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An FSP may not make an LMI policy claim while FOS is considering a dispute ... and more

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From: FOS Circular Autumn 2012:

Lender's Mortgage Insurance

FOS receives a number of disputes in which the applicant is in financial difficulty, the sale of a property securing their loan from the financial services provider (FSP) does not repay the loan in full and an unsecured shortfall debt remains. If there is a lender’s mortgage insurance (LMI) policy in place, the FSP may have made, or may intend to make, a claim on the policy after settlement of the sale of the security property.

This article outlines FOS’s view on an FSP’s obligations in dealing with a customer in financial difficulty when the FSP has made a lender’s mortgage insurance claim or may potentially do so after the sale of the customer’s property.


Our Terms of Reference and LMI policy claims

Under paragraph 13.1(a)(iii) of our Terms of Reference (TOR), an FSP:

“must not take any action to recover a debt the subject of the Dispute, to protect any assets securing that debt or to assign any right to recover that debt, while FOS is dealing with the dispute”.

The act of claiming on an LMI policy does not in itself constitute recovery action. However, if a claim is made and paid then an assignment will occur for the purposes of – and in breach of – paragraph 13.1(a)(iii). This is because, pursuant to the terms of the LMI policy or as a matter of equity, the insurer is subrogated to the rights of the lender.

The doctrine of subrogation was described as follows by Walton J in Burston Finance Ltd v Speirway Ltd [1974] at p 1652:

“simply that where A’s money is used to pay off the claim of B, who is a secured creditor, A is entitled to be regarded in equity as having had an assignment to him of B’s rights as a secured creditor”.

Subrogation was recently considered by the Supreme Court of Western Australia in Saraceni v Mentha [2011] WASC 94. In that case, the court noted that the right of subrogation is akin to an equitable assignment.

FOS regards the transfer of rights from an FSP to an insurer under an LMI policy, whether under a right of subrogation or by assignment, as prohibited by paragraph 13.1(a)(iii) of our TOR. This is because it involves the transfer or assignment of the right to recover the debt to the insurer.

Therefore, an FSP may not make an LMI policy claim while FOS is considering a dispute.


Previous communication about LMI policy claims

In Issue 2 of The Circular, in the article ‘Secured debts and shortfall issues’, we set out our approach in relation to financial difficulty and a shortfall debt on the sale of a property. We consider that entering into an LMI policy with an insurer does not override the duties or obligations that a FSP has to its customer, including the obligation to give genuine consideration to a customer experiencing financial difficulty.

We can review what steps the FSP has taken to assist its customer with any financial difficulty they are experiencing in repaying the shortfall debt. If an FSP merely follows the direction of its insurer and does not form its own view on the customer’s ability to repay the residual debt under a repayment arrangement, it may be unable to demonstrate that it has met its obligation to genuinely consider a hardship variation. If we conclude the FSP has not met its obligations, we can require the FSP to vary the credit contract in order to better address the applicant’s financial difficulty.

An award for non-financial loss may be made under our TOR if an FSP is found to have breached its obligations under 25.2 of the Code of Banking Practice or under the Mutual Banking Code of Practice (Codes) or good industry practice.


Recent changes

Since the article in Issue 2 of The Circular was published, the National Credit Code has been introduced. It requires all FSPs, including insurers, to be a member of an external dispute resolution (EDR) scheme. As a result of this, we have reviewed our approach to LMI policy claims.

How we handle a dispute will depend on where the debt resides. If the debt is currently with the FSP, then in most cases we will raise the dispute against the FSP and we will expect the FSP to take no further steps in making an LMI policy claim until the dispute has been finalised.

If the FSP has made an LMI policy claim before the applicant lodges the dispute with FOS but the claim is yet to be paid by the insurer, we will not prevent the insurer from continuing to assess and process the claim. However, we will require documentation from the FSP to show that the claim was raised with the insurer before the dispute and we will still continue to consider the dispute against the FSP.

If the claim is approved, the dispute against the FSP will come to an end. The applicant can lodge a new dispute against the insurer with the relevant EDR scheme. If the applicant did lodge a new dispute, the insurer would have to cease all collection activity or recovery action while the EDR scheme is considering the dispute.

Alternatively, if the insurer declines the claim then the FSP must continue to respond to the dispute.


Terms of settlement

As with any request for financial difficulty assistance, where resolution is reached between the parties, any terms of settlement between the FSP and the applicant must comply with the FSP’s obligations under either Code or follow good industry practice. It is therefore not appropriate for terms of settlement to provide that the shortfall debt, when known, be immediately referred to the insurer. This is because the passage of time between the date the terms of settlement are agreed and the settlement date of the sale of the security property may result in a change to the applicant’s financial circumstances. The FSP should genuinely consider the customer’s ability to pay the shortfall debt when it becomes due. A repayment arrangement may be more appropriate than any claim on the LMI policy at the relevant time.

For an FSP to meet its obligations in this regard, we consider that it should:

  1. obtain a revised statement of the applicant’s financial position at the time that the shortfall debt is known
  2. consider any realistic repayment proposals from the applicant
  3. if the repayment proposals are unsuitable, suggest any alternate arrangements, and
  4. clearly communicate the outcome of the assessment to the applicant.

 When entering into terms of settlement, the parties need to ensure that the future treatment of any shortfall debt arising from the sale of the property is clearly set out and accords with the FSP’s obligations as set out above. As outlined in the article ‘Financial difficulty: What is good industry practice?’ in Circular Issue 7, when we form an opinion about a financial difficulty dispute involving a non-regulated facility, irrespective of whether the FSP is a subscriber to either Code, we will take into account the relevant Code standards, as they represent good industry practice.


Comment: Some questions....

What happens if a complaint is made to FOS on grounds of hardship and then the complaint becomes "maladministration in lending"?

What if the lender has already accessed LMI to cover the borrower's hardship situation prior to the complaint going to the EDR, either COSL or FOS?

Do FOS and COSL operate under the same rules in all ways at all times?

It's rather challenging to deal with lenders who refuse to discuss anything about the LMI with the borrower. If you have problems accessing information check your original application form plus all information you may have had at the time of the loan application. One borrower discovered that their loan application stated they could contact the insurer for information. The original insurer was fine with that. The insurance company later sold their policies to another company. That insurer refused to supply the required detail. The LMI chose to either withhold that information or they never had it in the first place for the credit checking. Both the lenders and the insurer had the necessary information on the LAF and failed to use it to assess credit worthiness in light of the law and codes applicable at the time.

More than likely the insurers simply rubber stamped it, either through assignment of approval to the lender by the insurer, or simply disinterest in the details of high volume loan throughput in the heyday of Lo Doc, No Doc and anything goes with up to 100% loans and in house lending alternatives to even finding a deposit on your home.

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Guest Sunday, 17 January 2021