This blog post will be the 6th and final post for this series on Challenging the Force-Placed Insurance (FPI) Business Model. We have covered the early history of FPI, discussed how money center banks created a fee income FPI product, how Dodd-Frank cleaned that up, and finally, the loan servicing confusion as politicians attempted to fix FEMA.
Throughout all of these events, the basic force-placed insurance business model has not changed. Lenders have had to adjust business models to attract and retain borrowers, but insurance tracking has not changed in the last 40 years. It may be time for lenders to re-evaluate the force-placed business model. FPI trackers should do the same.
Breaking Down Break-Even
I was never formally trained in accounting, but early in my career I picked up an accounting book to learn break-even analysis.
According to Investopedia, “the break-even point is calculated by dividing the total fixed costs of production by the price of a product per individual unit less the variable costs of production.” In the case of the force-placed insurance business model, we will define these terms.
Fixed Cost: These costs include software, phone systems, office space, etc. used for the tracking operation. These are the costs that do not change in a tracking operation from month to month.
Product Price: Two revenue streams represent the FPI product price.
- Per Loan Per Month – this is a product price based on the number of loans tracked. Typically this is billed monthly to the lender. This fee is a Non-Interest Expense charged to the loan servicing department.
- Commission on Force-Placed Insurance – For break-even analysis, the commission is a product price loosely correlated to the number of loans. A typical premium rate is $0.80 per thousand dollars of the outstanding loan balance (OLB). When a borrower’s insurance lapses, the tracker will force-place insurance to protect the lender. The tracker bills the premium to the lender, who, in turn, charges the borrower. Insurance commission from force-placed premium creates insurance tracking revenue. The commission varies widely, but for our blog example, we are going to use 15%.
Variable Costs – These are the tracker’s expense that varies based on the number of loans tracked. Eighty-five percent of these costs are personnel-related costs. Other variable expenses include transaction-based software licenses (ex: OCR software), postage, envelopes, and others.
So how does all of this work? In regular break-even analysis, there are two costs (variable & fixed) and one per unit price.
FPI has an additional commission price that is based mainly on economic conditions. The number of loans force-placed in a portfolio determines this revenue stream. A 1% placement rate is the typical break-even point for the legacy force-placed insurance model. This placement percentage varies opposite to the health of the economy. Insurance trackers are profitable in a bad economy and look for additional cost-cutting measures in a good economy.
At some point, many years ago, lenders put pressure on insurance trackers to lower NIE associated with insurance tracking. Trackers complied and dropped per loan per month insurance tracking price below the actual cost to track the loans. Insurance trackers bet that commission revenue would be sufficient to ensure profitability.
In a good economy, lower commission revenue would drive insurance trackers to reduce their costs to remain profitable. Borrowers suffered as service levels decreased along with the tracking costs. This reduced service level was acceptable in the 1980s as bankers would say, “These borrowers are not living up to their obligations.” This statement may have been true 40 years ago, but today, that attitude will not retain customers.
Once trackers found ways to reduce costs (and the associated service levels), these remained constant even when a bad economy created increased commission levels. Low service levels are the root cause of why the force-placed insurance industry has a bad reputation.
There Must Be A Better Way
In 2006, Miniter Group created a new business model. This model allows insurance tracking costs to increase 50% over today’s insurance tracking industry standards, lowers NIE for the lenders, and does not rely on borrower force-placement to ensure profitability for the tracker. This Borrower-CentricSM Insurance Tracking Model gives insurance trackers additional operational budget to provide exceptional service for borrowers.