by Richard G. Carlston
To understand why the industry is facing unparalleled regulatory scrutiny, we must understand the slow, steady course of events that led us here. There is still time to stop the negativity, but we must work together as an industry.
It almost goes without saying that the title industry is under a period of intense regulatory scrutiny. The degree of scrutiny is greater now than at any time in the past 30 years. How long will this last? What will be the result from a regulatory perspective, a competitive perspective, and a litigation perspective? Where is the industry headed? Each is an excellent question likely having a response that continues to evolve. However, if one has any hope of answering these questions, one must first understand how the industry arrived where it finds itself today. Accordingly, through this article, I hope to provide my thoughts concerning why this regulatory environment exists because the answer to each of the how, what, and where questions likely turns on the answer to the question why?
While subject to dispute, I believe that the search for the answer “why” begins in 1999 in the state of California. In 1999, and for years previous, title companies maintained pooled escrow accounts in their own name for sums deposited in their escrows. These accounts were generally noninterest-bearing demand accounts. Interest-bearing accounts were available but generally not used due to the cost of establishing them. As property ownership expanded and property values increased, the size of pooled escrow accounts increased, resulting in intense competition by California lenders for these pooled accounts. Banks offered title companies “earnings credit” and “arbitrage” arrangements for pooled escrow accounts, permitting title companies to receive an economic benefit from having their pooled escrow account on deposit with that bank. While federal law prohibited the payment of interest on demand accounts, federal banking regulators took the position that these programs, if structured properly, did not constitute “interest.” This determination that these financial benefits were not interest under federal banking law, and arguably California banking law, was important since California law required any interest received to be paid to the party depositing the funds into escrow unless otherwise instructed. For years, regulators accepted this interpretation and permitted title companies to retain these financial benefits.
But the landscape changed unexpectedly and dramatically in 1999 when a title company discovered a significant embezzlement by one of its senior financial officers involving a fraudulent earnings credit scheme. The embezzlement was reported to the District Attorney of San Francisco for prosecution. The senior financial officer cut a plea bargain in which he disclosed other irregularities in the earnings credit program he established for the title company. Consequently, the District Attorney and City Attorney’s office filed a lawsuit against the title company claiming that the financial benefits received on its pooled escrow accounts constituted interest wrongfully taken by the title company. The notoriety of this lawsuit spawned tagalong private class actions, with the rhetoric escalating to stolen monies and criminal conduct.
Consequently, the Department of Insurance and the California Controller, in May of 1999, filed a defendant’s class action against the title industry, asserting that these financial benefits constitute “interest” under California law and had been inappropriately taken by the industry. At the time the lawsuit was filed, the Controller, who was becoming involved in a political campaign for a different office, held a televised press conference claiming that as much as 500 million dollars had knowingly been taken illegally by escrow and title companies from consumers by the title and escrow industry.
After significant negative publicity, settlements were achieved in 2003 and 2004. But the seeds of regulatory distrust in California were planted, tended, flowered, and spread to other states. Likewise, the template for regulatory pressure through negative political rhetoric in the press was perfected.
Before these settlements were achieved however, another event occurred in 2001 in this sequence of unfortunate events. This event had nothing to do with any industry misconduct but rather with the attempt by a mortgage guaranty insurer to offer a title insurance coverage product in violation of both the monoline restriction applicable to title insurers and the monoline restriction applicable to mortgage guaranty insurers.
After Radian Guaranty, Inc. (Radian) developed its Radian Lien Protection Policy (the RLP), which bundled lien priority insurance into a pooled mortgage guaranty policy, Radian undertook an extensive and effective marketing campaign to justify both its product and its right to issue the product. Radian told regulators that a risk of loss from an undisclosed senior lien constituted a mortgage guaranty risk because it was a loss suffered due to the default of the borrower. Radian claimed that the market and consumers wanted a cheaper alternative to expensive, slow, and unnecessary title insurance. The RLP was that solution according to Radian, because the RLP was both cheaper than title insurance and a safer alternative for the lender. Armed with its legal argument and its publicity themes of “cheaper, better, and more competition,” Radian undertook its national campaign despite knowing that several states had determined that the RLP constituted title insurance; and they prohibited it from being offered in their state.
When ALTA® began to challenge the RLP as being an illegal product, Radian refined its arguments but stuck to its press themes: A loan policy provides no benefit to consumers, who are already protected under their owner’s policy. Consumers pay for the lender’s insurance and want a cheaper and quicker alternative to title insurance. Consumers will save millions of dollars if the RLP is permitted, and lenders will receive greater protection due to Radian’s financial strength. Radian scored successes in the press, with regulators and the market.
