In the insurance industry, title insurance is known as a “long-tailed” liability risk, which means that it is common for claims to be made many years after policies are issued. For this reason, owners of real estate, their lenders and their counsel have long scrutinized the financial health of title insurance underwriters. Thus, when LandAmerica Financial Group, Inc.—the parent company owning the stock of two title insurance industry stalwarts—filed for bankruptcy protection recently, the specter that a major title insurance company, like any other insurer, could be financially impaired and subsequently default on its coverage obligations caused shockwaves in real estate circles.
We now know that LandAmerica Financial Group’s financial problems were isolated from its title insurance subsidiaries, Lawyers Title Insurance Corp. (“Lawyers”) and Commonwealth Land Title Insurance Co. (“Commonwealth”). Lawyers and Commonwealth, which together comprised the third largest title insurance company in the United States, have been sold to Fidelity National Financial, Inc. (“Fidelity National”) under the watchful eye of the Bankruptcy Court in Richmond, Virginia and Nebraska insurance officials. The sale closed on December 22, 2008. Accordingly, LandAmerica’s title insurance subsidiaries, which were subject to a statutory rehabilitation proceeding under Nebraska law, appear to be operating and serving their clients in an uninterrupted manner as members of the Fidelity National family of companies. As of September 30, 2008, Fidelity National reported a combined pro forma claim reserve of $2.6 billion and an investment portfolio of $5.2 billion.
Stakeholders in the title insurance industry dodged a bullet as a result of the sale of LandAmerica’s title insurance subsidiaries to Fidelity National. Residual questions about “what could have happened?” are likely to go unanswered, including the most central question of all: What would have happened if these title insurance companies, or any other title insurance company for that matter, failed and were subject to liquidation? There are many important questions here, and we address some of them below.
What Happens to a Title Policy if the Issuing Company is Liquidated Under State Law?
State regulations regarding title insurance companies are geared towards protecting the policyholders and others that do business with title insurance companies. For example, many states require title insurers to establish and maintain reserves (e.g., an unearned premium reserve) or to participate in some type of guaranty fund expressly related to title insurance. In addition, to ensure that funds will be available for payment of insureds’ losses, most states have minimum capitalization and paid-in surplus requirements and regulate investment alternatives available to insurance companies. To further assure that money will exist for payment of insureds’ claims, some states require title insurers to deposit amounts directly with the applicable state regulatory agency. Generally, these amounts must be held on deposit for as long as the insurer has any outstanding liabilities (whether fixed or contingent).
State regulations also may facilitate the purchase of reinsurance for the liability of the title insurance company with respect to outstanding title insurance policies to help provide coverage if the title insurance company goes out of business. For example, California law provides that in the event a title insurer becomes insolvent or is liquidated, all amounts set aside in the unearned premium reserve shall be used to purchase reinsurance for all outstanding policies and contracts for title insurance, which have no pending claims. California law further provides that amounts remaining in the unearned premium reserve and the guarantee fund, after the purchase of reinsurance and the payment of existing claims, are to be held in trust for 20 years to pay claims of policyholders as they arise. The reinsurance helps to assure the availability of funds to honor the long term policy commitments made by the insolvent title insurer.
Proceedings to rehabilitate or liquidate a title insurance company typically arise in the state in which the company is principally registered (e.g., its domicile) and are governed by that state’s law. For example, both Commonwealth and Lawyers are domiciled in Nebraska (as is Chicago Title), and, for that reason, regulators from Nebraska were involved in the efforts to sell those entities. Collectively, about 30% of the title insurance in the United States is underwritten by companies domiciled in Nebraska (about another 35% is underwritten by companies domiciled in California, including First American and Fidelity National).
In the event a title insurer is subject to liquidation, state laws directed generally to the liquidation of insurance companies, or state laws geared directly to the liquidation of title insurers, will also come into play. In Nebraska, for example, the statutes dealing generally with the supervision, rehabilitation and liquidation of insurance companies apply to title insurance companies, with the further proviso that the court conducting a liquidation is directed to “consider the unique aspects of title insurance and shall have broad authority to fashion relief that provides for the maximum protection of the title insurance policyholders.” The liquidation of a California-domiciled title insurance company also would be handled in accordance with the general statutory scheme for insurance company liquidations, except that a claim arising from the insolvency of a title insurance company is not a covered claim for purposes of the general California insurance guaranty association. Instead, claims arising from title insurance company failures are protected by a specific title insurance guaranty fund, as well as other statutorily-created funds, including a fund consisting of a specified percentage of the premiums collected. Conversely, in a state like Illinois, the Title Insurance Act contains specific procedures for liquidating a title insurance company and further provides that such liquidation provisions shall be the exclusive remedy and the only proceedings commenced in any court for the liquidation of a title insurance company.
