Opinion ID: 900305
Heading Depth: 1
Heading Rank: 4

Heading: Risk Shifting

Text: ¶ Norwest Parties' primary claim is that TOP is not insurance because there is no shifting of the risk. They argue that under our statutory definitions of insurance and title insurance there must be a risk shift and also a contract of indemnity, and that these elements do not exist with TOP. ¶ SDCL 58-1-2(10) defines insurance as: [A] contract whereby one undertakes to indemnify another or to pay or provide a specified or determinable amount or benefit upon determinable contingencies[.] SDCL 56-3-1 defines indemnity as a contract by which one engages to save another from a legal consequence of the conduct of one of the parties or of some other person. SDCL 58-9-33 defines title insurance as the insurance of owners of property or others having an interest therein or liens or encumbrances thereon, against loss by encumbrance, or defective titles, or invalidity, or adverse claim to title. ¶  `The essence of an insurance contract is the shifting of the risk of loss from the insured to the insurer.' In re Request for Opinion of the Supreme Court, 379 N.W.2d 822, 827 (S.D.1985) (quoting American Nurses Ass'n v. Passaic General Hosp., 192 N.J.Super. 486, 471 A.2d 66, 69 (1984)). Shifting the risk can be defined as the transfer of the impact of a potential loss from the insured to the insurer. Clougherty Packing Co. v. Comm'r of Internal Revenue, 811 F.2d 1297, 1300 (9th Cir.1987). ¶ Norwest Parties rely on the decision of the Virginia Supreme Court in Lawyers Title Ins. Corp. v. Norwest Corp., ___ Va. ____, 493 S.E.2d 114 (1997). We are not bound by the Virginia decision and do not find it persuasive for a number of reasons. First, unlike South Dakota, Virginia does not have a statutory definition of insurance. Also, that court did not review this issue under a de novo standard. Finally, the Virginia decision was a sharply divided 4-3 decision, and we are more persuaded by the dissent. See Id. 493 S.E.2d at 117-20 (Whiting, J., dissenting). ¶ We first must determine if there is a shifting of the risk between a borrower and NMI. Norwest Parties, pointing to the mortgage documents as proof, claim there is no such risk shifting. The mortgage executed by a borrower contains a warranty that the mortgage lien will have a first-priority status. Borrowers, at the time of closing, also sign an affidavit in which they agree to indemnify NMI in the event that certain off record defects imperil the first-lien status of the mortgage. This appears to indicate that the risk at all times stays with a borrower and never shifts to NMI. However, as the dissent in Lawyers Title noted, whether a particular contract is one of insurance does not depend on what it is called, but what it does. 493 S.E.2d at 119 (Whiting, J., dissenting) (citing Associated Hosp. Serv. v. Mahoney, 161 Me. 391, 213 A.2d 712, 721 (1965); People v. Roschli, 275 N.Y. 26, 9 N.E.2d 763, 764 (1937) (other citation omitted)). ¶ We must closely examine what TOP entails. Norwest indicates in various documents that TOP is not title insurance. However, if that were all that was required, anyone could avoid regulation by Division simply through documentary disclaimers. See Morgan v. City of Ruleville, 627 So.2d 275, 283 (Miss.1993) (McRae, J., concurring in part and dissenting in part) (noting that just because an entity stated it was engaged in self-insurance and thus should not be regulated, such should not be controlling because [a] wolf in sheep's clothing would, no doubt, purport to identify himself as a sheep.). Norwest Parties represent to a borrower that, while TOP replaces lender's title insurance, it is not a substitute for borrower's title insurance. However, they also represent to a borrower that TOP offers them indirect protection since the lender will clear up major title defects to protect itself which in turn would clear up the defect[s] for the [borrower]. It is also Norwest Parties' policy to not pursue a borrower if a title defect arises unless there was fraud on the part of the borrower. Thus, since the borrower would normally retain the risk of a defect in title, Norwest Parties' policy and representations that TOP will at least partially protect a borrower, create a shifting of the risk. ¶ We also find that there is a shifting of the risk when Norwest Parties sell a loan to Freddie Mac on the secondary market. Norwest Parties claim that, when a loan secured by a mortgage is made, NMI, as the originating lender, bears the risk that the loan is not secured by a first mortgage. They argue that when they sell a loan to Freddie Mac and warrant it is secured by a first mortgage, they are merely retaining the risk, not shifting it. We do not agree. ¶ Freddie Mac has agreed to accept TOP as an alternative to title insurance when it purchases a loan. NMI issues a master agreement to Freddie Mac when it sells a loan, and this agreement generally states that (1) the loan constitutes a valid first lien, and (2) in the event a claim or lawsuit arises involving title issues that could impair Freddie Mac's first-lien position or the value of the underlying property, NMI agrees to act to protect Freddie Mac's interest, including retaining counsel and paying for all defense costs, or repurchasing the loan. ¶ Although the Nebraska Supreme Court does not define insurance in terms of shifting the risk, we find its statements on this issue persuasive. That court held that at the time NMI sells a mortgage to Freddie Mac, NMI no longer has an insurable interest after the sale, and that the owner of the mortgage, Freddie Mac, bears the risk. Norwest Corp., 571 N.W.2d at 637. We find this opinion more persuasive than that of the Virginia Supreme Court in Lawyers Title, 493 S.E.2d at 116, holding: When Norwest Mortgage makes a loan, it is a mortgage loan secured by a lien interest in the realty. At that point in time, Norwest Mortgage incurs a title risk that the loan is not properly secured or that its lien is not first in priority. Then Norwest Mortgage sells that mortgage loan into the secondary market. At that point, Norwest Mortgage makes a warranty and representation to the secondary market purchaser that the loan is a first mortgage loan. ¶ Were we to agree with the Virginia Court we would be ignoring the fact that, absent the master agreement, Freddie Mac bears the risk. When Freddie Mac purchases a loan it becomes, in essence, the owner of that loan. If there is a claim against the title of the underlying property, Freddie Mac would bear the risk. That is why Freddie Mac requires either title insurance or TOP as a condition to its purchasing a loan. We reject Norwest Parties' argument that since NMI agrees to be responsible for any defects in title, the risk does not shift because Freddie Mac never receives the risk in the transaction. That ignores the underlying realities of risk absent the other agreements. That is also why Freddie Mac requires Norwest to guarantee NMI. Such an agreement would be unnecessary if NMI always maintained the risk.