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TITLE INSURANCE: THE PRIVATIZATION OF THE REGISTRO PÚBLICO DE LA PROPIEDAD IN THE UNITED STATES OF AMERICA, AND ITS PROJECTION BEYOND OUR BORDERS.

By José Manuel Pallí, Esq.

jpalli@wwti.net

For the past twenty years I have participated in a number of efforts –and witnessed some others- geared towards the promotion of title insurance outside the United States, the country where this product/service was ‘born” and where it has become an all but essential component of real estate financing. Those efforts have been relatively fruitful in some countries where the legal and cultural environment is similar to that of the United States (countries where the Common Law system predominates, such as Canada or the United Kingdom). But within the Civil Law world –the countries where the Civil Law system prevails- the efforts to promote title “insurance” are going nowhere. It is true that, in those civil law countries where there is a perceptible flow of US source investment into their real estate markets –such as México, or several countries in Central America where retirees and pensioners from the United States seek a better quality of life for their golden years-, American buyers of real estate occasionally[1] ask for title insurance (which is issued, in most cases, directly from the US by an American title insurance underwriter). But outside of the English speaking world, no country’s real property market has been penetrated by title insurance, a product or service which the public at large has not even heard of, in most cases[2].

There are a few reasons behind this failure to capture foreign markets, but none of them looms larger than our lack of imagination, which leads us to try to impose a product like this one with the argument that, if it works for us in the US –where it plays a big role in the world’s most solid and fluid housing finance market- it should work everywhere else. This is a false premise, and the title insurance industry’s persistence on it –mainly because of what some of the underwriters see as a successful experience in Canada- has prevented the development of a “civilized’ version of its product (one that is attuned to the culture and to the legal system of civil law countries).

But despite all this, at times it seems as if our title insurance industry is satisfied with the pace of their “international’ expansion and with the reception its product receives overseas. And a week seldom goes by without one of the large underwriters announcing the opening of new offices abroad (in Poland, in Turkey, in Spain), to the delight, it seems, of its stock-holders and of those who believe that, in today’s world, the worth of a company is judged by its ability to globalize itself. And even if not a single Pole or Mexican may show any interest in title insurance, as long as there is an American investor willing to buy it in the process of purchasing local real estate, the international expansion is justified.[3]

 The whys and wherefores of title insurance.

In the United States of America we have no concept of Registral Law (Derecho Registral) nor of  Notarial Law (Derecho Notarial), the two fields of the Law which, in the civil law system, combine to provide a framework or safety net for assuring legal certainty in real estate transactions. And we do not have this safety net  simply because we do not care to have it.[4]

The American public records system does effectively publicize those documents that may have an impact on property rights. But since those documents are not produced by a notary who also reviews other relevant documents in the chain of titles (there is no calificación notarial), and our registrars (or clerks of court) give only a cursory look to the documents they are asked to record (there is no calificaión registral), the function of assuring legal certainty in real estate transactions is left to the title insurance industry, which will indemnify those who suffer the consequences of a failure of title (and who have been provident enough to buy a title insurance policy). The key function of what civil law countries call the Registro Público de la Propiedad is thus virtually privatized through the title insurance industry, which, methodically and on a daily basis, duplicates in its title plants, the information filed with the public records system in each jurisdiction.[5]

The growth of the title insurance industry in the United States was driven by the huge expansion of the real estate (or housing) financing business. As a general rule, American banks will simply not lend money to someone purchasing real property unless the borrower obtains (and pays) for a title insurance policy. This policy will assure the lender that if, when his mortgage loan ends up in foreclosure –or at any other time while the loan is outstanding-, another party shows it has a better right (not disclosed and excepted in the policy) to the property securing the loan, the title insurance underwriter will indemnify the insured lender.

Every now and then, the politicians, those in charge of fostering the availability of affordable housing, and those charged with regulating the insurance business, both at the local and the national level, come together and decide to rock the boat of the title insurance industry, questioning its role, its commercial practices and its prices –in this Summer of 2006 we happen to be going through one of those cycles[6]-, although, at the end of the day, good sense prevails (induced, perhaps, by the industry’s excellent lobby), and the value of this product and the key role it plays as a lubricant for the real estate financing system is –implicitly, at least- acknowledged. Invariably, however, each time we go through one of these exercises, the title insurance industry insists that all it needs to do is to better educate a general public that simply does not understand title insurance, or worst, misunderstands it.

