The Office of General Counsel issued the following informal opinion on January 9, 2002, representing the position of the New York State Insurance Department.
Re: Residential Mortgage Lenders
1) Would the payments to the mortgage lenders/insureds under the proposed program constitute impermissible rebates under N.Y. Ins. Law § 2324 (McKinney 2000)?
2) Would the proposed payments violate N.Y. Ins. Law § 6504(c) (McKinney 2000), which prohibits a mortgage insurer from paying any compensation to any insured lender "in connection with the placement or renewal of any insurance?"
3) Is the proposal unfairly discriminatory?
4) Would the proposed payments constitute an unfair trade practice?
1) Section 2324 would not prohibit the payments under the proposed program because the company would include the terms of the fee in the policy issued to the mortgage lender/insured. However, the payments would constitute expense costs and must be accounted for in the rate filing.
2) The proposed payments would not be prohibited by § 6504(c) if there is an arms-length transaction and the payments reflect actual value for services rendered on behalf of the insurer.
3) There is nothing unfairly discriminatory about the proposal so long as all lenders are afforded the same opportunity to provide the services and receive compensation on the same basis.
4) The proposed payments would not constitute an unfair trade practice so long as they do not promote cherry picking or otherwise discourage lenders from making loans to higher-risk borrowers.
Under a companys proposed program, participating residential mortgage lenders would be paid fees for providing certain quality and productivity-related services. By having the mortgage lenders provide these services, the company expects that the overall quality of mortgage insurance business placed with them would be improved. The payments would vary depending on the extent to which the lender was able to achieve a materially higher-than-expected score on the companys proprietary mortgage score model. The score model uses various loan, collateral and borrower credit characteristics to predict the probability of a given borrower defaulting on his or her loan. The company states that it is highly predictive of the expected performance of a book of such loans.
A mortgage lender is the insured under a mortgage guaranty policy, but the borrower always pays the premium for the coverage. Hence, the company asserts that mortgage lending is a high volume business, and that mortgage lenders have no incentive to improve the quality of the business. The program looks to provide such an incentive, not by turning away potential borrowers but by providing more appropriate loans, thereby leading to fewer defaults, which would be in the companys interests, and would ultimately be beneficial to the borrowers. The program consists of three elements: quality improvement services, consumer education, and technology improvements. The lenders would undertake to educate borrowers and consumers so that they would obtain mortgage loans that would be best suited to their circumstances and with a lower probability of default. For example, reducing a 97% mortgage to 95%; or considering an adjustable mortgage with a first adjustment more than twelve months away. Lenders would also engage in joint marketing campaigns and distribute no-branded educational literature about the mortgage origination process. In addition, lenders would be encouraged to deliver via one of the companys electronic delivery channels (such as the Internet, electronic data interchange, etc.) at least 75% of the loans that they select for insurance. If the lender were also a servicer, it would use various company servicing tools that have been developed to mitigate default losses.
The fee would not be based upon particular mortgage policies, but determined by the book of business that the lender has with the company, through application of the score model. The company asserts that it would be difficult to determine the fees based upon a monitoring of actual services. However, it was expected that the improvement of the model scores were quantitatively related to the services performed.
The mortgage policy will specify that a fee will be paid to the mortgage lender/insured in accordance with the above, and the borrower will be fully apprised of such. The borrower will not directly benefit monetarily by the payment of the fees to the lender, although in the long run, the program may result in lower premiums on new policies issued. It is our understanding that there is no requirement under banking law that the lender must pass the payment on to the borrower.
N.Y. Ins. Law § 2324 (McKinney 2000), entitled "Rebating and discrimination", is applicable to property/casualty insurance (including mortgage guaranty insurance) and provides in pertinent part as follows:
(a) No authorized insurer, no licensed insurance agent, no licensed insurance broker, and no employee or other representative of any such insurer, agent or broker shall make, procure or negotiate any contract of insurance other than as plainly expressed in the policy or other written contract issued or to be issued as evidence thereof, or shall directly or indirectly, by giving or sharing a commission or in any manner whatsoever, pay or allow or offer to pay or allow to the insured or to any employee of the insured, either as an inducement to the making of insurance or after insurance has been effected, any rebate from the premium which is specified in the policy, or any special favor or advantage in the dividends or other benefit to accrue thereon, or shall give or offer to give any valuable consideration or inducement of any kind, directly or indirectly, which is not specified in such policy or contract, other than any article of merchandise not exceeding fifteen dollars nor shall the insured, his agent or representative knowingly receive directly or indirectly, any such rebate or special favor or advantage...
The payment of the fee to the mortgage lender/insured would constitute a rebate under § 2324, but would not be prohibited under the section so long as it was specified in the policy.
However, the rate filing for the program must reflect the payment of the fees for the services as expenses, in accordance with the standards and requirements of N.Y. Ins. Law Article 23 (McKinney 2000), since the services are being provided on behalf of the insurer, which is the justification for payment of the fees. Since the fee is a rebate of part of the premium, the premium collected must be adequate after the fees are paid.
N.Y. Ins. Law § 6504(c) (McKinney 2000) provides in pertinent part:
(c) In connection with the placement or renewal of any insurance, a mortgage insurer shall not permit any compensation to be paid to, or received by: any insured lender
Although the above section reads as if it is an absolute bar to any compensation to the lender, the Department has concluded that where a transaction is conducted at arms-length and the compensation is for actual services performed, such a payment would not constitute a violation of § 6504(c). For example, Circular Letter No. 2 (1999) concluded that certain lender captive reinsurance arrangements did not violate § 6504(c). While certain of the guidelines expressed in the circular letter are not relevant to this inquiry, one factor that is relevant is that the transaction is fair and equitable and at arms-length. However, the payment must bear a direct relationship to the services rendered, may not exceed the value of the services, and may not be used as a reward for the placement or renewal of the policies.
In the latter regard, concern has been expressed that this program would result in "cherry-picking", whereby the lender would refer only better quality loans to the company so that the lender would get the advantage of this program. The company must take steps to ensure that the payments to the lenders are for actual services rendered, and that any improvement in a lenders model score is not the result of cherry picking, or, for that matter, coincidence.
Unfair discrimination and unfair trade practices
There is nothing inherently unfairly discriminatory about the proposal so long as all lenders are afforded the same opportunity to provide the services and receive compensation on the same basis, in accordance with the standards enunciated in N.Y. Ins. Law § 2301 (McKinney 2000).
Nor would the proposed payments constitute an unfair trade practice under N.Y. Ins. Law Article 24 (McKinney 2000) so long as they do not promote cherry picking or otherwise discourage lenders from making loans to higher-risk borrowers.
This opinion is restricted to interpretation of the New York Insurance Law. Accordingly, the company may wish to receive confirmation from the Banking Department that the program does not run afoul of the Banking Law.
Inasmuch as the company has not submitted a rate or form filing in regard to this program, this letter is not to be construed as approval of any specific policy form or rating plan.
For further information you may contact Principal Attorney Paul A. Zuckerman at the New York City Office.