The hidden costs behind title insurance: How title companies used to pay “inducements” (kickbacks) to encourage lawyers and realtors to use them and the 2018 New York State regulations designed to stop them.

Title insurance is a must for all home buyers in New York.   A title company searches the public record to identify potential issues with the title.  Common problems include things like old liens, judgments, encroachments, survey overlaps, outstanding mortgages or unpaid taxes against the property being purchased.  Title companies play an important role in real estate transactions because they act as a “risk mitigater” because they verify that the piece of property is unburdened by title issues and “indemnify” the owner and lender for such problems.

There are two types of title insurance; owner title insurance and lender title insurance, both of which you pay for at the closing if you are mortgaging your home.  If a person emerged to claim that they were the rightful owner of the house, or had a judgment or lien against the house, then there might be title “claim” to the applicable insurer.  Assuming the title insurance company agreed, and had not excepted coverage in the original policy, lender title insurance would reimburse the lender the amount they lent to purchase the home (or your title was damaged), or might hire title attorneys to repair the problem.  If you had owner title insurance policy, you would be paid for the value of the loss, or the title insurance company would work to sort out the title claim (indemnify you for your losses, including attorneys fees to repair the title issue).

Either way, title companies are integral to the home buying process protecting consumers from purchasing a home that could present headaches down the road.  But how do we choose a title company and how much will the buyer and seller pay at the time of closing?

Most clients will defer to their attorney or real estate agent in selecting a title company, particularly if the attorney or real estate agent employs that company regularly.   Recently, the New York State Department of Financial Services has been investigating the relationship that gratuities, fancy parties, and other “entertainment” related expenses might play a role in the retention of a title company, and the effect of such inducements on the cost of title premiums in New York.

As the article referenced above indicates, title companies in New York have been spending tremendous amount of money on these so-called “marketing expenses” or “inducements; meaning that, collectively, buyers in New York pay higher title insurance premiums at closing.   A 2015 investigation by New York’s Department of Financial Services (DFS) found that title companies spent millions of dollars on incentives to attorneys and real estate agents.  These incentives violate the “anti-inducement” portion of New York State’s insurance law.

Over the past year, DFS has been drafting regulations designed to illuminate the relationships between title agencies, title insurers, and the undisclosed fees associated with these “inducements.”    The DFS’ regulations due to become fully effective in February 2018 seek to clarify the law by providing a list of expressly prohibited “inducements” including meals, concert tickets and parties.  Additionally, the regulations seek to force the main title insurers to re-issue their premium calculations excluding the costs of the alleged “inducements.”

According to a DFS press release, the rules “clarify that the New York anti-inducement statute is not limited to situations in which there is a direct quid pro quo for business, and establishes clear guidelines of expenses that are not permitted.”

An accompanying regulation from DFS requires title companies to make a “good faith effort” to compete in the marketplace, and “[requires] a title insurance agent or corporation that accepts business from an affiliated person to function separately and independently from the affiliate, including being staffed by its own employees.”  This regulation takes aim at the structure of many smaller title firms, particularly those owned by the attorney or real estate agent by requiring them to act independently and prohibiting them from relying on a handful of firms for their entire business.  The business models of some small title firms, who are reliant on a small, steady source of clients may therefore be significantly altered.

The Bottom Line– New NYS DFS regulations attempt to offer more transparency in closing costs, particularly in the often overlooked sector of title insurance.   The theory is that you, the consumer, is best service by a clear understanding of the charges and fees being charged at the Closing.

(With thanks to Contributor Owen Voutsinas-Klose)