Reinsurance Transactions: A Recent Decision Highlights The Absolute Necessity Of Risk Transfer – No Risk Transfer, No Reinsurance

Reinsurance is a great way for insurance companies to manage their risk. An insurer issues a policy with a million dollars in liability limits, and then cedes, by way of example, 75% of that risk, or $750,000 to a “reinsurer.” The reinsurer charges a small premium based on its actuarial bet that most claims will never exceed $250,000. The insurer is likewise pleased to pass of the majority of the risk for a small portion of the premium it collected. It is critical to remember, however, that the fundamental tenet of all insurance transactions, including reinsurance transactions, is risk transfer. If no risk of loss is transferred from the insurer to the reinsurer, there is no reinsurance transaction.

This precise problem was addressed recently by a federal district court in Menichino v. Citibank, N.A., 2014 WL 462622 (W.D. Pa., Feb. 4, 2014). By this opinion, a claimant was found to have successfully articulated a RESPA (“Real Estate Settlement and Procedures Act (“RESPA,” for short)) cause of action against Citibank by alleging that Citibank charged fees for reinsurance but did not accept any risk. Citibank is also facing claims for unjust enrichment. While these are merely allegations, and none of these facts have been proven, the claimant’s lawsuit survived the preliminary motions stage, and provided all reinsurers a reminder to carefully consider risk transfer in structuring its transactions.

Menichino shines a spotlight on a lending practice from the pre-bubble-burst halcyon days of real-estate financing, when banks dished out mortgages like hotcakes and homebuyers ate them up without thinking twice. The plaintiff mortgagors in the case claimed to have been issued Citibank residential mortgages between 2005 and 2008 in Maryland, Pennsylvania, New York, North Carolina, Illinois, and Georgia. These mortgagors did not have the typical 20-percent of the purchase price to put down, so Citibank required them to get mortgage insurance from a select group of providers. The plaintiffs would pay the mortgage insurance as part of their regular mortgage payment. That’s a fairly standard arrangement in the mortgage industry, so no big deal there.

According to the lawsuit, Citibank issued the primary mortgages in the first instance, and then Citibank’s reinsurance subsidiaries would also “reinsure” the primary mortgage insurance from the select group of providers. Citibank purportedly gleaned fees from the mortgages, and also from “reinsuring” the required mortgage insurance. The plaintiffs contend that Citibank’s subsidiaries would therefore receive a portion of the mortgage payment as a “reinsurance premium,” in addition to the principal, interest and other fees and costs that Citibank was entitled to as the primary mortgage lender.

The violations of law, according to the allegations in the lawsuit, arise from the fact that the Citibank subsidiaries who issued the “reinsurance” never accepted any risk of default on the mortgages. According to the plaintiffs, the subsidiaries were paid a “reinsurance premium,” but they never actually “reinsured” anything. As set forth in the complaint, the reinsurance contracts between the primary mortgage insurers and Citibank’s reinsurance subsidiaries didn’t even require the reinsurers to have enough funds to pay claims – if there wasn’t money for reinsurance claims, the primary mortgage insurers, not the Citibank subs, were out of luck.

Plaintiffs argued that the “reinsurance” premiums were really kickbacks and unearned fees in violation of RESPA, which prohibits mortgage insurers from paying kickbacks in order to obtain business in connection with real estate settlements. On Citibank’s motion to dismiss, Judge Mark Hornak of the U.S. District Court for the Western District of Pennsylvania found the plaintiffs’ allegations plausibly state a RESPA claim.

The borrowers also sought monetary relief under their respective states’ common law for unjust enrichment, which is typically precluded where actual contracts govern the transactions being complained of. Pointing to mortgage documents notifying homebuyers that some of their mortgage payments might go to the bank’s reinsurance subsidiaries, Citibank argued that the unjust enrichment claims were precluded by notice and the existence of controlling contractual language. The way Judge Hornak saw it, however, the alleged kickbacks were established by the allegations of contracts between the primary mortgage insurers and Citibank’s subsidiaries – contracts that the borrowers weren’t parties to. The Court allowed the unjust-enrichment claims to go forward as well.

This is simply a preliminary ruling, and there is a long way to go in the case. Citibank may still win at the summary judgment stage. But there’s a basic reinsurance point in all this that’s important to remember: If you can’t clearly show a court what risk is being incurred through a reinsurance agreement, a court might doubt its legitimacy. Reinsurance deals can get pretty complicated, so you need experienced insurance attorneys thoroughly vetting your documents to ensure the judiciary will be satisfied that everything is on the up-and-up. If you’re in need of such counsel, or have any other reinsurance questions, contact Bill Sinclair, head of STSW’s commercial litigation group, at 410-385-9116 or bsinclair@silvermanthompson.com, or associate Chris Mincher at cmincher@silvermanthompson.com or 443-909-7505.