California regulators plan to tighten rules governing affiliated businesses and step up enforcement of anti-kickback provisions in existing law — changes they estimate could cost the state’s title insurers and underwritten title companies up to $732 million a year in profits.
The California Department of Insurance says the proposed new regulations, which are the subject of two public hearings this week, will increase competition in the state’s title insurance industry.
Some critics of the industry say that because consumers don’t shop around for title insurance, title insurance companies focus their marketing efforts on real estate brokers, agents and lenders who can steer business their way.
One way to do that is to form joint ventures, also known as affiliated or controlled businesses, in which title insurers and real estate brokers and lenders share profits from the sale of settlement services.
A federal law, the Real Estate Settlement Procedures Act, allows companies to form affiliated businesses and share profits based on their ownership stake in the companies. But the companies must have their own employees, separate offices and phones, and can’t share proceeds on a per-referral basis.
Last week, three large real estate brokerages and a company that produces natural hazard disclosure reports agreed to pay $39.3 million to settle allegations they created sham businesses in order to split profits on the sale of the reports (see story).
Regulation of affiliated businesses at the state level varies. California law limits title insurance companies to obtaining 50 percent of their business from such joint ventures. But Department of Insurance officials say existing law gives them little enforcement power, leaves key terms undefined, and doesn’t spell out in detail the type of records companies must maintain or for how long.
The new regulations would institute more stringent reporting requirements, which regulators say would help them more accurately assess how much business is channeled through affiliated businesses. Companies that originate less than 5 percent of their title insurance orders through affiliated businesses would be exempt from the more strict reporting requirements.
Although the law already requires title companies to maintain records that indicate the source of title orders, it doesn’t say how long they have to be kept. The Department of Insurance proposes that all title companies be required to keep records that would allow them to track the source of title orders and commissions paid dating back seven years.
The regulations would also give the Department of Insurance new enforcement powers, including the ability to conduct examinations for compliance, fine companies that violate the rules, and suspend or revoke their licenses.
In addition to increased enforcement powers, the regulations have a "sunshine" element, requiring title insurers and underwriters to disclose affiliated business arrangements to the public in their advertising and Web sites (see text of proposed regulation).
Complying with the new regulations will cost title insurers money, regulators acknowledge, and companies that are most dependent on affiliated businesses for title orders may also see a sizable drop in revenue.
"Some title insurers and underwritten title companies may need to develop new strategies for accessing the market place or for ownership and other affiliated business arrangements, or may need to re-engineer their businesses plans to comply with these regulations," the Department of Insurance warned in its public notice of the proposed action.
The business development and re-engineering costs of complying with the regulations, including legal advice, regulatory filing, and training, will cost title insurance companies about $500,000, the department estimates. System development and computer applications could add another $750,000 to the cost of compliance.
Regulators say a title insurance underwriter might see annual revenue fall by $33.2 million or more, while underwritten title companies may lose $1.4 million or more.
The proposed regulations could force "one or more domestic insurers" and "several underwritten title companies" out of business, the department estimates, with $245 million in lost salaries and wages.
All told, title insurers and underwritten title companies stand to lose as much as $732 million in annual after tax income, the Department of Insurance estimates.
Consumers will be better served in the more competitive marketplace that emerges, the Department of Insurance maintains, and if jobs are lost and businesses closed, those impacts "should be offset by other improvements in terms of the state’s aggregate economic activity."
A spokesman for an industry group, Craig Page of the California Land Title Association, said in an e-mail Friday that the group was still finalizing its comments on the proposal. Page said the Department of Insurance "has clearly put significant efforts into this regulatory package and the CLTA looks forward to being involved in the process as it moves forward."
A 2006 industry-sponsored study found that affiliated businesses accounted for a growing share of the title and settlement services business, but concluded they did not charge consumers more. The Real Estate Services Providers Council Inc. (RESPRO) said at the time that 19 states had "highly restrictive" rules governing affiliated businesses, including limits on the size of the stake real estate-related companies could take in joint ventures (see story).
In addition to forming affiliated businesses, another way title insurers have sought to win businesses referrals from real estate professionals is through inducements like food, entertainment and educational programs.
In December 2006, First American Title Insurance Co. agreed to pay $10 million to settle allegations that the company generated title orders in California through inducements to real estate professionals that included cash payments, software, tickets to rock concerts, and trips to racetracks and casinos (see story).
The California Insurance Code prohibits title insurers, underwritten title companies and controlled escrow companies from paying "any commission, compensation, or other consideration to any person as an inducement for the placement or referral of title business."
The statute allows "reasonable expenditures" for food, beverages, entertainment, educational programs, and promotional items that are not intended as inducements for referral of title insurance business. Because the statute does not spell out what constitutes a reasonable expenditure, the Department of Insurance in another proposed regulation would allow expenditures of up to $25 per person, per year.
To monitor compliance, the regulations would establish new reporting and documentation requirements, and make it clear that the Department of Insurance "may utilize all enforcement remedies provided by statute to enforce the provision of the regulations," according to a notice explaining the rationale behind the proposed changes to regulations governing reasonable expenditures.
A hearing on the proposed changes to regulations governing affiliated businesses is scheduled for 10 a.m. Tuesday, Aug. 12, in the administrative hearing room on the 22nd floor of the Department of Insurance, 45 Fremont St., San Francisco.
The hearing for the proposed changes to regulations reasonable expenditures is scheduled for 10 a.m. Wednesday, Aug. 13, in the same location. For more information, see the meeting notice.
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