Thursday, December 08, 2011
When two underwriters announced they were ceasing issuing new policies after they discovered agents had committed escrow fraud, industry members and regulators took notice. And it’s not just these two instances. Earlier this year a large agent shut its doors due to escrow fraud it had perpetrated. And, due to the current market and not defalcations, a few other regional underwriters have had to close their doors in the last few years.
With transparency the new buzzword, leaders in the industry are attempting to work on an industry solution to curb the potential escrow fraud epidemic as regulators investigate ways to protect policy holders from insolvent insurers.
“I think you are going to see myriad solutions attempted to solve the problem,” said Michael Holden, state agency manager at North American Land Title Insurance Co. “And I think it is going to come from all corners of people associated with the industry.”
Holden and other industry experts shared their views on what those solutions may be and where they may come from.
The heart of the matter
The defalcations that led to the downfall of Southern Title and New Jersey Title Insurance Co. shed additional light on what could be considered a hole in the oversight of title agents across the country, escrow functions.
“I think that for the longest time in many states escrow and title are considered separate because many agents are assigned to a policy issuing agency contract,” said David Townsend, president and chief executive officer of Agents National Title Insurance Co., explaining his belief that states will be engaging in increased market conduct and escrow scrutiny. “It is silent as to escrow authority because, in a lot of states, escrow is unregulated. So what I perceive happening is greater scrutiny on the escrow side of things and a focus on defalcations; basically escrow fraud prevention.”
Nick Henderson, president of First Nebraska Title and Escrow Co. also noted that there has been more of a recognition that there is a major function of the title insurance industry that is out there that is not related to title.
“The interesting thing is of course we’ve had an opportunity for laws and underwriter practices to grow up around title,” Henderson said. “But to come in at this point and start regulating escrow when you historically have not will be interesting. There is such a custom and practice in many of the states so it will be interesting to see if they elect to really push to somehow regulate or license that.”
Vincent Danzi, general counsel for Equity Settlement Services Inc., said the situations with Southern Title and New Jersey Title have caused him to wonder whether regulatory oversight has been focused on the right area of the title agent’s work and see that perhaps consolidating insurance regulators and banking regulators, like has been done at the Consumer Financial Protection Bureau is a sign of things to come.
“It is interesting, for instance, that in New York State, the insurance department does not license title agents. I think many of us have looked at the coordinated licensing of title agents as an important step to establishing a regulatory framework for our industry. And yet as I read about the recent headlines, I think to myself, ‘Has the regulatory emphasis been in the wrong part of our business?’ We’ve predominantly talked about licensing for title agents in the context of licensing them to underwrite and issue title insurance and we have looked at title insurance underwriters from the perspective of claims reserves available for policy holders yet, at least recently, the real damage suffered by underwriters at the hands of title insurance agents has not been brought about by negligence in writing title insurance policies; it has been caused by allegedly misappropriating money those agents held in a fiduciary/escrow capacity. This begs the question as to whether these fiduciary duties are adequately regulated or supervised. I believe that part of the explanation for the relative lack of clarity on this issue stems from the state-by-state friction which remains between the judiciary’s exclusive power to regulated the practice of law and the legislature’s powers to regulate non-attorney fiduciaries.”
He said he believed more states will look at escrow licensing next year.
Some states, including Iowa, have begun licensing escrow agents in the state. While many closings are done by parties to the transaction — such as the real estate agent, the lender or the attorney who issued the title opinion on the property — there were still many abstractors and other private closing entities that had to go through the licensing process in order to legally perform closings as of July 1.
The law requires any person who is not a party to the real estate transaction who provides real estate closing services to be licensed as an Iowa closing agent. ‘Real estate closing services’ are defined as “the administrative and clerical services required to carry out the conveyance or transfer of real estate to a purchaser or lender.” These services include “preparing settlement statements, determining that all closing documents conform to the parties’ contract requirements, ascertaining that the lender’s instructions have been satisfied, conducting a closing conference, receiving and disbursing funds and completing form documents and instruments selected by and in accordance with the instructions of the parties to the transactions.”
Protecting policy holders
First and foremost on the mind of the regulators is how to protect the policy holders who are purchasing title insurance. To assure that this happens, regulators may require more reserves or increased oversight of agents from their underwriters.
“I think you are going to see several departments of insurance who are proactive and actually go out and require more reserves and require some better agent monitoring from their underwriters,” Holden said.
There is also the matter of how to ensure a policy holder is still covered should their title insurer become insolvent. Florida is one state that addressed this issue in the last year, passing a law that put a system in place to do that.
Under the new law, a court-appointed receiver must review the condition and file a plan of rehabilitation with the court for approval. The plan must provide that policies on property in Florida must remain in force.
As a condition of doing business in Florida, each title insurer is liable for an assessment to pay all unpaid title insurance claims and expenses for administering and settling unpaid claims on real property in the state for any title insurer that is ordered into rehabilitation.
Upon the making of an assessment, the office will order a surcharge on each title insurance policy thereafter issued on Florida property. The office will set the per transaction surcharge in an amount estimated to generate sufficient funds to recover the amount assessed over a period not to exceed seven years. The amount of the surcharge ordered cannot exceed $25 per transaction for each impaired title insurer.
