A new chapter in title insurance: state and federal probes are changing the way title insurers do business.

Undisclosed commissions. Improper steering of business to favored partners. Reinsurance transactions that don't seem to transfer risk.

The headlines are familiar to anyone who has followed the bid-rigging and finite reinsurance clouds that have hung over much of the commercial insurance industry over the past year.

But in an eerie parallel, a growing number of probes by both state and federal officials are raising many of these same issues in one of the most complex and least understood sectors of the industry--the $16.7 billion home title insurance market according to the American Land Title Association.

Though the inquiries continue to morph as they expand to look at more areas of the industry, essentially the probes have grown out of concerns raised by regulators in California, Colorado, Washington and Florida--and the federal Department of Housing and Urban Development--that title companies were entering "phony" reinsurance treaties with captive reinsurers owned by builders and real estate firms as a means to circumvent state and federal prohibitions against the payment of referral fees on title insurance business.

"I wake up in the morning and ask 'what are you guys thinking?'" said California Insurance Commissioner John Garamendi, who also was among the first insurance regulators to probe the behavior of brokers and agents with respect to contingent commissions. "Where are the ethics in the insurance industry, or maybe even in corporate America? The problem is that it's extremely bad for the economy, in that it diverts desperately needed resources into inefficient systems."

The Law

So-called "rebating" of title insurance is restricted under several state laws and the federal Real Estate Settlement Procedures Act, which bars paying or accepting "any fee, kickback, or thing of value" in connection with a referral for any real estate settlement service that involves "a federally related mortgage loan." Under guidelines issued by HUD, a mortgage loan is considered to be "federally related" if it involves permanent financing; is secured by a lien on improved residential property; and is made by a lender that either is regulated by a federal agency, such as the Federal Reserve, or has federal insurance on its deposit accounts.

Earlier this year, HUD settled cases in Texas and Oklahoma for nearly $7 million that involved alleged kickbacks from title insurers to lenders, realty agents, builders and developers sending them customers. According to HUD spokesman Brian E. Sullivan, the department currently has about 60 ongoing investigations nationwide into alleged violations of RESPA's anti-kickback provisions.

The department also is expected to issue comprehensive revisions to the RESPA regulations to Congress at some point in the summer. An earlier round of revisions proposed in July 2002--which would have encouraged mortgage lenders to provide a "guaranteed mortgage package" that would include the loan and all other charges related to closing costs, including title insurance--was pulled in March 2004 from the White House Office of Management and Budget after it received significant opposition from both industry groups and consumer organizations.

Making Changes

On Feb. 18, the Colorado Division of Insurance and Santa Ana, Calif.-based First American Corp. signed a consent decree, in which the title insurer agreed to provide $24 million in policyholder refunds for premium that had been ceded to captives. California's investigation is focused initially on title insurers Fidelity National Financial Inc. and LandAmerica Financial Group Inc.'s reinsurance treaty programs, Garamendi said.

In the wake of the inquiries, most of the major title insurers have announced plans to voluntarily end their captive reinsurance arrangements. In the eight-year history of such programs, regulatory input on the practice was relatively scant, said James Dufficy, vice president and regulatory counsel for First American.

Upon reaching the consent decree with the Colorado department, Dufficy said the company decided to apply it across the nation, as First American "didn't want the shadow of a doubt, so we're just going to pay (consumers) what amounts to a rebate, a bounty, in the form of this reinsurance premium."

LandAmerica, likewise, announced it would no longer conduct the transactions, and set aside $714 million in reserves to pay potential claims.

However, after an April 4 hearing on the California title insurance market, the commissioner said he became convinced that problems in the title market are more fundamental than previously believed. The hearing featured testimony from Fidelity National and LandAmerica, and Garamendi also subpoenaed William Lyons Homes, KB Homes, Re/Max, United Home Mortgage Corp., Shea Financial Services and Wells Fargo Home Mortgage.

According to Garamendi, who serves as chair of the National Association of Insurance Commissioners' Title Insurance Working Group, the investigation has expanded to look at computerized programs offered by title insurers to realtors and mortgage lenders that enable title insurance transactions. He believes there is the potential that such programs, in effect, likewise serve to steer business to the insurer.

In late April, the commissioner also reached a settlement with Stewart Title of California Inc., a subsidiary of Stewart Information Services Corp., to repay $160,000 to cover costs and expenses associated with the department's investigation of the company, and $594,102.67 of "inducements" paid to real estate agents. The inducements came in the form of payments for business support services, providing gift certificates and door prizes for realtor events, making rent payments, funding special events and sponsoring broker activities.

