Disputes between lenders and insurers over mortgage indemnity insurance coverage became a significant issue in the early 1990s—the last major property recession in the UK and the United States. Unsurprisingly, these disputes have now again become a major issue in the current recession.
The purpose of mortgage indemnity insurance is to provide financial institutions that hold mortgage loans, and that serve as trustees of mortgage backed securities, with additional protection against losses that arise from loan defaults. Over the past year, the rate of loan defaults has dramatically risen, and there has been a corresponding rise in claims made under these policies. In response, mortgage insurers have been quick to deny coverage and in some cases even seek rescission of these policies.
During the last recession, our clients were faced with various defenses raised on behalf of the insurers. We see the same defenses being raised this time. Hence, the time for policyholders to act to protect their positions under their policies is now. Lenders should examine the terms of their policies, and be aware of defenses likely to be raised by insurers.
Claims Reporting Requirements
Insurers argue that the first hurdle policyholders need to overcome is to report the claim within the time limit provided under the policy—at least as that time limit is interpreted by the insurer. The terms of the policy also may provide for the proof of claim to be in a specified form, and may require that certain information be provided concerning the underlying loan.
If there is a time limit for submitting such information, lenders need to determine from when that time limit runs. Insurers often argue that the time to submit a claim begins to run as soon as the loan goes into default—even though there is often no provision in the policy providing for this. They increasingly are attempting to argue that policyholders have lost their rights to submit certain claims because of alleged failures to comply with proof of claim requirements and time limits.
An extreme example of the position some mortgage insurers are taking in the United States is with respect to proof of claim requirements. In these cases, the insured submits the prescribed claim form the insurer contends is dictated by the insurance policy, in advance of the time specified in the policy. Then as the time to file the proof of claim is about to expire (as the time limitation is interpreted by the mortgage insurer), the mortgage insurer sends the insured a letter in response to the claim form stating that the insured has not provided sufficient documentation for the insurer to investigate the claim.
Therefore, the insurer claims, the insured has failed to abide by the contractually imposed deadline for submitting a proof of claim. It is as if the insured has not even submitted a proof of claim form at all, and since the time to file such a claim has expired, the mortgage insurer contends that no valid claim can be made for coverage under the policy.
This novel and harsh interpretation of proof of claim requirements in mortgage insurance policies often is unsupported by the express terms of the policies themselves. More importantly, such positions are contrary to the law of most jurisdictions governing the actions an insured must take to comply with proof of claim requirements.
The actual proof of loss conditions in most polices generally do not impose a requirement that the insured must submit all information that the insurer may request to analyze a claim within the initial claims-submission period. Nor do the policies usually impose a requirement that for a proof of claim to be timely, the insurer must completely investigate a claim and make a coverage determination within the initial period in which an insured must file its proof of claim.
Thus, often mortgage insurers' arguments regarding the proof of claim requirements in their policies fail, based on the explicit terms contained in the policies themselves.
Proof of Loss
Even if a proof of loss condition in a mortgage insurance policy actually requires certain information from the insured within a specified period of time—and the insured fails to strictly comply with this condition—coverage still is not voided in most jurisdictions. Courts generally have found that an insured satisfies the proof of loss condition where there is substantial compliance with the provisions.1
"The purpose of those requirements is to enable the insurer to form an intelligent estimate as to whether the claim comes within the terms of the policy, to prevent fraud, and to enable the insurer to make an investigation to determine its rights and liabilities."2
Consequently, if an insured substantially complies with a proof of loss condition, the insurer cannot assert that coverage is voided and that it has no further obligations to act on the claim because the insured has not provided the insurer with all the information it needs to investigate the claim within the proof of loss time limitation.3 Rather, once the insured has substantially complied with this condition, at the very least, the insurer has the obligation to investigate the claim further.
The failure of the insurer to so investigate may, in fact, give rise to a bad faith claim in the United States against the insurer.
Even if an insured submits an untimely proof of loss, most courts still require the insurer to establish that it suffered actual prejudice as a result of the insured's failure to meet the time requirement for the insurer to avoid its coverage obligations.4 Courts also have held that where an insurer argues that there is no coverage under the policy, it cannot rely on the failure of the insured to comply with a policy condition, such as a proof of loss condition, as a defense to a claim.5
In some cases, courts have concluded that an insurer may waive compliance with proof of loss requirements where there is conduct that is inconsistent with an intention to strictly enforce compliance with the conditions.6
The doctrine of tolling further refutes the argument made by mortgage insurers that a proof of claim is not timely filed unless the insurer receives all of the information needed to complete its investigation within the prescribed period for filing a claim. This is because courts in some jurisdictions have held that when an insured suffers a compensable loss under an insurance policy, the limitations period tolls from the date the insured provides notice of the claim to the insurer until the date that the claim is denied.
In short, mortgage insurers rarely are justified in denying coverage to their insured because of the insured's purported failure to comply with proof of loss requirements. These contentions regarding proofs of claims are but one example of the kinds of arguments that policyholders are likely to encounter as they seek to recover the insurance they have purchased to cover loan defaults.
Post-Proof of Claim Issues
Once an insured defeats an insurer's arguments regarding notice of the claim, our experience in England in the last recession was that the insurers scrutinized the files to see whether they had any arguments on nondisclosure of material information that would allow them to avoid the policy.7 They checked the financial institutions' lending criteria to ensure that there had been proper compliance as assessed by the insurer. In the event that the insurer believed there had been lending outside the bank's own lending criteria, they sought to avoid the policy.
In many circumstances, they alleged there had been misrepresentation to the insurer of material facts and circumstances, which they claimed enabled them to avoid the policy. One of the major areas upon which they focused was valuation of property and assets. Insurers argued that they were not obliged to pay out under a policy where the financial institution had a claim against the valuer for failure to properly value the asset.8 Whether this argument can be defeated depends upon the construction of the individual policies.
It therefore is advisable for all financial institutions with bad debts to examine the terms of their mortgage indemnity insurance and seek advice to ensure they comply with the terms of the insurance. Valuations also should be examined in particular where a loan is provided on a loan-to-value basis, rather than a loan-to-purchase price basis.9
As financial institutions increasingly are calling upon their mortgage insurers to abide by their contractual obligations to insure mortgage losses, policyholders must be vigilant in protecting their rights to coverage. With some planning, and knowledge of their rights, lenders can increase the likelihood of recovery.