In its annual review of the title insurance industry, AM Best analysts found the recent momentum of growth and profitability shows “no signs of slowing down.”
The report, titled “US Title Insurers: Rising Profitability, Declining Premium Growth,” was conducted by analysts David Blades, Fred Eslami and Ann Modica, and pointed to broad levels of success in the industry.
“Title insurers have enjoyed a sustained period of underwriting and operating profitability for several years, owing to strengthening macroeconomic conditions and better general financial health for the U.S. consumer. That momentum has shown no signs of slowing down through mid-2019,” the report stated. “AM Best’s U.S. property/casualty title insurance composite saw considerable growth in both pretax and net operating profits in 2018, reflecting success for national companies, as well as smaller companies operating in a single state or specific region of the country.”
The potential downsides, analysts wrote, almost entirely rely on macro factors outside of the title industry itself.
“The ability of title insurers to maintain favorable operating results at or near the levels of recent years will depend largely on the health of the housing market, the recovery of which has been somewhat uneven — home prices in some parts of the country have risen above earlier peaks but remain below those peaks in other areas,” they wrote. “The employment market, consumer confidence, and the desire for home ownership among consumers (including millennials) all remain favorable for the housing market — and thus for the title market. … Furthermore, technological advancements have provided opportunities for title insurers to learn how to harness technology to grow their business and sustain bottom line profitability.
“However, these positives are countered by a number of negative factors, among them, a potential slowdown in economic growth; signs of a weakening housing market; limited housing inventory; the rising costs of materials; and land and labor shortages. In combination, these factors could drive up home prices and hurt affordability, particularly for first-time homebuyers, many of whom are burdened with household and student debt. Another noteworthy factor is the effect of the federal cap on state and local tax (SALT) deductions from federal tax liability on the country’s real estate markets, especially in states such as California, New York, and New Jersey.”
Despite all the potential headwinds, the report acknowledged the strength the industry has shown since the recovery from the Great Recession.
“Still, a number of title insurers have demonstrated the ability to operate profitably, even when market forces are less than ideal and revenues are depressed to some degree,” analysts wrote.
Among the best measures of the strength of the title industry is AM Best’s analysis of underwriting performance. At the height of the housing crash, in 2008, the industry loss ratio was 11.7. In 2018, for the second consecutive year, it was at 4.1 – the lowest mark since 2003.
“That the industry has maintained loss ratios at such a low level despite mortgage interest rates rising throughout most of 2018 and only slight premium growth over the last few years is an encouraging sign,” the report stated.
In addition, the underwriting expense ratio for the title industry was 89.0, down 80 basis points from a year earlier, and far below 2008’s high-water mark of 97.5.
“For title insurers, a substantial portion of this expense is composed of the costs of services for abstractors and attorneys, as well as the involvement of highly specialized title agents themselves, rather than acquisition costs,” the report stated. “Title insurers’ heavy upfront costs include title search and examination, which ultimately benefit both policyholder and title insurer. In 2012, after several years of expense ratios above 90.0, the aggregate expense ratio for title insurers declined below that level (reflecting expense management initiatives at the industry’s leading insurers), where they remain today.
“Typical underwriting procedures include a search of numerous public documents, as well as the evaluation of real property characteristics such as flood zone, location, and construction type. Because these processes are critical to effective, comprehensive title searches, the ability to maintain scale, as well as to expand or contract in line with market conditions, is paramount for a title company’s long-term financial success.”
As underwriting has become less risky and more efficient, net premiums written have continued to surge. As a whole, the industry recorded $14.3 billion in net premiums in 2018, the most since 2005, at the peak of the housing boom. But it’s not just the total premiums that have been encouraging, the report stated, but the industry’s profits along the way.
In 2018 the industry recorded $1.149 billion in profits, spurred in part by a significant drop in tax burden following the passage of federal tax reform. Outside of a one-time capital gains of $1 billion in 2011 at Fidelity National Financial, the profits are far and away the most the industry ever recorded, 27 percent higher than the previous mark of $903 million set in 2016.
However, analysts noted that as premiums have recovered to the high marks of 15 years earlier, the growth rate has slowed.