"What we're trying to do is create a situation where the class free market system operates well, and that system demands a well-informed consumer that has multiple choices available to them," Garamendi said. "The consumer has always had the option to select, but the consumer was totally ignorant of that opportunity, because in the financial transaction of buying a house, the title insurance is seen as a less important instrument, because it's not as costly as the price of the house or the price of the loan."

But in the area of inducements, title industry representatives complain that little guidance had been provided as to what sorts of activities would, and would not be penalized. Mike Skalka, general counsel, Stewart Title Guaranty Co., was quick to point out that the company's settlement provided no admission of wrongdoing.

"Unfortunately, the California Department of Insurance has not clearly defined what constitutes a violation," Skalka said. "Stewart has a strong reputation for integrity. We continue to seek guidance from governing bodies concerning lawful marketing activities."

Expense Check

While most forms of insurance involve the assumption of risk and the provision of financial indemnity, title insurance focuses primarily on loss prevention and the elimination of risk through thorough title searches, said James Maher, executive vice president of the American Land Title Association. The group estimates that roughly one-quarter of all residential real estate transactions have issues with the title, but that the overwhelming majority are cleared up by the title company prior to issuing the policy. Hence, because of the labor and cost involved, the expense ratio for title insurers averages 90%, compared with 30% for property and casualty insurers, according to ALTA.

But others question why there hasn't been better transparency in defining what those expenses are, particularly given that the industry's loss ratio is only 6%, and with Garamendi noting that costs should have plummeted now that most chain of title is by way of computer.

"This is the little village of insurance that nobody is paying attention to, and it's about as rotten as you can get," opined Woodstock, Vt.-based risk and insurance consultant Peter Rousmaniere. "The thing that puzzles me is that nobody has sat down, to my knowledge, and done an economic analysis of this business. You take a finite contract, and work out how much it costs to do a title search, and eventually what happens is that you end up with about 50% to 70% of the premium that is unaccounted for, because there is nothing that is called commissions."

Looking forward, Garamendi expected to bring findings at some point in May which could include formal accusations, calls for formal hearings or more settlements. He also said the NAIC would continue to examine industry practices and see if there were "new tools" that could potentially address abuses.

Iowa's Model

One rather extreme option would be for states to adopt the policy that Iowa has maintained since 1948--a complete statutory prohibition on the use of privately written title insurance, noted attorney James W. Carney of the Des Moines firm of Carney, Appleby, Nielsen & Skinner.

The Iowa Title Guaranty program, which is administered by the Iowa Finance Authority, was created when a title insurance company went bankrupt in the northwest part of the state. The program issues title policies with coverages identical to those provided by the ALTA policy form, but it pays no commissions. On average, Iowa Title Guaranty policies charge $1 per thousand dollars borrowed, compared with rates of $3 to $7 per thousand nationwide, Carney said.

"Over the period of time Iowa Title Guaranty has been operating, there have been few losses," Carney said. "We have as close to perfect titles in Iowa as anywhere in the United States. We like to think we have the premiere land title system in the country.... In large states like Florida, Texas, California and New York, consumers could save millions of dollars per year on closing costs (if similar programs were adopted) and it would provide true competition for the title industry."

Garamendi, for one, didn't find that solution particularly likely, though he said he just received a "big fat file" on the Iowa program, and he is intrigued by the way profits from the sale of policies are used to aid in construction of low-income housing.

"Is there a prayer of a chance that the State of California will outlaw title insurance? It's not going to happen," Garamendi said. "You're up against a huge industry, and relationships that involve realtors and builders and everybody else, so the chance of getting that through the Legislature is zero."

Key Points

* Title insurance is a $16.7 billion business.

* California, Colorado, Washington and Florida are probing the title insurance industry over "phony" reinsurance treaties with captive reinsurers designed to avoid prohibitions against accepting referral fees.

* Rebating of title insurance is restricted under several state laws and the federal Real Estate Settlement Procedures Act.

Learn More

First American Corp. A.M. Best Company # 58370 Distribution: Direct, captive agents

Fidelity National Financial Inc. A.M. Best Company # 18525 Distribution: Direct, agents

LandAmerica Financial Group Inc. A.M. Best Company # 50112 Distribution: Agents

For ratings and other financial strength information About these companies, visit www.ambest.com.