Federally sponsored mortgage enterprises
weigh in on homeowners loss settlement
IIABA and NAMIC argued that barring purchases of mortgages protected
by ACV policies would deprive consumers of one means to reduce
premium at a time when many are struggling to find affordable coverage.
By Joseph S. Harrington, CPCU
For most of us, if you want to own a home, you need a mortgage. And if you want a mortgage, you must meet conditions established by Fannie Mae and Freddie Mac, the “government-sponsored enterprises (GSEs)” that purchase and hold most residential mortgages in the United States.
Among those conditions, to protect GSE collateral, is a requirement that mortgaged dwellings be insured for property loss. To that end, Fannie Mae and Feddie Mac announced in early 2024 that, as of June 1, they would be rejecting mortgages for dwellings insured for actual cash value (ACV) only. Eligible mortgages would have to be backed by replacement cost dwelling coverage.
For agents and insurers—and consumers, if they knew of it—the announcement was bad news at a bad time. A spirited response prompted the GSEs to back off and postpone the proposal indefinitely while interested parties deliberate.
Limiting options
In a joint letter to a federal agency overseeing the GSEs, the Independent Insurance Agents & Brokers of America (IIABA) and the National Association of Mutual Insurance Companies (NAMIC) argued that barring purchases of mortgages protected by ACV policies would deprive consumers of one means to reduce premium at a time when many are struggling to find affordable coverage.
Among other things, the letter explained that insisting on replacement cost coverage would be inappropriate for people who purchase older homes with the intention of renovating them. In those cases, the replacement cost may quickly exceed the mortgage balance; the mortgage holder would gain nothing from the added coverage.
Similarly, the letter explains that owners of manufactured homes may prefer to insure their dwellings for the purchase price, which is often lower than the cost of comparable site-built homes, and add replacement cost coverage for partial losses.
Apart from these coverage concerns, the associations argue that the GSE proposal requires extensive planning and coordination for how consumers, lenders, insurers, and agents will monitor and report on the status of insurance coverage.
Is this new?
There’s some dispute whether the 2024 proposal constituted a new rule or a renewed effort to enforce existing ones, but the point will presumably be moot as the various parties deliberate in coming months. As it is, Fannie Mae and Freddie Mac have included insurance loss settlement requirements in their guidelines for mortgage sellers and servicers, even if those guidelines haven’t been universally enforced.
Fannie Mae specifies that property insurance on a one- to four-unit family dwelling must amount to the lesser of:
- 100% of the current replacement cost of “improvements” (building property),
- The unpaid principal on the loan, if that amount exceeds 80% of replacement cost; or
- 80% of the current replacement cost, if the unpaid principal is less than that.
Freddie Mac expresses things differently, stating that the required insurance must be the greater of:
- The unpaid principal balance of the mortgage; or
- 80% of the current replacement cost.
Freddie Mac adds another requirement:
The coverage required . . . must not exceed the replacement cost of the insurable improvements, even when the [unpaid principal balance] of the mortgage exceeds such replacement cost.
That’s a curious comment, given that property insurers cover structures for their replacement costs, not for unpaid balances, although the GSEs might be better off if the latter were covered. Clearly, there’s good reason for some clarifying conversations among insurers and mortgage lenders.
While they’re at it, the parties will probably want to clarify consideration of insured perils. While Fannie Mae and Freddie Mac are keen to secure replacement cost coverage on their collateral, their sometimes-contradictory provisions regarding covered causes of loss may be leaving them exposed.
Each of the major GSEs requires that residential mortgages they purchase must be protected from the following perils: fire, lightning, explosion, smoke, windstorm, hail, riot, civil commotion, vehicles, and aircraft. If one of those perils is not covered under the dwelling policy coverage, separate insurance for that peril must be acquired.
Agents and brokers will readily recognize how that list of perils falls far short of what is found in the market today. Ironically, the list mirrors the list of covered perils in the essentially defunct HO-8 policy, which provides ACV coverage. Even the rarely used HO-1 and HO-2 forms provide broader perils coverage.
In their efforts to ensure replacement cost coverage, the GSEs may be overlooking a factor that could leave some mortgagees with no coverage at all. Yeah, it’s time to talk.
The author
Joseph S. Harrington, CPCU, is an independent business writer specializing in property and casualty insurance coverages and operations. For 21 years, Joe was the communications director for the American Association of Insurance Services (AAIS), a P-C advisory organization. Prior to that, Joe worked in journalism and as a reporter and editor in financial services.
