The Federal Housing Finance Agency (FHFA) is considering litigation against mortgage lenders and insurance providers for allegedly colluding to overcharge Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) over the last few years.

“Our analysis suggests that the Enterprises have suffered considerable financial harm in the LPI market,” says a recent FHFA Office of Inspector General report. “We estimate that—in 2012 alone—the Enterprises’ combined financial harm amounted to $158 million due to excessively priced LPI coverage.”

Fannie Mae, Freddie Mac: LPI providers overstated their loss ratios

Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) require that homeowners maintain a minimum amount of hazard to protect their interests against fire and other accidents. If the homeowner lets their policy lapse, than the mortgage servicer has to step in and purchase lender-placed insurance (LPI) as one of the requirements for GSE backing. But if the lender ends up foreclosing on the home, Fannie and Freddie are on the hook for the LPI premiums, which is where the potential for abuse creeps in.

In a similar investigation, the New York Department of Financial Services (NYDFS) found that LPI providers have overcharged homeowners by overstating their loss ratios, which are used to calculate premiums, in some cases by 200% or more.

loss ratio data 0614 Fannie mae FHFA

The NYDFS also found that LPI providers gave kickbacks to mortgage servicers who steered business their way in the form of 10% – 20% commissions and reinsurance arrangements but that they “do little or no work for the commissions.” It concluded that the commissions were incentives for servicers to buy overpriced LPI.

FHFA: At least $674 million in related settlements nationwide

If it goes through with the lawsuits (so far it has only decided to study the issue), it will be following a string of litigation against major banks and mortgage servicers. The FHFA OIG report says that there have been at $674 million in total settlements on behalf of overcharged homeowners nationwide including a $19 million settlement with Wells Fargo & Co (NYSE:WFC) and QBE last year, a $300 million settlement with borrowers last September, and a $95 million settlement with Citibank in February this year.

Many of these cases took place in Ney York, California, and Florida, which is also where 48% of earned LPI premiums were paid out by Fannie Mae / Federal National Mortgage Assctn Fnni Me (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) in 2012. The FHFA OIG report doesn’t accuse any specific companies of wrongdoing, and the $158 million is an estimate, but considering how much other groups have gotten in settlements for LPI overcharges it would be surprising if the FHFA didn’t follow suit.