In certain situations, insurance companies may hedge their risk against any loss in an insurance contract. This is called re-insurance. Typically, no one would have an issue with this as it is smart to minimize your risk in certain situations.

How would you feel if I told you that your mortgage company can hedge its risk against you, not by re-insurance, but by forcing you to own flood insurance at a high premium rate without giving you an opportunity to shop for the cheapest option. Not only are you paying higher premiums, but you typically pay service or administrative fees to the mortgage company for acquiring the insurance for your property. This is called “forced-placed” or the more friendly term “lender-placed” insurance. Force-placed policies are typically taken out by banks or other lenders on homes where the owner does not have sufficient or any coverage. Regulators in the past have accused insurers of dramatically overcharging for such policies. You can’t blame the mortgage company for wanting to hedge their insurance coverage on you, but only if it is done legally.

Ordinarily, in an open marketplace, your mortgage company would shop for the cheapest, best suited, policy for you. You can do the same thing with mortgages (e.g., lendingtree.com). The problem arises when a mortgage company, or bank, has a prior arrangement with an insurance company to send the all of their forced-placed insurance contracts. Even more onerous is when it’s alleged the insurance company would send a “kickback” (or commission) to the mortgage company for more forced-placed contracts. Such was the case recently in class action lawsuits in New York and Colorado against HSBC and American Security Insurance Company which settled out of court on Friday, April 10th. The plaintiffs alleged that HSBC imposed force placed insurance policies with loss limits exceeding the outstanding mortgage balance. The plaintiffs, in their motion for approval, stated:

The proposed settlement returns approximately 90% of the commissions that were paid to the HSBC defendants in connection with [forced-placed flood insurance] placed during the class period. . . .

The deal would also bar HSBC from ordering insurance for customers at a higher level than necessary when their policy lapsed.

Flood insurance is expensive and we all know it will get more expensive in the wake of the Biggert-Waters Flood Insurance Reform Act and the Homeowner Flood Insurance Affordability Act of 2014. Wouldn’t you prefer to select your own insurance coverage rather than a mortgage company, whose interests may not be aligned with your own?