Reserving for Title Insurance in a Changing Real Estate Market

1. 2007 Casualty Loss Reserve Seminar Paul J. Struzzieri, FCAS, MAAA September 10, 2007 Reserving for Title Insurance in a Changing Real Estate Market

2. Outline • Title Insurance Basics • Reserving Framework • Actuarial Considerations • Current Market Challenges Page 2

3. I) Title Insurance Basics • The Title Insurance Process • Types of Policies • Unique Issues • Coverage Explained • U.S. Market Share Page 3

4. The Title Insurance Process • Real estate transaction goes to contract • Deposit placed into escrow account • Title search of public records • Documents examined to understand impact on title • Title commitment (evidence) prepared & compared • Inspections performed; surveys examined • Any problems are corrected • HUD-1 form prepared • Closing - prior liens and mortgages paid off; documents executed; title changes hands • Documents recorded at Clerk’s Office, etc. Page 4

5. Types of Title Insurance Policies • Purchase Mortgages • Loan Policy – based on loan amount • Owner Policy – based on purchase amt. • Simultaneous Issue Policy • Refinance Mortgages • Lender requires new loan policy • Original owners policy still in force Page 5

6. Issues Unique to Title Insurance • Title insurance is mono-line • Goal = loss prevention • Low loss ratios (< 10%) • High expense ratios (90%+) • Maintain title plants • Search and examination • Cost to resolve problems Page 6

7. Unique Issues (continued) • Loss is “incurred” prior to effective date • No stated expiration date • Expires when home is sold or when a mortgage expires or is refinanced • How to earn premium? • Title insurers do not know whether policies are still in-force! • Premium = one time; non-refundable • Buyer pays premiums for both Owners and Lenders policies Page 7

8. Title Insurance Coverage Basics • Lender’s interests are protected (loan policy) • Owner’s interests are protected (owners) • Coverage includes: • Cost to cure the defect (up to policy amount) • Defense costs (approx 30% to 40% of loss) Page 8

9. Title Insurance Coverage Causes of Claims • Mistakes in recording legal documents • Incomplete public records • Forgery and fraud • Errors in title search, examination or use of surveys or inspections • Improper closing/escrow procedures • Taxes and assessments • Mechanics’ liens Page 9

10. Title Insurance Coverage Example #1 • Young couple buys home from widow (whose husband died without a will). • Widow’s step-son shows up and claims a share of the home. • Owner’s title insurance policy pays the missing heir the value of his share. Page 10

11. Title Insurance Coverage Example #2 • Mortgage is refinanced; new loan policy is issued. • Afterwards, a prior lien is discovered. • For example, an unpaid mortgage. • Lenders title insurance policy will respond by satisfying the prior mortgage. Page 11

12. U.S. Market Share Page 12

13. II) Reserving Framework U.S. Statutory • Actuarial Reserves • Annual Statement Schedule P • Statement of Actuarial Opinion • Statutory Reserves • Comparison of Statutory and Actuarial Reserves • Supplement Reserve? Page 13

14. Actuarial Reserves • Form 9 = Statutory Annual Statement • Schedule P • By Policy Year • By Report Year • Statement of Actuarial Opinion – since 1996 Annual Statement • Opine on total Schedule P reserve • Case + Bulk + IBNR + ULAE • Net of reinsurance only Page 14

15. Statutory Reserves • Known Claims Reserve = • Case reserves • Bulk reserves (if any) • Statutory Premium Reserve (SPR) = “Unknown” Claims • SPR = Unearned Premium Reserve • Formula = Amount & Take-down Pattern • Supplemental Reserve (if any) Page 15

16. Comparison of Statutory and Actuarial Reserves • Compare Schedule P reserve against Known Claims Reserve + SPR • Schedule P includes Known Claims, so really testing SPR vs. IBNR (incl. ULAE) • If SPR > IBNR, book SPR • If IBNR > SPR, book SPR + Supplemental Reserve • Supplemental = Excess of IBNR over SPR Page 16

17. Title Insurance Industry Reserve Comparison @ 12/31/06 Known Claims = $752M SPR = $4,291M Supplemental = $13M Total = $5,056M Schedule P = $3,913M Page 17

18. III) Actuarial Considerations • Data • Loss development patterns • Trend • Expected loss ratios Page 18

19. Data Considerations • Title insurers do not know the number of policies in-force • Premium and loss data generally not available separately by: • Commercial vs. Residential • Owner vs. Loan policies • Refi vs. Purchase mortgages • State or region • Agent vs. Direct Page 19

20. Loss Development Patterns • Schedule P triangles available (20 policy years) • But, tail is longer than 20 years • Loss development patterns influenced by • Economic variables in future periods • Demographics; homeownership patterns • Refi’s extinguish exposure on original loan => Some policy years will develop faster (slower) than other policy years Page 20

21. Trend Considerations • Premium trends vary with home prices • Severity trends vary with several factors (home prices, wages, etc.) • Frequency trends are cyclical • Large defalcations may disguise loss trends • Underwriting/pricing changes very difficult to measure Page 21

22. Expected Loss Ratio • ELR difficult to estimate due to data limitations and inability to measure coverage/price changes • Alternative to using explicit trends = Econometric modeling • Mortgage interest rates • Refinance percentage • Supply & demand • Affordability index Page 22

23. Expected Loss Ratios For example: • ELR for refinance policy is lower than purchase policy? • Years with increasing refi percentages historically have had lower loss ratios • Econometric modeling can be useful to develop relationships between title insurance loss ratios and refinance percentages (or other variables) Page 23

24. Refi Percentage vs. Title Insurance Loss Ratio Page 24

25. IV) Current Market Challenges • Real Estate Environment • Impact on Claims • Actuarial Implications Page 25

26. Real Estate Environment • 2001-05 “The Golden Years” • Low mortgage rates • Record homes sales • Staggering increases in property values • Affordability index high • Credit markets loosening • Adjustable mortgage/low initial rates • Borrowing the down-payment • Loans in excess of property value • In this environment, people can borrow their way out of trouble (or sell their homes) Page 26

27. Real Estate Environment • 2007- ?? “The Perfect Storm” • Falling homes sales • Flat or decreasing property values • Tightening credit markets • Owners unable to borrow (or sell) their way out of trouble • Increasing delinquencies, defaults • Spike in foreclosures Page 27

28. Impact on Claims • Foreclosure searches trigger wave of reported claims • Increase in frequency • Possibly higher % close no pay • Net effect = ?? • Mortgage fraud on the rise • Large defalcations • Claims not discovered in a rising housing market, but are an issue in a declining one • Higher frequency and severity • Policy Years 2004 – 2006 in particular Page 28

29. Actuarial Considerations • Any speed-up from foreclosures? • Some claims not in historical data • Sophisticated mortgage frauds involving multiple parties • Regional companies may have different experience, depending on market • Foreclosures high in FL, NV, AZ, CA • Just the beginning of the foreclosures Page 29