State insurance regulators in New York and California are examining whether a relatively new type of home-loan insurance violates anti-kickback laws and could, in the long run, raise the cost of buying a house.
The insurance is called "pool," or "secondary," insurance and is sold by mortgage insurance companies to banks and other lenders that want a second layer of protection against defaults on home loans. It supplements the primary insurance coverage against default that many home buyers are required to buy.
In theory, the extra coverage lowers a mortgage holder's loss if a homeowner defaults. For that reason, Fannie Mae and Freddie Mac, companies based in the Washington area that buy home loans from lenders, will pay more for loans that carry this extra coverage. That's why many lenders, such as First Union Bank and Bank of America, have been eager buyers of the new insurance and helped make it so popular over the past three years.
Some major lenders, including Chase Manhattan Bank and Countrywide, however, will not buy pool insurance because of concerns about the practice, and one of the largest mortgage insurers, General Electric Capital Corp., won't sell it.
And state insurance regulators say they are reviewing whether mortgage insurers--including MGIC Investment Corp., Radian Group Inc. and PMI Group Inc., the nation's largest mortgage insurance companies--have, in practice, underpriced pool insurance for lenders that, in exchange, channel to the insurers a large volume of primary insurance business.
Primary mortgage insurance generates fat profit margins that in large volumes could make up for any shortfall in the less-profitable business of pool insurance, industry executives and analysts say.
Spokesman for MGIC, PMI and other companies deny tying the price of pool mortgage insurance to the volume of primary mortgage insurance business they receive.
That is so, they say, despite quarterly financial filings with the Securities and Exchange Commission that suggest a correlation between the two types of business. For example, PMI said in a Sept. 30 filing that its market share in new primary insurance increased partly because of an increase in pool insurance and similar products.
Underpricing could lead to higher-than-expected losses at mortgage insurers if the residential real estate market sours. That could raise the cost of mortgage insurance generally and, ultimately, the cost of buying a house, said insurance analyst Charles Titterton of Standard & Poor's.
"As currently constituted, [pool insurance] is not a profitable as a stand-alone business, and the only reason they do it is to get the primary business," Titterton said.
Officials at Fannie Mae, a government-sponsored mortgage finance company, agree, although the company buys loans carrying pool insurance. "How long can you offer a 49-cent hamburger to draw customers in?" said Fannie Mae's David Jeffers.
New York state officials examined the issue last year and found that nearly every pool insurance transaction they looked at was underpriced. In February they issued a circular to companies selling pool insurance in New York banning the product--or so they thought.
The officials learned that mortgage insurers have continued to sell pool insurance and defend it as being adequately priced. State insurance regulators reopened their inquiry this summer, requesting documents from all pool insurers. California regulators opened their own inquiry.
The chief counsel of the Department of Housing and Urban Development was concerned enough about the issue to write a letter in September reminding mortgage insurance companies of the federal prohibition against providing "a discounted or below-market price in return for referrals of primary mortgage insurance business."
But HUD will not actively scout for violations in the industry unless it receives a complaint from an insurer, lender, consumer or state insurance regulator, spokesman David Edger said.
Federal bank regulators, such as HUD, seem to be taking a laid-back attitude. Only the Federal Deposit Insurance Corp. has issued guidelines reminding banks of the prohibition against kickbacks in the home loan settlement process.
A group of homeowners filed suit last week in federal court in Georgia against PMI, MGIC and other mortgage insurers, seeking millions of dollars in damages on allegations that the companies violate federal anti-kickback laws by underpricing pool insurance for lenders that channel primary insurance business their way. The federal law, the Real Estate Settlement Procedure Act, prohibits such tie-ins to ensure that lenders seek the best-priced insurance for home buyers, not for themselves.
The plaintiffs argue that reducing the price of pool insurance is the same as giving a mortgage lender cash and is an incentive to seek the cheapest pool insurance rather than act in the consumer's best interest by seeking the cheapest primary insurance.
The companies said they will fight the lawsuits. They said the fact that they have lost no money on pool insurance proves they price it properly, but insurance regulators and analysts called that argument misleading. They said the pool insurance in question is only about three years old--about how long it takes before home-loan defaults start to show up.
The past three years have been marked by one of the lowest home loan default rates ever, thanks to the robust economy. Regulators and analysts warn that once typical default rates start to kick in, the profitability of pool insurance may look very different.