Keeping What Works: How the GSEs are Protecting Homeowners, Taxpayers and the Industry
Imagine if you lost your home to a devastating fire. For most people, property insurance provides a lifeline to rebuild, repair, and recover from that event. Now imagine that you are only given the resources to rebuild half of your home. In the midst of an already difficult situation, coming up with those additional funds would be a debilitating blow for most homeowners.
This is why property insurance is an essential component of sustainable homeownership. When a loss occurs, such as water damage from a burst pipe, a fire, or wind damage, homeowners need adequate property insurance coverage so they can repair or rebuild their homes without financial burden.
That’s where Freddie Mac and Fannie Mae (the GSEs) come in. Our longstanding requirements are in place to ensure that for any home loan we purchase, insurance policies are written to provide the funds necessary for the homeowner to rebuild or repair the home at the current cost of materials and labor. There are two important aspects to this. First, the coverage amount must be sufficient taking into consideration the property’s replacement cost value (RCV). Second, claims must be settled at replacement cost, subject to the policy coverage amount – this is sometimes referred to as RCV coverage or as an RCV policy.
We do not accept actual cash value (ACV) policies, which allow insurers to estimate the cost of depreciation factors, such as the age and wear and tear of the property, and deduct the total depreciation amount from the insurance claim payout.
As disasters continue to increase in frequency and severity, and certain markets face availability concerns, it is important to ensure lenders and servicers have a clear understanding of the GSE requirements related to property insurance. These long-established requirements not only protect the safety and soundness of our companies, mortgage lenders and servicers, and U.S. taxpayers, but importantly, protect homeowners themselves.
Upfront premiums for an insurance policy with ACV coverage are typically more affordable but for the same damage or event, a homeowner may receive a lower payout than if the insurance policy had RCV coverage. An article published by the National Association of Insurance Commissioners provides the following scenario to highlight the differences between policies with RCV and ACV coverage:
For example, let’s say we have two families, the Smiths and the Johnsons. Both families have the exact same amount of damage ($15,000) to their roofs. Each family also has a $1,000 deductible. A deductible is the part (or amount) of the claim [homeowners] will have to pay out of pocket.
The Smiths have an RCV policy, meaning once the roof is replaced, they will be reimbursed the full cost of the roof repair, minus their deductible. The Johnsons have an ACV policy, meaning they will only be paid for the current value of the roof repairs, minus depreciation and their deductible. The breakdown of their payments is below.
| Family | Damage | Depreciation | Deductible | Payment |
|---|---|---|---|---|
| Smith Family | $15,000 | -n/a | -$1,000 | = $14,000 |
| Johnson Family | $15,000 | -$10,000 | -$1,000 | = $4,000 |
So, while premiums on an insurance policy with ACV coverage may seem initially more affordable for homeowners, the combined out of pocket expense of insurance deductibles and depreciated reimbursement payouts could make recovering from a significant loss financially insurmountable. This is just one illustration of why an insurance policy having RCV coverage is a key element for a homeowner’s long-term financial stability.
In February 2024, we reminded industry stakeholders of our requirements that mortgage lenders and servicers must obtain and document the RCV to confirm that the policy coverage amount is sufficient and that claims must be settled on a replacement cost basis. These were not changes in policy but included clarifications to ensure lenders and servicers comply with the GSEs’ longstanding requirements.
In recent months, however, we have received feedback from industry participants about the ability of lenders and servicers to comply with our requirements to obtain a property’s RCV. In an effort to be responsive to these concerns, on May 8, 2024, Freddie Mac and Fannie Mae issued an Industry Letter and a Selling and Servicing Notice, respectively, providing a temporary pause on the GSEs documenting non-compliance with these RCV policies.
In coordination with the Federal Housing Finance Agency, during this pause we are engaging the industry and conducting additional research to evaluate the reported obstacles to lender and servicer compliance with these requirements. We’re also reviewing the more recent concerns expressed regarding our foundational requirements that policies must have RCV coverage. In the interim, we expect lenders and servicers to continue to confirm the adequacy of property insurance coverage for GSE loans while we engage in this research. We look forward to engaging productively with stakeholders as we explore solutions to how we can best protect homeowners, the housing market, and U.S. taxpayers.
Insurance providers are important participants in the housing market, and we are dedicated to working together to support long-term sustainable homeownership. In addition, we encourage current and future homeowners to ensure they have an RCV policy when reviewing or renewing current policies or purchasing a new policy.
Additional Resources
©2024 by Freddie Mac.
