For the second time in two years, private mortgage insurers are facing the possibility of an overhaul of their industry, this time in the form of a lawsuit charging that the companies illegally courted lenders with cut-rate services funded by premiums charged to homebuyers.
The lawsuit, filed in U.S. District Court in Augusta, Ga., seeks class action status and claims that services provided by insurers to lenders, such as contract underwriting, pool insurance, and captive reinsurance, amount to kickbacks for referrals of business in violation of the Real Estate Settlement Procedures Act.
The suit alleges that the insurers have been hurting consumers by offering these services at a below-market cost and making up the difference by charging higher premiums.
Though only Mortgage Guaranty Insurance Corp. of Milwaukee and PMI Mortgage Insurance Co. of San Francisco were named as defendants, many said they expect other major mortgage insurer defendants to be named later.
"We suspect that the entire industry will be (or already has been) named," wrote David M. Graifman, analyst at Keefe, Bruyette & Woods Inc., in a research note Monday morning.
A spokesman for GE Capital Mortgage Insurance Corp. said the General Electric unit had not been named in any suit. A spokeswoman for United Guaranty Corp. declined to comment. A Radian Guaranty spokesman said he was unaware of any such proceedings against the company. Republic Mortgage Insurance Co. and Triad Guaranty did not return calls by press time.
Whatever the suit's outcome, it could hardly come at a worse time for mortgage insurers. The companies, which insure the credit risk of home loans with low down payments, already have a black eye from last year's debate over and passage of the so-called cancellation law, which took effect in July. This law requires that insurance be automatically terminated once the homeowner's equity reaches 22% and gives the borrower the right to request cancellation once equity is at 20%.
Though the insurers and their lobbying group, the Mortgage Insurance Companies of America, ultimately supported the legislation, they were seen as slow to do so and came under attack from politicians who charged that the companies were ripping off consumers by collecting premiums even after insurance was no longer needed.
In the Georgia suit, the plaintiffs are seeking three times the amount they have paid to the insurers, plus attorneys' fees and expenses. They also want a declaration that the controversial practices are illegal.
The complaint says that thousands are eligible to join the plaintiff class, which is defined as anyone who has obtained a loan insured by the companies in question and whose lender got pool insurance or other special benefits from the insurers since Jan. 1, 1996.
In a statement, PMI's chairman, W. Roger Haughton, said his company intends "to vigorously defend ourselves in this litigation, and we are confident that we will prevail." In a separate statement, MGIC said it will "aggressively defend against this lawsuit and deny liability."
Private mortgage insurance is required for any loan with a down payment of less than 20% in order for the credit to be eligible for purchase by Fannie Mae or Freddie Mac, the secondary market giants. Though the consumer pays the premium, it is the lender that decides which insurer gets the business.
Though mortgage insurance is dominated by just seven companies, it is a fiercely competitive business. In recent years, companies have competed by offering costly services to woo business from lenders.
Examples include contract underwriting, in which the insurer processes loan applications for the lender in exchange for a fee and the opportunity to supply insurance for any loan that needs it. In other cases, companies have set up captive reinsurance arrangements, in which the insurer shares some of the risk - and revenues - with lenders.
The suit was not a complete surprise to industry-watchers.
"There are a number of event-risk issues in the industry, and this is one of them," Mr. Graifman, the Keefe Bruyette analyst said of the lawsuit.
Regulatory guidance on Real Estate Settlement Procedures Act violations has been unclear, one mortgage insurance executive said. The law states that no person can give or take a fee, kickback, or "thing of value" in exchange for referring real estate-related business.
Mr. Graifman said he does not expect the suit to have any long-term impact on insurers' profits.
"There's definitely going to be legal costs involved," he said, "and there's definitely going to be management distraction and more scrutiny brought to private mortgage insurance. But I don't see how this is going to impact the volume the industry gets or how it gets distributed to individual companies in terms of market share."
In fact, he said, "in a bizarre way this could have a positive impact, because if companies are providing these services below cost to lenders, there would actually be a positive impact on earnings" if the insurers were legally prevented from continuing to do so.
"If one company provides a service like contract underwriting, they all have to," Mr. Graifman said. "And if they're all legally prevented, they all won't offer it. It's still a level playing field."