Radian found sympathetic reporters and encouraged the publication of articles supporting use of the RLP in lieu of title insurance. From nationally syndicated real estate columnist Ken Harney’s articles, to reports all across the nation, the themes of cheaper, faster, and the need for greater competition within the title industry, were echoed by reporters in the press having little understanding or appreciation of the applicable laws, the public policies behind them, or the benefits and costs of title insurance. Several consumer groups, advocating cheaper products, quickly parroted the view that title insurance was too costly. ALTA®’s efforts to explain the importance of title insurance and the illegal conduct by Radian were often ignored by the press and consumer groups.
ALTA® experienced greater success on the regulatory front. ALTA® developed materials that contradicted virtually all of the claims made by Radian, including price claims, and focused on consumer benefits and protections achieved through title insurance. ALTA® stressed the benefits and importance of title insurance, the laws and the policies behind the laws. ALTA® identified the potentially serious consumer consequences arising under the RLP. Overarching this campaign was the need for a level playing field. ALTA® visited various state regulators and shared this information and material with them. ALTA® also approached the Title Working Group of the National Association of Insurance Commissioners (NAIC). The NAIC undertook an extensive and thorough investigation of the RLP and ultimately concluded that the RLP constituted a product that included title insurance coverage in violation of the Model Title Insurers Act. Thereafter, the NAIC undertook an investigation of products being offered by property and casualty carriers. Prior to completion, this investigation stalled due to the NAIC’s focus on the captive reinsurance issue discussed below.
While ALTA®’s actions ultimately proved successful due to the issuance of a cease and desist order against Radian by the California Department of Insurance, many state regulators were noncommittal in applying their laws given the confusion generated by Radian with its legal and social arguments. Indeed, the Department of Financial Institutions in Illinois took the position that as long as Radian didn’t market the RLP as a substitute for a title policy, the product was approved.
But it was not only state regulators that commanded ALTA®’s attention. Radian was successful in convincing Senator Phil Gramm, Ranking Member of the Senate Committee on Banking, Housing, and Urban Affairs, that the RLP should be considered. Senator Gramm testified in a hearing on housing and community development needs in December 2001 that title insurance was too expensive and that fixing this situation “could probably do more to promote homeownership … than by any increase in appropriations for housing that will be made in the next eight years combined.” Then in 2002, he sent a letter to HUD promoting the merits of “lien protection insurance” as an alternative to title insurance as a way of reducing the cost of homeownership. He closed his letter with the following: "I think innovative alternatives to traditional title insurance, which have the potential to lower the cost of homeownership, merit consideration. As you investigate ways to reduce the barriers to homeownership, I encourage you to evaluate alternatives to traditional title insurance, such as lien protection."
The illegal conduct by Radian was stopped by the cease and desist order, resulting in the termination by Radian of its efforts to market the RLP. Radian requested a hearing before an Administrative Law Judge, and after a multiday administrative hearing, the Administrative Law Judge ruled in favor of the Department. The acceptance of this decision by then new Commissioner Garamendi was delayed for several months. During this delay, the Consumers Union wrote to Commissioner Garamendi noting that one of the "obstacles to refinancing is high closing costs, the most significant of which is the cost of title insurance," that "Californians are paying too much for title insurance" and urging him "to investigate whether insurers are charging excessive rates and to help consumers save money by fostering greater competition in the marketplace."
Commissioner Garamendi ultimately upheld the decision of the Administrative Law Judge. Radian filed a writ proceeding seeking to overturn the decision, which led to a published Court of Appeal decision sustaining the cease and desist order on the ground that the RLP illegally included title insurance coverage.
In addition to its legal maneuvering, Radian also attempted to introduce legislation in California to amend the definition of mortgage guaranty insurance to include lien priority insurance. In so doing, it coordinated with legislators, consumer groups, and the press. Nonetheless, despite its efforts, the bill was defeated in committee.
While the saga of the Radian has been completed, the consequences arising from the saga have not. Radian’s actions encouraged property and casualty companies to bundle lien priority into their products. The publicity attendant to the themes developed by Radian -- that title insurance is too expensive and that more competition needs to be introduced into the title insurance market -- struck a chord with the press, consumer groups, and regulators. Finally, the controversy brought to light rating errors relative to the provision of the short-term rates to qualifying consumers leading to regulatory action as well as private class actions.