This essay, although addressed to my colleagues in the Americas –most of them “civil lawyers”- and bent on explaining title insurance to them, is also a humble attempt to help my brethren in the title insurance industry in their educational efforts to clarify and dispel a number of misconceptions, insofar as they have had an impact on “international” title “insurance”.

What is title insurance?

Contrary to what is the norm in the case of all other insurance products which protect the insured party against the occurrence of future and somewhat uncertain events (what in most all civil law countries’ insurance laws is described as a “riesgo futuro e incierto”), title insurance does not look forward, but backwards, and protects the insured party against defects or limitations in the insured title that could put into question the validity, solidity or priority of his rights over a specific piece of property.

The eventuality or contingency that triggers the insurer’s obligations under the title insurance policy is the manifestation –usually through the adverse claim of a third party- of such defects or limitations bearing on the insured title; but title insurance only covers them if they already existed at the time the policy was issued but were not detected in the title examination process that precedes the issuance of the policy. Defects or limitations that are caused or created subsequent to the date of policy are not within the scope of the title insurance coverage.

This is why questions abound as to the “insurance” nature of this product that only covers pre-existing risks, which, on top of it, must have survived an exhaustive investigation of the chain of titles that supports the insured title. The goal of title insurance is to eliminate risks.[7], not to take them on. It does protect against certain risks that are often all but undetectable through the examination of the records –forgery, fraud, incapacity[8]- but it does not cover defects that result from acts or events that take place after the policy is issued.

But that is also why title insurers charge a one time premium –this often comes as a pleasant surprise to those who are negotiating for an insurance product they barely know anything about- which you need not renew periodically as you must do in the case of the traditional insurance lines –like property, casualty, health, etc. And when statistics show that, in the case of most other lines of insurance, over eighty percent of the premium money is used for paying claims, title insurance underwriters historically destine only about six percent of the premium money for those purposes, which is even more surprising in the midst of a society as prone to litigate as America’s is.[9]

The day will arrive when the industry itself will come to terms with a stark reality: title insurance is not “insurance”. And this day may be getting closer as a result of the industry’s dabbling with international markets.[10]  Chances are that title insurance will then be defined as a financial product or service (a guarantee?) that facilitates and accelerates traffic in the real estate market, particularly in those real estate markets mature enough to sustain a large volume of secured financing.

Title insurance and real estate financing

The policies issued for the benefit of mortgagees (loan policies) vouch for the validity and perfection of the security interest, as well as its priority over other encumbrances. At the same time, the loan policy does what an owners policy –issued for the protection of those who purchase a piece of real property- does: it warrants the solidity of the title to the land offered as security, as vested, in the case of a loan policy, in the mortgagor.

The national mortgage market in the United States of America grew exponentially in the years following World War II, driven by a Federal Government resolutely in pursuit of accessible and affordable housing for all Americans. Title insurance played an important role in that rapid growth due to its ability to homogenize title risks (at a National level), and it was a factor in the inducement of private banks towards lending against real property (making them more comfortable), bringing down the cost of the loans and opening the road for the securitization of mortgages in a secondary market.[11]

What Civil Law critics of title insurance say

Civil Law criticism of title insurance is mostly centered on two main issues:

(1)   Title insurance is criticized because it increases the costs of real estate transactions[12]

(2)   Title insurance is also criticized because it is not capable of satisfying the true needs and expectations of those who are victimized by title defects, because all it does is indemnify the insured party with money (in case of a total or partial loss0 when that party’s expectation –specially in other cultures- is to remain as the owner and occupant of his dwelling, for example. In other words, the beneficiary of a title insurance policy gets some degree of economic certainty, but legal certainty is not enhanced by title insurance[13].

