lower” than standard market value when adjusting and resolving payment for Katrina claims.
Among these and other issues that have bubbled up as a result of the tough scrutiny of experienced individuals and entities that have committed their time to these efforts is the concept of “guaranteed replacement cost vs. replacement cost.”
Until recently, challenges between two replacement-cost theories may have been less understood by many, especially homeowners. However, now that we are even more aware of the degrees of loss due to environmental catastrophes, it is timely to examine that gap, or, at the very least, to bring it to the attention of homeowners.
In a microscopic-sized nutshell: Up to about 10 years ago, most homeowner policies contained a “guaranteed replacement cost” clause that was understood to mean that the home would be rebuilt—essentially replaced. However, some insurance clauses guaranteed only “replacement cost,” which meant that the stated value of the home only was covered. This resulted in the potential to leave up to about 58 percent of property undervalued.
Estimates suggest that more than one-fourth of homeowners—26 percent—are underinsured. This can be due to upgrades that have not been addressed in the policies at the time of installation or renewal. It can also be due to construction costs due to seasonal supply and demand, regional demands and regional inflation, It might be as simple as a lack of attention by the homeowner because of stresses on quality time among families with two working parents.
Those potentially affected by the unintentional gaps created by the varying limits of coverage include the lender, the borrower, the servicer and those who ultimately have the beneficial interest in the mortgage, including a securitization trust.
It would appear that during loan origination—at the underwriting stage—if the amount of insurance was reviewed and considered due to varying factors to assess adequate coverage, and adequate coverage was ultimately maintained, the parties involved would all be better protected in the event of loss. So, a quick and relatively inexpensive step added to the process could potentially save an immeasurable amount of money that may have otherwise been lost.
If lenders, borrowers and investors would demand that coverage be evaluated at the underwriting stage, or at some point during origination, it would make sense that the parties would all be guaranteed proper, if not more adequate coverage.
As it is with compliance high cost and compliance rules engines, as well as with fraud detection engines, all of which the servicer and investor communities are becoming more aware, perhaps wider spread usage of a tool that addresses the underinsurance issue on the front end is another way to minimize many facets of potential risk. Now that the issue has been discovered, perhaps a solution of evaluating and confirming proper coverage will become a viable option for protecting the parties involved in the loan transaction.
One common misconception during my days as a compliance officer was that the compliance department was merely overhead—another department that just wanted to say "no." Instead, think of your compliance department as a haven to explain the challenges and changes ahead—a place that offers alternatives and working solutions that benefit all involved.
Compliance departments and compliance tools are not overhead; instead, they are critical parts of the proces that I refer to as a department that will offer solutions to provide "lack of loss" while assisting with risk management.
(The views expressed do not necessarily reflect the policies or views of the Mortgage Bankers Association. MBA NewsLink welcomes your articles on issues involving the real estate finance industry. Articles/inquiries should be sent to Mike Sorohan, editor, at msorohan@mortgagebankers.org.)
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Publisher: Cheryl Crispen, Senior Vice President - Communications and Marketing
Editor: Mike Sorohan 202/557-2855 MSorohan@mortgagebankers.org
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