Is Title Insurance Overpriced?
Title Insurance Fees Paid by Borrowers Include Referral Costs
"I recently read that some of the large title insurance companies have been kicking back to home builders 50%
of the premiums collected from the people who buy houses from the builders. Doesn’t that mean that title insurance
is seriously over-priced...?"
The price of title insurance must include the heavy referral costs incurred by the title companies, so in this
sense it is overpriced. The referral costs that have come to light recently in Colorado, where companies funneled
50% of the premiums from builder customers to reinsurance affiliates owned by the builders, may be just the tip of
the iceberg. Investigations have recently started in both Florida and California.
In Michigan, title companies pay referral fees to builders directly. House sellers in Michigan are required by
state law to purchase an owner’s title policy for the buyer. If the seller is a builder, however, the premium is a
flat $25, provided the builder arranges for the buyer to purchase the loan policy required by the lender from the
same title company. The premium on the loan policy is not discounted by 60%, as it is when the house seller is not
a builder. This situation has stimulated a class action lawsuit against the 4 largest title companies in Michigan.
Why Title Insurance Generates Substantial Referral Fees
Borrowers typically know little or nothing about title insurance, which is part of much larger transactions that
they encounter very infrequently. In most cases, therefore, a borrower purchases policies from the title company
recommended by the industry professional most closely involved in their transaction. On the purchase of a new house,
this will be the builder. On the purchase of an existing house, it will probably be the Realtor. On a refinance,
most likely it will be the lender.
Because the referrers select the title company, the companies must market to them rather than to the consumers
who pay the premiums. For this reason, the price charged the consumer plays little role in the marketing of title
insurance. Many referrers do not care how much the consumer pays. Indeed, their interest is best served by large
profit margins which enable the title companies to pay hefty referral fees.
Title companies don't want to pay referral fees, but they must compete for the favor of the builders, brokers
and lenders who can refer clients to them. Referrals have value and they want a piece of it.
Referral Fees are Illegal Under RESPA
Under the Real Estate Settlements and Procedures Act (RESPA), referral fees are illegal unless they constitute
payment for services rendered, and the payments must not exceed the value of the services. However, the Department
of Housing and Urban Development (HUD), which has responsibility for enforcing RESPA, does not have the army of
examiners it would need to do the job effectively.
Violations of the anti-kickback provision of RESPA are widespread. Small players do it with many different
varieties of under-the-table payments. Large players generally search for legal ways to comply with the letter of
the law while violating its spirit. Title companies in Colorado viewed the reinsurance affiliate as such a device.
Reinsurance Affiliates as a Method of Complying With RESPA
Some large lenders have used this device to extract referral fees legally from mortgage insurance companies. The
lenders have reinsurance affiliates that receive part of the mortgage insurance premiums paid by borrowers who have
been referred to the mortgage insurers by the lenders. In exchange for the premiums, the affiliate shares the risk
with the insurer. This is the legal cover for RESPA compliance.
The title companies in Colorado used the same device, reinsurance affiliates owned by builders, to pay off the
builders. It boomeranged, however, because of the major difference between mortgage insurance risk and title
insurance risk.
Losses from defaults are a major part of the costs of mortgage insurers. And while they can go for many years
with no problems, losses will balloon when real estate prices collapse. Since one can never be sure when this will
happen, nor how large the losses will be when it does, it would be very difficult for HUD or anyone else to
establish beyond reasonable doubt that the reinsurance affiliates are being overpaid for the risks they assume.
Most title insurance costs, in contrast, stem from their risk prevention functions rather than from insurance
losses. Title insurance losses account for a small part of the premium dollar, and are much less vulnerable to
conditions in real estate markets than mortgage insurance losses. The finding in Colorado, that the builders’
reinsurance affiliates have had zero losses, is thus powerful evidence that the premiums paid to them were only
thinly-disguised referral fees.
RESPA Enforcement Is Uneven
Why do the title companies get all the heat for paying referral fees? RESPA states very clearly that those who
receive kickbacks are as guilty as those who pay them. Indeed, their demands drive the referral process. But the
title industry has some large players, who make the best targets for district attorneys and class action lawyers.
The failure of the title companies has been their inability to resist the pressures to pay. It is difficult because
they must compete for the patronage of builders and others in a position to refer customers to them, who can play
one title company off against another. It would be easier for them to say no if the recipients of referral fees had
as much to lose from exposure as the payers.
Is a Crack-Down the Best Response?
When news emerges of widespread payoffs, as it did recently in Colorado, the knee-jerk reaction is to demand a
step-up in enforcement actions. In my view, this is the wrong response. Terminating referral fees by regulation
would require an army of examiners, and even then it wouldn’t work. The financial incentives are too strong, there
are too many ways that payoffs can be made, and there are too many people involved for regulation to be effective.
Another option which is being considered in some quarters is to socialize the title insurance industry. In Iowa,
only a state agency is allowed to sell title insurance, although residents are permitted to buy policies from
out-of-state firms. Some view Iowa as a possible model for a complete overhaul of the industry.
I favor a market-based solution, the goal of which would be to eliminate referral power and with it, referral
fees and any need for RESPA examiners.
A market solution must be based on the following principal: whoever selects the title company from whom title
insurance is purchased must pay for the policy.
Implementation of the principal requires three rules. The first would mandate that title loan policies, if
required by mortgage lenders, had to be paid for by mortgage lenders. The second would mandate that on purchase
transactions in which Realtors were involved, the owners’ policies had to be paid for by the Realtors.
These rules would eliminate "perverse competition" by insurers for the favor of referrers, which raises the price
of title insurance. Instead, title companies would compete to sell to lenders and Realtors, which would reduce the
price of title insurance.
Of course, lenders and Realtors would embed the title insurance premiums in their own prices to consumers, but
they would cost borrowers far less in that form than they pay now. Lenders and Realtors would be price-sensitive
buyers because they are paying the premiums, and they would be knowledgeable buyers because they are in the market
continually. Prices should drop sharply, provided that state regulation of title premiums doesn’t prevent it.
The third rule that is needed is one that eliminates state regulation of title insurance premiums. If lenders and
Realtors purchase title insurance, regulation of premiums is not needed and can only impede the decline of title
costs to consumers.
The most radical part of this proposal is the one involving Realtors. Unlike lenders, Realtors don’t need title
insurance for themselves but would be pressed into service as purchase agents of home buyers. This makes all kinds
of sense, although important details such as how the responsibility would be allocated when there is a buyer’s agent
as well as a seller’s agent, have to be worked out.
The title insurance industry is under the gun and it will be interesting to see how it responds. The market-based
solution described above would be painful in the short-term, but the industry would survive and ultimately become
stronger. If the industry hunkers down and resists all meaningful change, it might or might not outlast its critics,
for many of whom the socialization model ala Iowa has a strong appeal.
The market for mortgage insurance works very much like the market for title insurance, but it is simpler.
Mortgage insurance protects only the lender, there is no analogue to a buyer title policy. Further, the lender has
all the referral power; no other entity involved in the settlement process has any say in the matter. The remedy is
equally straightforward: lenders should be required to pay for their own mortgage insurance.
Copyright Jack Guttentag 2006 www.mtgprofessor.com
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