 The true needs and expectations of an insured owner may, occasionally, be colored by culture –in some cases, people may feel more attached to a house or an heirloom than in others- but title insurance goes beyond the provision of economic certainty: the protection afforded by a title insurance policy is not limited to an insurer’s eventual duty to indemnify. A title insurance policy is, indeed, an indemnity contract between the company issuing it and a named beneficiary, but once the company is notified by the beneficiary of the existence of a loss caused by an adverse claim questioning the legality of the insured title, the obligations of the title insurance underwriter are as follows:

1.- To indemnify the beneficiary for the loss he has suffered –up to the amount of insurance shown in the policy, to the extent the loss is not due to a title problem that the policy has listed as an excepted from its coverage;

2.- The underwriter also has a duty to defend the beneficiary –at the company’s expense- in any court procedure where the validity and priority of the beneficiary’s rights over the property and his titles are questioned;   and, when feasible

3.- Eliminate or correct the encumbrance or defect bearing on the insured title.

The restoration of the policy’s named beneficiary in the full exercise of his rights over the property is frequently the only valid option, if the title in question is to keep its marketability. And it is precisely in that concept of marketability of the land title where we find the key for the success of title insurance as an all but essential lubricant for the smooth functioning of the real property market in the United States.

A title insurance policy does not warrant that a given land title is perfect; it does not even call the insured title good. It calls it marketable, meaning that is has no defects that would justify its rejection by a reasonable buyer, and the title insurance underwriter is ready to back that assessment up to the amount covered under the policy. It is in this aspect of title insurance that we begin to discern a little more clearly the role it plays as a risk distribution mechanism: despite its vocation towards the elimination of all risks –by detecting and curing all title defects before the policy is issued-, title insurance selects those defects that should not compromise marketability and insure them, thus making the land title in question acceptable to the market.

Conclusion

To argue, as some in the civil law world do, that title insurance is a booby trap, or a racket, entails the assumption that the financial markets in the United States are neither sophisticated nor refined, and that free lunches are consistently served –two of the largest title insurance underwriters go back more than one hundred years.

It is true that it is a line of business where, as it happens in most fields, there are practices that defy common sense. Take, for example, the title insurance industry’s insistence in issuing a “new” policy –charging a new “insurance” premium for it- every time a debtor decides to renegotiate or refinance his mortgage at a lower interest rate (in some cases, this means issuing a new policy, insuring the title to the same property that secures the “same” credit that was covered by a policy issued only a few weeks ago). Over the past five years, the title insurance industry has seen its revenues vastly enhanced by these transactions called “refis”. But the market itself, sooner or later, finds a way to correct these nonsensical practices, and the premium rates applicable to “refis” have come down sharply. [14]

It is also true that the international projection of title insurance, which could be hoped to help clarify the differences between the way real estate transactions are conducted in the United States and in other countries, has thus far failed in this regard. In the United States, there seems to be a very negative perception of the risks run by real estate investors south of the Rio Grande. Though this is not a well founded assessment, it is often strengthened by newspapers and other media[15], and the title insurance industry has occasionally contributed to it (more out of ignorance than out of guile). There may be some within the industry that enjoy –and thrive in- this type of disinformation; after all, the purchase of any line of insurance is driven by fear, and sometimes by confusion. But credibility has few stronger enemies than exaggeration, and this is a product in search of credibility. 

There are, of course, title problems in México -and in every country in Latin America-, just as there are title problems in the United States and everywhere else. But, in order for it to be credible, a product that resembles the oddly named title insurance, and which is able to play, in Mexico, a similar role to the one played by title insurance in the US

-helping and accelerating the growth of housing finance- should be solidly grounded in Mexico’s needs, and designed so as to assimilate and absorb typically Mexican title risks, as perceived by the Mexican real estate and financial markets. The same designing job should be undertaken in other foreign countries, in the context of different cultures, and seeking the consensus of all the key players in those foreign real estate markets.     

 


[1] In a conversation –in July 2006- with one of the largest builders of houses and condominiums in Panama, which presently sells over sixty percent of its inventory to foreign buyers, its sales manager assured us that, in a recent experiment, only 1 out of 600 foreigners who were offered title insurance chose to purchase it.

 

[2] México, where one of the four largest title insurance underwriters sought and obtained regulatory clearance to issue home-grown policies –through a local subsidiary-, is a case in point. If you visit the web-page of the Asociación Mexicana de Instituciones de Seguros –http://www.amis.com.mx- you will find no reference to seguro de titulación or title insurance. And what little advertising for title insurance you will find is going to be directed to the foreign investors (specially in the beaches and resort towns). Which is not surprising, since the Mexican Insurance industry seems not to consider title insurance an insurance product

-but rather an American fad-, and the same happens in other countries. 

