Friday, 7 June 2013

Mortgage-linked insurance coverage: a lucrative business for banks, but not obligatory for clients

Do you know what you're signing?
SPAIN Even if mortgages were easily obtainable these days, and even if one were achieved in the present market, it is certain the mortgagee (the client, in fact) will be obliged to contract insurance linked to the mortgage. It may be life or accident insurance with the financial entity as beneficiary, what is sometimes called non-payment guarantee, or unemployment insurance. Those are 'against' the person; for the property itself, 'obligatory' insurance will probably be against damage by water or fire, for instance. But not all 'obligatory' insurance is required by law.>>>
Present practice by those financial entities is to require insurance coverage as described above, and maybe more.

They will say that the mortgage may not be approved unless such insurance is contracted. And, of course, the insurance 'must' be contracted through the bank's own insurance company, although not all  own such an entity but might have agreements with some of the larger companies.

The thing is, there is no legal requirement for any of it. So it is imposed by the banks themselves - which also means it is negotiable.

Articles 5 and 8 of Law 2/1981 of March 25, Regularization of the Mortgage Market, says that if a credit establishment wishes to emit bonds based on its mortgage business, the mortgaged properties must be covered by damage insurance. But it does not say who should pay for it ; and it certainly does not oblige the mortgagee to do so.

Given that the obligation of coverage is legally the exclusive responsibility of the financial entity, it is not fair that it should be passed on in its entirety to the client. But then, it isn't that easy to find a bank where fairness has been at the forefront of its business philosophy.

This is particularly so when damage to a mortgaged property does happen. The mortgage contract will very likely contain a clause whereby any indemnization for such damage goes to the bank, rather than the client and the owner of the property. That could mean that other, separate coverage must be obtained - preferably elsewhere.

Abusive practices
This practice is abusive not only because it obliges the consumer to contract unsolicited goods and services, but also because it benefits the credit entity exclusively. The abuse is made worse when the bank obliges a mortgage client to take on more expensive insurance than strictly necessary. Fire coverage is considerably cheaper than household insurance, for example.

Another problem is that the client is almost always unable to carry out  comparative shopping with other insurance companies as the bank will impose its own interests on the contract.

Life and accident insurance abuse
Further to what we say above about the beneficiary of the insurance contracted as described, contracting life insurance in this way has additional complications.

In most cases, the financial institution will benefit from life or accident insurance even when the mortgage has been paid off. The client will be asked to sign something to that effect, though it is much more likely to be included in the small print.

It is understood that in the case of accident insurance, an accident is such that prevents the mortgage from being paid. But in any case, the bank benefits, not necessarily its client.

XXXXXcheck : artículo 87 de la L.C.S.? XXXXXX
Banks interpret the law as they see fit

To justify their imposing clauses as described above, that is 'amortization insurance', the banks interpret the 'obligation' of such imposition because the Bank of Spain issued a circular (8/1990) that says (in translation): "financial entities must include in mortgage operations  [...] the need to constitute an insurance of amortization of the debt in case of death, invalidity, illness or unemployment of the credit holder."

You will notice that even if taken literally, the circular, while ordering the inclusion of insurance in the contract, does not say the client is also obliged to contract insurance. In other words, the bank passes on the obligation of insurance to the client without question.

Another piece of regulation on Transparency in Contracting Mortgage Loans, dated May 5 1994, in its Annex II-5 says that future costs, pending payments or those that are agreed that the mortgagee must pay, should be made clear and specific. In the regulation's annex, under letter f), it says that  'insurance derived from the life insurance of the mortgagee may be included, when applicable'. Clearly indicating the possibility of choice regarding whether to contract such insurance, or not. This in no way serves a s abase on which to impose an insurance contract.

Problems with amortization insurance
While it is certainly the job of a lending instiution to protect itself against non-payment of a loan, one of the most common problems arising from it occurs when the worst happens. That is, the death of the mortgagee.

It is common banking practice not to address the insurance company concerned, but rather the heirs of the deceased or his/her guarantors.

There are court sentences that have decreed this practice abusive. For instance, a sentence handed down by the Provincial Audience of Valladolid on April 26 1999, said that the bank involved should have contacted the insurance company well before demanding payment of the rest of the mortgage from e decesed's widow. The bank should have made every effort to recover the capital through the insurance company before going to court against the widow. Anything else, and having contracted insurance would make no sense, as would the designation of a beneficiary (covered in Article 1289 of the Civil Code).

What the bank had tried to do was get paid twice: by being the beneficiary of the insurance policy, and by recovering a good part of the remaining mortgage from the widow. An abusive practice indeed.

The client can choose the insurance company
It is also abusive practice to demand that a mortgagee contract a specific insurance company, usually linked financially with the lending entity.

A 1993 resolution by the Bank of Spain's equivalent of an ombudsman, called Servicio de Reclamaciones, tells us of a case. The claimant (i.e. the client) had subrogated a mortgage that the developer of his property had had with the bank.

Among other obligations on the contract, he was obliged to make he payments on a fire insurance taken out on the property. He requested permission to change insurance company for one that ioffered the same coverage for less money.

The bank refused on the basis that the new policy established the value of the property slightly lower than the original. This despite the fact that the property had decreased in value, and the mortgage had in good part been paid off by then.

The ombudsman decided that good banking practice had not been evident, the rejection being considered totally unjustified given that the risk to the bank was by then considerably lower than it had been when the original insurance coverage had been taken out.

Limiting competition
These practices by lending institutions go a long way to limit competition, especially when the small print obliges insurance coverage to remain current during the life of the mortgage. Should this not be so, the conditions of the mortgage could be impacted.

This clause, though, would be abusive and 'attempt against' free competition, according to Article 1.1 of the Law in Defense of Competition 16/1989, which supposedly regulates unequal conditions for the same commercial transactions or rendered services. That is it tries to create a level playing field.

Why do we quote 'old' cases and laws?
Because they are current law and regulation. This is one of the deepest problems about banking in Spain: the laws are derived from the practices of banks during the Franco era (he died in 1975), when bankers not only bankrolled his side of the Civil War, but were also allowed to practically do what they liked during the almost 40 years of his dictatorship (1939-1975), albeit under the 'laws' of the time, which favoured the banks over their clients.

Spanish legislation has not yet caught up with the 21st century in terms of banking practices, probably because the country's banks have been bankrolling all political parties in and out of government - but that's another issue.

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