Sha’Ron James, director of the Division of Rehabilitation and Liquidation at the Florida Department of Financial Services, did a presentation on the program during the National Association of Insurance Commissioners’ annual fall meeting.
Several regulators on the committee questioned James about how this might work in other states. Justin Ailes, vice president of government affairs at the American Land Title Association (ALTA), was quick to respond.
“I think a lot of the industry sense is this may be a very Florida-specific solution that may have some serious consequences in other states,” he said. “I mention that because if there is any interest in a similar type of legislation, make sure the safeguards are in place and I would be interested in working with anyone who is interested in doing so.” He noted that the end result should not be considered as a clear consensus of support from the industry.
Because of their concerns about solvency and defalcation, some states are looking to hold the underwriter liable for the actions of their agents, something that has agent and underwriters concerned.
Ailes noted several states where steps have already been taken to impose stricter liability on underwriters.
“Minnesota attempted to pass a strict liability statute,” he said. “Maryland regulators pressed for new CPL and solvency legislation. Beginning back in 2009, Washington state took some enforcement steps to hold underwriters vicariously liable for the marketing acts of their agents. And back in 2010, Illinois found underwriters liable for theft of escrow funds on policies issued by a properly terminated agent.
“As we look at the NAIC’s plans for 2012, they are focusing on ways to mitigate the impact of both insurer and agent insolvencies on policy holders,” Ailes continued. “They are going to continue to work with other regulatory bodies to combat fraud or unfair real estate settlement activities and start to look at whether title insurance guarantee funds or other kinds of measures ought to be implemented to protect policy holders in the case of an insolvency.”
Illinois’ law requires closing protection letters (CPLs) be issued to all parties involved in a real estate transaction.
The law, 215 ILCS 155 §§ 16-16.1, came about after a notorious defalcation occurred in the Chicago metro area. Frank Pellegrini, chief executive officer of Prairie Title, said the agent who committed the defalcation had been cancelled by its underwriter, but continued to do business in Illinois. After the agent closed up shop, the state regulator contacted the underwriter to see how they would address the problem. The underwriter informed them that because the agent had been cancelled, the underwriter had no authority to act in this case.
Like Illinois’ story, Nebraska’s law requiring underwriters to have more liability for the actions of their agents stemmed from a significant defalcation that occurred around 2002.
The law states, among other things, that “a title insurer is liable for the defalcation, conversion or misappropriation by a title insurance agent by or under written contract with the title insurer of escrow, settlement, closing or security deposit funds handled by such title insurance agent in contemplation of or in conjunction with the issuance of a title insurance commitment or title insurance policy by such title insurer. However, if no such title insurance commitment or title insurance policy was issued, each title insurer which appointed or maintained a written contract with such title insurance agent at the time of the discovery of the defalcation, conversion or misappropriation shares in the liability for the defalcation, conversion or misappropriation in the same proportion that the premium remitted to the title insurer by such title insurance agent during the 12-month period immediately preceding the date of the discovery of the defalcation, conversion or misappropriation bears to the total premium remitted to all title insurers by such title insurance agents during the 12-month period immediately preceding the date of the defalcation, conversion or misappropriation.”
Finding an industry solution
While regulators are looking at ways to protect policy holders and hold someone accountable for the fraud that has been taking place, industry members have been looking for ways to address the situation as well.
“I think you will see market conduct pressure from the regulators in situations where there is cause for concern,” Townsend said. “But, I would hope that if an underwriter is not currently reviewing and keeping close tabs on escrow of their agents that they would begin.”
Holden agreed, saying that underwriters may want to be more proactive and put better controls in place.
“This is just my opinion, but I think the optimum solution is an industry solution,” Pellegrini said. “I think the regulators welcome that. My view is that we can’t expect regulators to roll up their sleeves and provide the answers to some of the very vexing circumstances that cause losses and jeopardize a consumer’s interests. The industry can come up with the right answers to deal with these things, and should.”
ALTA has been having several discussions about how best to address the issues at hand in a way that is beneficial to both the underwriters and the agents. Pellegrini, who is president-elect of ALTA, said there has been a great deal of effort spent in studying the problems that have arisen in various states and the issues that have come up, such as large defalcations and market conduct violations.
“The industry should continue to study the issues. Work between the underwriter community and the agent community should continue toward finding reasonable mechanisms to prevent escrow theft and to prevent and address market conduct violations. I think the best solution is one that is going to be arrived at within the industry itself,” Pellegrini said.
Charles Cain, vice president and agency manager for the Midwest Region for WFG National Title Insurance Co., noted that it might be difficult to come up with an industry solution.
“One of the major underwriters was looking to create a requirement that everyone who is one of their agents maintain a bond for theft and embezzlement,” Cain said. “They pulled back on that requirement in the vast majority of jurisdictions where it was not already required by some regulatory scheme.
“I think for the underwriters it will take a regulatory scheme for them to be able to ask for or require higher levels of fidelity coverage for closing and settlement. It’s very difficult in the marketplace unless the entire industry were to change in a given jurisdiction and that is not very likely. I think it does take a regulatory scheme to do it,” he continued. “That being said, I do not think underwriters are adverse generally when regulators are looking to create those standards for the agents.”
He also noted that because regulations and practices are different in each jurisdiction, it can be difficult to come up with national standards and get everyone to agree to them.
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