[3] One of the reasons why American investors –specially the more sophisticated ones- often buy title insurance in Mexico is their belief that a title insurance policy may be helpful in case they need to leave their investment position; in other words, they use it as part of their exit strategy. And this makes a lot of sense, particularly if you anticipate that the exit door could be through another American investor. Title insurance has also been used effectively in the international arena in a similar way –as a sales tool- for the resale of rights for which there is not a very fluid market, such as time shares.

 

[4] There is no reason why we could not have a registration of rights system (registro de derechos) in the United States, as they have in Germany and in Spain(as well as in Cuba, before Castro). A registration of rights system is more advanced than the registration of documents system we have, since it strives for perfection in order to better protect the rights of third parties who rely on the information contained in the public records. The common law culture should not be an obstacle for such an upgrade: the United Kingdom has implemented a registration of rights system very similar to the one Germany has. In the United States we do not even have an homogenous national recording system ( the public records in each state, sometimes in each county, have their own peculiarities), and the RESPA (the Real Estate Settlement Procedures Act), in its original version passed by Congress in 1976, had a Section XIII which extended an invitation to all the key players in the real estate market to jointly design a model geographically based recording system that could serve as the baseline for the development of a uniform public records system for the Nation. The studies and plans fostered by the HUD through this invitation may have been sleeping in the drawer of some Washington D.C. bureaucrat for the past thirty years.   Mexico, a country whose political organization –a true federation of states- is similar to that of the United States of America, has also generated a great diversity of registries or recording systems amongst its thirty two estates (entidades federativas), but is a lot closer to finding the consensus needed for adopting a national uniform system for the registration and publicity of property rights. 

 

[5] A title plant is nothing more than the systematic ordering of the recorded information –lifting the documents from the public records, where they are filed and indexed according to the parties’ names- pursuant to a geographical criteria, creating a parcel index, which is much easier to use than the grantor grantee index found in the public records system. In the civil law world, such a geographically based recording technique is known as folio real, and it is precisely what the Germans and the Spaniards use.   

 

[6] In April 2006, a subcommittee of the House Committee on Financial Services held hearings to investigate the inner workings of the title insurance industry, and its interaction with other key players in the real estate market Concurrently –and over the past few months-, the Insurance commissioners in a number of states launched their own investigations, focusing on the degree of competitiveness within the industry, its pricing structure, etc, and some substantial fines have already been applied at the time this is written

[7] In my early years trying to convert Mexican real estate developers into the benefits of title insurance, we frequently dealt with title problems that had remained uncorrected for years (and which had not impeded a number of “uninsured” conveyances) with a zeal that always led our Mexican clients –faced with our request to cure the defect before we issued our policy- to ask: “Why do you call what you are selling ‘insurance’ if it does not cover this trifling?”     

 

[8] The brand new (2006) American Land Title Association forms do a good job of emphasizing this –in items 2(a) and 9 on the face of the jacket for the ALTA loan policy form, for instance- by expanding the list of affirmative coverages to fourteen (where there were only five in the older forms).

 

[9] This huge –and frequently criticized- disparity between title insurance and other lines of insurance may only be apparent, and it can be explained by the fact that, unlike in other lines of insurance, the majority of expenses for title insurance –the title examination, the curing of existing defects, some services related to the closing of the real estate transaction, among others- are incurred prior to the policy being issued. But the source of this “problem” is found in a title insurance industry that insists in identifying as “insurance” a financial product or service that has nothing in common with the traditional insurance products. The problem is only magnified when the industry “explains” that what the premium really pays for is the underwriting skills –the search and curative work done prior to issuing each policy- while tying the very same premium to ever escalating property prices.   

 

[10] The underwriter which, after a long and strenuous process before the Mexican insurance regulators (which regulators had previously told one of its competitors that they did not see any “insurance” in title insurance), “domesticized” itself in México, accepted to have title insurance treated as one more line among the damages (daños) insurance category. As a result of this very unusual and all but compelled regulation –at the behest of the American title insurance underwriter- title insurance in Mexico is subjected to an incomprehensible strait-jacket, and the one and only local underwriter has to comply with four different reserve requirements that have no correlation with the kind of risks covered by title insurance.

