Impairment Coverage Could Aid Lenders Hurt by Katrina.(flood insurance)

Raymond Reed is the chief underwriting officer of Lenpex, a Deans & Homer affiliated company. As a managing general underwriter, Lenpex provides insurance solutions and related consulting services to the mortgage lending industry.

Hurricane Katrina caused more flood and wind damage to property than any previous event in U.S. history. As chronicled in the media, many of the owners of the damaged properties do not have adequate insurance to make the necessary repairs. Not so well publicized is the fact that many lenders hold mortgages on those properties.

Aid from federal and local governments, as well as efforts made by lenders to keep homeowners in their homes, will no doubt have a major impact on the number of foreclosures. Unfortunately, however, there will still be much unrepaired damage and there will be many foreclosures. How these foreclosures will impact the mortgage lending industry has not yet been determined, but for many lenders a mortgage impairment policy will soften the blow.

Fannie Mae, Freddie Mac and Ginnie Mae all require their lenders to purchase mortgage errors and omissions coverage, which is often included in a mortgage impairment policy. Due to widespread damage caused by Katrina and the likelihood of uninsured damage, the mortgage impairment policy can have value well beyond compliance with the secondary mortgage market's requirements for insurance.

A mortgage impairment policy is a hybrid insurance product that provides both first-party mortgage holder's interest coverage and third-party mortgage errors and omissions coverage. The first party coverage protects the lender from its loss of mortgage holder interest due to uninsured physical damage to mortgaged property. Basic coverage protects against "required perils" or those causes of loss that the lender requires the borrower to purchase to insure the mortgaged property.

For example, most mortgage documents require the borrower to obtain and maintain fire coverage on the mortgaged property, so as a required peril, a basic mortgage impairment policy would protect the lender if a mortgaged property was damaged by fire and if the borrower did not have the required insurance. Some insurers also offer a broader coverage that protects the lender from damage to collateral caused by causes of loss "not required" to be insured in the mortgage documents. Such coverage often extends to flood and earthquake.

If a mortgaged property is not located in a Special Flood Hazard Area (Flood Zones A and V), lenders typically do not require the borrower to obtain flood coverage. Hurricane Katrina caused flood damage to many properties outside of the Special Flood Hazard Area, so the broader MI coverage may become beneficial to the ...