“Year-over-year DPW (direct premiums written) growth in the title industry was sizable in 2015 (15.5 percent), when a comeback in the U.S. housing market bolstered title premiums in 2015, despite slower growth in the construction of single-family housing and a slight rise in interest rates from the previous year-end,” the report stated. “However … premium growth has slowed in the last two years, with DPW for AM Best’s title insurance composite up only 3.6 percent in calendar 2017 and 0.7 percent in calendar 2018.”
Finally, the industry’s return on equity (ROE) has continued to grow as well, up to 25.8 last year, the second-highest mark since the housing boom.
“An improvement in underwriting income, a rise in net investment income, and a decline in the tax burden helped drive the year-over-year improvement in the aggregate ROE in 2018,” the report stated. “Unrealized gains have been higher than historical norms since 2015, which also added to total returns.”
The Big Four remain the Big Four – and after Fidelity’s proposed acquisition of Stewart fell through, it appears they will remain the Big Four for some time to come. AM Best said the Big Four accounted for 87.3 percent of all premiums in 2018, but their share has diminished bit by bit over time. In 2008, the Big Four accounted for 96.3 percent of all premiums written.
“Despite their dominance, however, the four top underwriters have gradually lost market share over the last decade, and the downward drift in favor of smaller regional title insurers is likely to continue,” the analysts wrote. “These small regional title carriers (often eschewing partnerships with title agents) are entering the market with a strategy to help search public records more quickly. These companies generally charge less as a result, helping lead to the wider distribution of industry premium, a trend that AM Best expects will continue.”
The report addressed industrywide concerns over data security, breaches and defalcation, saying in addition to the financial losses themselves, reputational damage to the industry is “of potentially greater importance.”
“The growing digitization of the title insurance process requires companies to ensure that online and mobile website features are secure; encryption, security controls, firewalls, and cloud access are among the tools title insurers use to protect non-public information. A distinct risk to title insurers is fund transfer fraud resulting from hacks or system compromises,” the report stated. “Cyberinsurance generally covers this type of risk (third-party phishing schemes whereby a company or company agent has voluntarily given the money, unknowingly, to a fraudster). However, this type of scheme can fall within a gray area coverage-wise, so title companies need to carefully assess their commercial crime insurance coverage or obtain specific social engineering attack coverage.”
The increasing digitalization of the mortgage process is changing the industry, and AM Best analysts said title companies were among those helping to spearhead the movement toward eClosings, specifically to speed up title insurance approvals.
“The transformation from manual closings to simplified eClosings creates a great need for complementary, streamlined digital processes for title companies,” they wrote. “Ultimately, improving both the front- and back-end experiences for title insurance customers is the goal — continued progress in the digital transformation of title insurance transactions will therefore be a primary focus for the industry, to lower costs and enhance quality.”
The report cited Blockchain and remote online notarization among technologies which it expects will play a larger role, particularly in the industry’s approach to data and cybersecurity.
“As the industry continues to integrate technological innovations into the title insurance process, implementing necessary safeguards, strengthening employee training, and managing other aspects of risk management will be vital,” it stated.
Notably, analysts stuck with their conclusions in an April 5 commentary which stated that Blockchain would not replace title insurance.
“Implementing Blockchain in a scalable and reliable manner will require overcoming several hurdles, and comes with numerous operational risks, as with any new technology,” they wrote. “Additionally, to fully realize the value of blockchain, current title systems and land records will need to be converted into distributed ledger systems. Given the perennially valid concept of ‘garbage in, garbage out,’ any fraudulent or erroneous records would be transferred as such, so due diligence will be as necessary, as always.
“Blockchain will support, not replace, the title insurance industry. If implemented properly, insurers will benefit from greater transparency and a smaller likelihood of error. Blockchain can enhance transparency by improving the process of digitizing title records and transactions; it won’t obviate the need for title insurance.”
The report concluded by detailing the key part title insurers play in the real estate transaction.
“Title insurers play a valuable role in protecting property rights by facilitating transactions between lenders and homeowners, and insureds will still need a real life insurer who can compensate them and provide support as needed when it comes time to defend their property rights,” the report stated.