 

[11] The example of this ever growing and unique American mortgage market was, for a long time, the best argument for those who wanted to promote title insurance outside its natural habitat. It was also the best tool to defend  title insurance from its harshest critics –specially the Spanish Registrars, and the civil law notaries (the Notariado Latino) in general-. But over the past five years, financial institutions in Spain have generated twice as many mortgages as they did at the turn of the Century (a  volume of six hundred thousand million euros), and without title insurance, as my colleagues in Spain tirelessly remind me.

The securitization of mortgages is still incipient in Spain. But contrary to the expectations of many in the title insurance industry, countries like Argentina and México have been able to place mortgage backed securities in some of the most sophisticated financial markets in the World –even in the United States- without the enhancement of title insurance and with the blessing of the large credit rating companies. This debunks the “logic” behind the “what works for us should work for everybody else” approach, and should strengthen the hand of those in the industry (and even outside of it) who advocate for a redesign of this typically American –almost parochially so- product to adjust it into “something” –which should not be called “insurance”- that responds to the perceived needs, risks and circumstances of each foreign market.   

[12] This argument about the allegedly higher transactional costs in a legal environment where title insurance is used can only be addressed by a comparison between the transactional (or closing) costs of a real estate financed transaction in the US -one where a policy of title insurance is issued- and the transactional costs in countries where there is no title insurance. And this is not an easy comparison to make, because both, civil law notaries’ fees (aranceles notariales) and the rates by which the title insurance premium fees are calculated, tend to vary from one jurisdiction to another. But the highest rates applicable to title insurance in the United States today –in those estates where title insurance is more expensive- rarely exceed 0,750% of the loan amount (this should include the policy and the title search), and this, on the average, seldom amounts to more than between twenty and twenty five percent of total closing costs.  

 

[13] The purists of Registral Law –and of civil law, in general- cling to this argument which, rather than decry title insurance, blandishes it. It is precisely in search of economic certainty that the financial markets in the United States resort to title insurance. And  it is the quest for  economic certainty as well that motivates those who invest in real property in foreign countries when they seek the protection of a title insurance policy: an economic certainty that is only a phone call away, by ringing up a title insurance company that they know to be solvent. The prudent investors who opt for using title insurance do not need to concern themselves with the solvency of the foreign recording system operators or that of the particular civil law notary who prepared their deeds, nor about establishing these parties’ negligence through litigation in a foreign court of law. The importance of that economic certainty  for many of those American investors who purchase land in México, for instance, is further revealed by their reluctance to buy title insurance from Mexican subsidiaries of American title insurance underwriters, even id they are re-insured by the latter: in most cases, they ask for a policy issued directly by the American underwriter, in the United States, and subject to US laws.    

[14] This is an area where Spaniards can also claim their system clobbers title insurance, at least from the consumer’s perspective. Since 1994, Spain has a “Ley de subrogación y modificación de préstamos hipotecarios” –Law # 2 / 1994- by means of which the mortgage debtor can -without needing to obtain the creditor’s consent- move for an improvement in the loan’s financial terms (when the rates are lower, and once a year only) while the mortgage preserves its rank or priority.     

 

[15] This negative image is fed by a series of prejudices and delusions which, after years of repetition, have become part of the folklore on the northern side of the border. For instance, the rights of a property owner, which Mexican law (and civil law in general) calls dominio, is frequently identified with fee simple ownership, a common law concept which, though similar, is far from being identical to dominio. In  another example of misinformation, you will often read that the rights a foreign investor holds through a fideicomiso en zona erstringida (the Mexican Federal Constitution, in article 27, bars foreign “direct” ownership of lands close to the country’s coast-line and its international borders) are no more than leasehold rights (a complete fallacy), or that the trustee in such a structure (which must be a Mexican bank) warrants the quality of the title to the property placed in trust for the benefit of the foreigner (when in fact, the deeds whereby these trusts or fideicomisos are settled specifically deny the existence of any such warranties from the bank). Another false claim that is frequently made (and this one has even found its way into some of the international risk rating companies Investors Reports) is that Mexico’s land title recording system is a replica of the Australian Torrens System (there are as many recording systems and techniques in Mexico as there are states, but none of them follows Torrens). And there are plenty more.