Insurance liquidations are complex proceedings, due in part to the lack of a uniform law like the United States Bankruptcy Code and the existence of multi-state insurance corporations with assets in different states. Although the Bankruptcy Court in Richmond, Virginia authorized the sale of the stock of LandAmerica’s title insurance subsidiaries (LandAmerica itself was not a domestic insurance company), neither Commonwealth nor Lawyers were subject to bankruptcy proceedings. In fact, it is a safe bet that a proceeding to liquidate a title insurance company will not take place in a bankruptcy court and instead will unfold under applicable state laws and in one or more state tribunals. Section 109 of the United States Bankruptcy Code expressly delineates certain entities that are not eligible for bankruptcy relief. Domestic insurance companies are included among this list.
To address some of the complexity associated with insurance company liquidations, there are model insurance liquidation statutes, with a recent one being the Insurer Receivership Model Act (IRMA), adopted in December 2005, by the National Association of Insurance Commissioners (NAIC). IRMA is intended to comprehensively address the administration of an impaired or insolvent insurer from conservation and rehabilitation to the liquidation and winding up of a receivership estate.
Other model acts have included the Insurers Rehabilitation and Liquidation Model Act and the Uniform Insurers Liquidation Act.
The state of domicile for a title insurance company may also have specific laws dealing with a liquidation involving claimants in more than one state. Under Nebraska law, for example, a claimant from a different state can file a claim either in the Nebraska liquidation proceeding or in an ancillary proceeding instituted in the claimant’s home state related to the liquidation of the title insurer, provided the claimant’s home state is considered a “reciprocal state” under Nebraska law. A “reciprocal state” is one which has statutory provisions for the liquidation of an insurance company that are similar to Nebraska’s. Absent similar laws, Nebraska law provides that the out of state claimant has to assert its claim in the Nebraska liquidation proceeding.
While laws regulating the distribution of assets of an insolvent title insurer may vary from state to state, they tend to follow a general prioritization scheme, which provides as follows: (1) the costs and expenses of the administration of the insurer estate during liquidation; (2) (a) claims under policies for losses incurred, including third-party claims and claims for losses of any federal, state or local government; (b) claims for unearned premiums; and (c) claims of guaranty associations for payment of covered claims or obligations; (3) claims of the federal or any state or local government other than those claims in class 2 above; (4) debts due employees for services and benefits; (5) claims of any state or local government for a penalty or forfeiture; and (6) claims of shareholders or other owners.
What Happens to Money Held in Escrow by an Insolvent Title Insurance Company?
Although the laws of each relevant state should be consulted, as a general proposition, state law requires title insurance companies to keep escrow, settlement, closing and title indemnification funds in accounts and maintain records of such accounts separate from their operating, surplus and reserve funds. Such funds generally are the property of the persons entitled thereto under the escrow, settlement, closing or title indemnification agreement and can be used only in accordance with the terms and conditions under which the funds were accepted by the title insurer. For example, Nebraska law provides that security and escrow funds held by a title insurer shall not become general assets of a title insurance company and shall be administered as secured creditor claims in any insolvency proceeding.
Problems sometimes arise, however, when the title insurer does not properly segregate funds and ultimately does not have enough funds remaining to satisfy all escrow obligations in full. In the late 1990s, this occurred in respect of the liquidation of Intercounty National Title Insurance Company. In that case, Intercounty’s re-insurer stepped in and covered the title insurer’s obligations to depositors.
Generally, there is a system of external and internal “checks and balances” designed to ensure the proper handling of escrow money held by title insurance companies. For example, in New York, the New York State Department of Insurance has the right to audit the accounts of title insurance companies that operate within the State of New York. As a practical matter, this type of audit appears to be infrequent. On the other hand, it is not uncommon for title insurance companies to hire external accounting and auditing firms to review their accounts on an annual basis to ensure compliance with state and federal law. Further, title insurance companies generally have their own internal procedures for handling escrow accounts. For example, certain title insurance companies have standardized escrow forms and will require, before holding money in escrow, a fully executed escrow agreement, together with a W-9 form, if applicable, executed by the party entitled to the benefit of the earned interest on the escrowed funds.
Although we do not address issues related to a title company agent, including escrow issues, it should be noted that most title insurance company agency agreements provide that a title insurance company’s agent is not an agent for the purpose of conducting settlements or performing escrow services. Additionally, a standard “closing protection” letter issued by title insurance companies (i.e., a letter making a title insurer responsible for certain acts of its agents in connection with escrow closing activities and services) does not generally protect a depositor from escrow money losses arising from an agent’s insolvency. Accordingly, a depositor may not have any claim against the “deep pocket” title insurer for escrow money lost due to an agent’s insolvency. Finally, we do not address issues relating to 1031 exchange services provided by title insurance company affiliates which are not themselves regulated title insurance companies.
As with other companies that underwrite insurance products, the failure of a title insurance company will trigger the additional involvement and supervisory oversight of state law regulators who will endeavor to protect the interests of policyholders and persons whose funds are being held in escrow. The ultimate effectiveness of their intervention, including their ability to prevent any loss to policyholders or escrow depositors, will depend upon many different factors, including the size and complexity of the company that fails, the legal protections that are available in the domiciliary state when a title company fails, and the availability of resources in guaranty and similar funds that can be used to satisfy claims and purchase future insurance coverage.