Capital foreclosure is a type of home equity loan in which a disproportionate percentage of minority and senior homeowners have been saddled with loans that require high fees and high interest rates. Such loans, which were commonplace from 2003 to 2008, effectively reduced borrowers’ equity positions to zero and were clearly unaffordable given the relatively limited income of these borrowers. In response to the widespread use of such loans, a number of consumer organizations, together with the attorneys general of various states, filed suits against large banks, their directors and officers, who committed capital embezzlement. The lawsuits were based on the theory that banks, along with their directors and officers, encouraged and assisted lenders in predatory lending schemes, knowing that they could arrange and sell those loans in the form of mortgage-backed bonds and, at the same time, time, remove such loans from its financial statements. A number of these lawsuits have been settled and payments have been made to affected homeowners. Other lawsuits are ongoing.
Insurance is a contractual relationship that arises when one party (the insurer), for a fee (premium), agrees to compensate the other party (the insured) for losses caused to a certain subject (risk) caused by certain unforeseen circumstances (hazards or dangers). The term ‘guarantee’, commonly used in England, is considered synonymous with ‘insurance’.
The 10/10 Rule is a matter of analyzing and demonstrating the transfer of risk as a precondition for the use of reinsurance accounting, which was codified in the early 1990s with the adoption of Financial Accounting Standard (FAS) 113 (and its statutory counterpart, SSAP 62). FAS 113 itself was a response to alleged abuses and set the standard for testing whether something should be called an insurance contract. FAS 113 required that the transfer of risk be demonstrated by comparing the present value of the cash flows associated with the contract and, in particular, by exceeding certain thresholds of “significance” of risk. The thresholds, often referred to as the 9a and 9b tests, are: 9a. The reinsurer assumes significant insurance risk under the reinsured parts of the underlying insurance contracts. 9b. It is possible that the reinsurer could suffer a significant loss from the transaction. While neither “significant” nor “reasonably possible” was defined in this context, standard rules of thumb quickly emerged in the implementation of FAS 113. The most commonly cited is the “10/10 Rule”. This rule states that a contract reaches a threshold if there is at least a 10 percent chance that it will suffer a loss of 10 percent or more in present value (expressed as a percentage of the contract premium ceded).