Before the collapse of the housing market in 2008, it was common for large, high-volume mortgage lenders to form captives to spread their exposures to property mortgage insurance (PMI). But once the market bottomed-out, these arrangements fell under greater legal scrutiny and many courts are now finding them lacking. According to attorneys David McMahon and Peter Felsenfeld of Barger & Wolen, in a new online article in Risk Management magazine, the way premiums are collected by the captives may be a violation of federal law.

Mortgage reinsurance captives…are not funded by premiums paid by the parent company. Just like a standard reinsurer, they operate by collecting premiums from the PMI provider and sharing in the payment of losses. They are “captives” by virtue of their relationship to the parent institutional lender. In that way, they appear to the outside world just like any other wholly owned subsidiary of the lender.

Once commonplace, this arrangement may create legal exposure to lenders that outweighs the benefits of reinsuring through a captive. Courts are increasingly frowning on the captive mortgage reinsurer model, allowing class actions to proceed against lenders that allege the premiums generated constitute improper referral fees or even “kickbacks.”

As the authors report, court decisions over the last few years are increasingly chipping away at the concept of mortgage reinsurance captives and putting lenders on the defensive. For more, you can read the entire article at RMmagazine.com.