In response to concerns expressed by members of the title industry, the NAIC Title Working Group turned its attention to captive reinsurance involving residential properties in 2005. The Colorado Division of Insurance undertook an investigation into whether these structures acted, in effect, as illegal kickback and rebate schemes. Sharing its results with other members of the NAIC, additional states undertook similar investigations. Ultimately, a general consensus was achieved among regulators resulting from the various state investigations and shared through the NAIC, that captive reinsurance programs were, in operation, illegal kickback and rebate schemes approaching 50 percent of the title insurance premium in some cases. This led to various settlements among the title insurers utilizing captive reinsurance arrangements. These settlements were widely publicized with the constant portrayal of the programs as illegal rebates and referral fees.
The practical effect of the captive reinsurance issue was a further solidification of the belief that title insurance rates are too high, since under these programs, a company could rebate close to 50 percent of the premium. Little consideration was given to the fact that only a few title insurers used captive reinsurance programs whereas others did not. Little consideration was given to the fact that the amount of business conducted through captive reinsurance arrangements was insignificant and did not affect title insurance rates. Instead, regulators were quick to adopt the view that the existence of captive reinsurance programs was conclusive evidence that title insurance rates were too high.
Sham Affiliated Business
Next up for the NAIC was the question of sham affiliated businesses. The Colorado Division of Insurance initiated an investigation of sham affiliated business with encouragement from the Land Title Association of Colorado. According to the division, it discovered widespread sham affiliated businesses in Colorado, and it acted to correct the problems. In addition, it shared the results of its study with the NAIC, and the NAIC began examining sham affiliated businesses. That examination is ongoing and will likely result in a revision to the Title Insurer Model Act. Like captive reinsurance, the ability to provide rebates and referral fees through sham affiliated businesses was viewed as further evidence of the excessive nature of title insurance charges.
All of the publicity concerning the foregoing led to widespread belief among regulators and consumer advocates that title insurance rates should be examined. This perception led to a series of data calls and rate investigations premised on the assumption that title insurance rates are excessive.
Similarly, market conduct examinations focusing on rebates, referral fees, and affiliated businesses have commenced. In conjunction with these examinations, departments are reconsidering their regulatory approach to title insurance. While there have been some settlements, most notably the settlements achieved in conjunction with the New York investigation in May of this year, where, among other things, certain title insurers agreed to reduce their residential rates for properties having a value below 1 million dollars, most are ongoing. The California Department of Insurance has just proposed a new regulation that would substantially alter and expand reporting requirements for companies engaged in business in California while at the same time setting a rate cap. This proposed regulation, with it rate regulation, is claimed necessary because of a finding by Commissioner Garamendi that a reasonable degree of competition does not exist in the business of title insurance, and a “comprehensive, uniform system for preventing excessive rates is necessary to ensure appropriate rates in this noncompetitive climate.” Other investigations are ongoing but not advanced as far. Virtually, all investigations, however, involve a rate investigation concerning the question of whether title rates are excessive.
The GAO Study
This year, prompted by the publicized concerns surrounding rates and practices in the title insurance industry, Congressman Michael Oxley, Chairman of the House Committee on Financial Services, asked the United States Government Accountability Office (the GAO) to undertake a study of the title industry. Congressman Oxley asked the GAO to:
In my opinion, this unfortunate compounding series of recent events has been instrumental in the heightened regulatory scrutiny and review taking place. Much of this is premised on misperception and misunderstanding about title insurance. Much is devoid of proper analysis. Much is consumer-driven based on a perception that title rates are excessive and constitute a barrier to property ownership. Some is driven by politics. Some is the fault of companies within the industry, and some is the fault of companies outside the industry. Some is the fault of regulators.
Regardless, steps should be taken to correct problems. Obviously, both regulators and consumers need a better understanding of the importance of our closing and settlement services and the value of title insurance, and educational efforts should continue and be widespread. But, in addition to education, three additional actions would be instrumental is correcting the problems. These steps were outlined to Congress through the testimony of ALTA® President Randy Yeager. They are:
|Richard G. Carlston is a shareholder with the firm of Miller, Starr & Regalia in Walnut Creek, CA, and represents ALTA® in various matters. He has been very involved in ALTA®’s strategies for Hill testimony and meetings with the GAO. He can be reached at RGC@MSandR.com.|