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HO Coverage for Homes in Foreclosure

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Bill Wilson
Abstract
Do you have any homeowner insureds whose homes are or have been in foreclosure? Do you have any mortgage companies who, as a result of a foreclosure, are insisting that you return unearned premium to them? This article should give you some food for thought as you deal with this growing problem.

Question..."With so many homes going into foreclosure/repossession, I've been asked the question what our responsibility is in the following cases: (1) House is repossessed but INSURED calls in to cancel policy and refund comes (A) if insured is premium payor or (B) if mortgage holder is premium payor, and (2) House is repossessed and BANK calls in to cancel policy and refund comes in (A) if insured is premium payor or (B) if mortgage holder is premium payor."
Question"The mortgagee has notified the insurance company that our insured's loan has gone into foreclosure. A first legal action has been mailed. The borrower still has the opportunity to reinstate their loan which would cause the foreclosure action to be cancelled. The insurance company is going to set up a cancellation for this property, unless we get proof from the homeowner that the dwelling occupied and not going thru foreclosure. Is this a legal reason for cancellation?"
Question"With foreclosures on the rise, we’re getting an increasing number of cancellation requests from mortgage companies. They’re asking us to cancel our policies as of the date the ownership was transferred (I assume because their force-place contract then kicks in) and refund any unearned premium to them. Two questions:

"First, is it appropriate for us to honor these requests since our policyholder no longer has an insurable interest in the home? Or are we still subject to notice requirements since the policy also provides liability, contents, etc.?
"Second, when the policy is ultimately canceled (at the mortgagee’s request or by us), is it appropriate for us to return the unearned premium to the mortgage company? What if the premium was paid by the policyholder?"
Answer?These kinds of questions have been flooding in lately. We ran a quick blurb months ago in our VUpoint newsletter but it's time we added something permanently to the library. The first caveat to keep in mind is that we're not lawyers and aren't offering legal advice. We recommend that you run this by your counsel because what you can or can't and should or shouldn't may very well be governed by statutes, regulations or case law in your state.
Lenders around the country are contacting agents and demanding that homeowners policies be cancelled and unearned premiums be returned to the lenders on foreclosed properties. Because of underlying legal issues that could involve statutes, loan agreements, case law, or other legal parameters, we cannot suggest a specific course of action other than pointing out that an insurance policy is a contract between an insured and insurer. The agency is not a party to the contract, nor under normal conditions is a lender aside from a mortgage or loss payable clause. Therefore, the agency should consider directing the lender to the insurer.
We've heard of insurers initiating cancellation procedures against insureds based on foreclosures constituting a material increase in risk in states where that is a valid basis for mid-term cancellation. One state regulator that we're aware of has restricted cancellations even for unoccupied dwellings.
In examining the current ISO HO-3 policy, we see nothing in that form which gives a lender a right of cancellation of a contract to which it is not a direct party. We also see nothing in that form which entitles a lender to any unearned premium proceeds under a contract between two parties, one of which is not privy to the loan agreement. Whether the lender has any rights that supersede the policy is a question that a qualified legal professional would have to answer.
Two coverage issues do arise. First, if the HO named insured no longer owns the real property, his or her insurable interest may vanish unless such interest is imposed by the loan agreement. However, keep in mind that the HO policy provides coverage for personal property and liability coverage. The lender certainly does not have a right to cancel coverage of property in which it has no interest unless there is a legal precedent for this.
Second, if the insured has vacated the premises, there is one school of thought and a body of case law in some jurisdictions that says that coverage on the dwelling ends when residency ends. If that's the case, neither the named insured nor the lender may have coverage under an in-force HO policy, coverage for the latter depending on what notice the mortgagee may have provided to the insurer in accordance with the mortgage clause. For more on this issue, check out this VU resource:
Again, the policy is a contract between insurer and insured. For the most part, only those two parties have any right to cancel the policy and receive any premium refund. A notable exception is premium financing where the finance company has power of attorney. Most mortgage clauses don’t give a mortgagee any right of cancellation or entitlement to receive a premium refund. There might be an exception by statute or regulation for payment out of escrow, but that would require a legal opinion. Absent that, an agent would have to be very careful about accepting a cancellation request from a mortgage company or sending them any return premium. Let the insurer handle the matter entirely…it’s the agency’s customer (or ex-customer), but the insurer’s contract.
Last Updated: October 19, 2012

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Revised: February 2012