The Consumer Financial Protection Bureau’s recent crackdown on alleged “kickbacks” paid by mortgage insurers to mortgage lenders should put the CFOs of companies that deal with consumers or are involved in captive insurance arrangements on alert, insurance experts say.
On April 4, the CFPB, created by the 2010 Dodd-Frank Act to protect individual consumers of financial products, announced “four enforcement actions to end what the Bureau believes to be improper kickbacks paid by mortgage insurers to mortgage lenders in exchange for business.”
The CFPB believes the mortgage insurers enacted the scheme by buying essentially worthless “captive reinsurance designed to make a profit for the lenders.” In return, the lenders, who were not named by the bureau, steered business to the mortgage insurers. To the CFPB, such actions are illegal acts that inflated the costs of already burdened homeowners; to the insurers they were a legal way to back up their financial structures during tough times.
The CFPB reached a settlement with the mortgage insurers in which they admitted no criminality but are required to change their practices and pay the bureau a total of $15.4 million in fines. A consent order for the settlement was filed with the U. S. District Court for the Southern District of Florida. It still needs to be signed by the presiding judge to have the full force of law.
Homeowners Underwater
During the mortgage crisis, with many homeowners underwater on their loans, mortgage insurers became a target of regulators, who saw the added costs of insurance as onerous to consumers, according to Richard E. Gottlieb, an attorney who chairs the consumer financial services practices at Dykema, a national law firm.
Typically, banks require mortgage insurance on loans to protect them against the risk of default when homeowners borrow more than 80 percent of the value of their homes. The lender, rather than the borrower (the homeowner), picks the mortgage insurer. Besides their monthly mortgage payments, borrowers pay a monthly insurance premium.
The CFPB’s actions may have broader implications for senior managements of companies that deal with the public – even tangentially. “If you are doing business or facilitating business with consumers, you need to read the tea leaves,” Gottlieb says. “They may not only regulate [a business] practice out of existence, but you may get penalized for it.”
The CFPB filed the complaint against Genworth Mortgage Insurance Corp., Mortgage Guaranty Insurance Corp., Radian Guaranty Inc. and United Guaranty Corp.
Radian Guaranty, which agreed to pay a $3.75 million penalty, has not entered into any new captive reinsurance arrangements since 2007. “During the high-claim years that followed the most recent economic downturn, captive arrangements have proven to represent a critical component of the company’s loss mitigation strategy,” the insurer said in a press release.
In effect, the reinsurance coverage acquired from mortgage banks served “to protect our capital position during a period of stressed losses,” according to Radian. The company reported that as of December 31, 2012, it had received total cash reinsurance recoveries from these captive reinsurance arrangements of about $750 million.
In the typical arrangement covered by the settlement, a bank would set up its own captive insurance company. The captive’s purpose was to reinsure the mortgage insurance the bank itself bought for its clients. That meant that the bank was insuring portions of its own homeowner-default risk that was covered by the mortgage insurer.
To the CFPB, it was an overly sweet deal for the banks. “The ‘reinsurance’ provided by the lenders’ captive reinsurers was of little if any value because the projected value of the reinsurance to [the mortgage insurer] was far less than the premiums” the bank expected to earn, according to the CFPB complaint.
The reinsurance payments were an illegal way for the mortgage insurers to circumvent a provision of the federal Real Estate Settlement Procedures Act (RESPA), according to the CFPB. The provision bars lenders from accepting payments aimed at getting the lender to steer business toward the payer.
Under the settlement, the mortgage insurers would be barred from entering into any new captive mortgage reinsurance arrangements with affiliates of mortgage lenders and from securing captive reinsurance on any new mortgages for a period of ten years. They “will also be prohibited from paying illegal kickbacks or otherwise violating the Real Estate Settlement Procedures Act,” according to the CFPB.
To Andrew Barile, a Carlsbad, Calif.-based insurance and reinsurance consultant, the crackdown should serve as a warning to CFOs: They should pay a lot more attention to the operations of their companies’ captives. With captives increasingly seen as a source of cheap capital via loans to their parent companies, finance chiefs have a growing interest in the self-insurance vehicles.
Nevertheless, many finance chiefs don’t show up regularly at captive insurance company board meetings, according to Barile. In the wake of the CFPB’s increased vigilance, “they better take a closer look at their captives to make sure that they’re not violating the custom and practice of the insurance laws,” he says.
