Reserving for Title Insurance

2004 Casualty Loss Reserve Seminar2004 Casualty Loss Reserve SeminarPaul J. Struzzieri, FCASPaul J. Struzzieri, FCASMilliman, Inc.Milliman, Inc.September 14, 2004September 14, 2004

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OutlineOutline

I.I. Introduction to Title InsuranceIntroduction to Title Insurance

II.II. Financial Reporting IssuesFinancial Reporting Issues

III.III. Actuarial Challenges & MethodsActuarial Challenges & Methods

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I) Introduction to Title InsuranceI) Introduction to Title Insurance

a)a) Types of PoliciesTypes of Policies

b)b) CoverageCoverage

c)c) Unique IssuesUnique Issues

d)d) MarketsMarkets

e)e) DistributionDistribution

f)f) ReinsuranceReinsurance

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Types of Title Insurance Types of Title Insurance PoliciesPolicies

a)a) Purchase MortgagesPurchase Mortgagesi.i. Lender Policy – based on $ amount Lender Policy – based on $ amount

of loanof loan

ii.ii. Owners Policy – based on $ amount Owners Policy – based on $ amount of purchaseof purchase

b)b) Refinance MortgagesRefinance Mortgagesi.i. Lender requires new policyLender requires new policy

ii.ii. Owners keep original policyOwners keep original policy

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Purchase vs. Refi MortgagesPurchase vs. Refi Mortgages

(amounts in billions)

$0

$400

$800

$1,200

$1,600

$2,000

$2,400

$2,800

$3,200

$3,600

$4,000

Purchase Volume Refinance Volume

Refinance Volume $174 $420 $530 $185 $134 $228 $242 $754 $437 $195 $1,117 $1,426 $2,515

Purchase Volume $388 $474 $490 $584 $505 $557 $592 $754 $848 $829 $914 $1,032 $1,295

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

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CoverageCoverage

a)a) Lender’s and owner’s interests are Lender’s and owner’s interests are protectedprotected

b)b) Cost to cure the defect; plus defense Cost to cure the defect; plus defense costscosts

c)c) Common title problems:Common title problems:i.i. Defects, liens, easements – catch during Defects, liens, easements – catch during

searchsearch

ii.ii. Hidden hazards – undisclosed heirs, forged Hidden hazards – undisclosed heirs, forged deedsdeeds

iii.iii. Unmarketability of titleUnmarketability of title

iv.iv. DefalcationsDefalcations

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Coverage Example #1Coverage Example #1

Young couple buys home from Young couple buys home from widow (whose husband died widow (whose husband died without a will).without a will).

Widow’s son shows up and claims Widow’s son shows up and claims a share of the home.a share of the home.

Title insurance pays the missing Title insurance pays the missing heir the value of his share.heir the value of his share.

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Coverage Example #2Coverage Example #2

Just prior to closing, a prior lien is Just prior to closing, a prior lien is discovered.discovered.

For example, a paid but unreleased For example, a paid but unreleased mortgage.mortgage.

Purchaser can decide not to close Purchaser can decide not to close based on this discovery.based on this discovery.

Title insurance policy will respond if Title insurance policy will respond if unmarketable.unmarketable.

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Issues Unique to Title InsuranceIssues Unique to Title Insurance

a)a) Loss is “incurred” prior to policy Loss is “incurred” prior to policy issuanceissuance

b)b) No policy expiration date No policy expiration date how to how to earn premium?earn premium?

c)c) Goal of title search & examination Goal of title search & examination = loss elimination= loss elimination

d)d) High expense ratios (90%+); low High expense ratios (90%+); low loss ratios (4-10%)loss ratios (4-10%)

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U.S. Market ShareU.S. Market Share

2003 DWP2003 DWP ShareShare

1)1) Fidelity National FinancialFidelity National Financial $4.9B$4.9B 32%32%

2)2) First AmericanFirst American 3.3B3.3B 21%21%

3)3) Land AmericaLand America 2.8B2.8B 18%18%

4)4) Stewart TitleStewart Title 1.8B1.8B 12%12%

5)5) Old RepublicOld Republic 1.0B1.0B 6%6%

SubtotalSubtotal 13.8B13.8B 89%89%

All OthersAll Others 1.7B1.7B 11%11%

TotalTotal 15.5B15.5B 100%100%

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International MarketsInternational Markets

a)a) CanadaCanada

b)b) AustraliaAustralia

c)c) EuropeEurope

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Distribution ChannelsDistribution Channels

a)a) Agency Business (86%)Agency Business (86%)i.i. Independent Agents – including Independent Agents – including

attorneys (59%)attorneys (59%)

ii.ii. Owned Agencies (27%)Owned Agencies (27%)

b)b) Direct (14%)Direct (14%)

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ReinsuranceReinsurance

a)a) Typically excess of lossTypically excess of loss

b)b) Larger title insurers reinsure Larger title insurers reinsure the othersthe others

c)c) Assumed and ceded = offset Assumed and ceded = offset each other each other

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II) Financial Reporting IssuesII) Financial Reporting Issues

a)a) Financial ReportingFinancial Reportingi.i. Form 9Form 9

ii.ii. Statement of Actuarial OpinionStatement of Actuarial Opinion

b)b) Categories of Statutory ReservesCategories of Statutory Reserves

c)c) Reserve TestingReserve Testing

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Financial ReportingFinancial Reporting

a)a) Form 9 = Statutory Annual StatementForm 9 = Statutory Annual Statement

b)b) Schedule PSchedule Pi.i. By Policy YearBy Policy Year

ii.ii. By Report YearBy Report Year

c)c) Statement of Actuarial Opinion – since Statement of Actuarial Opinion – since 1996 Annual Statement1996 Annual Statement

d)d) Opine on Schedule P reserve, NOT Opine on Schedule P reserve, NOT booked reservebooked reserve

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Categories of Booked ReservesCategories of Booked Reserves

a)a) Known Claims ReserveKnown Claims Reserve

b)b) Statutory Premium Reserve Statutory Premium Reserve (SPR) = “Unknown” Claims(SPR) = “Unknown” Claims

i.i. SPR Functions as Unearned SPR Functions as Unearned Premium ReservePremium Reserve

ii.ii. Formula = Amount & Take-down Formula = Amount & Take-down PatternPattern

c)c) Supplemental ReserveSupplemental Reserve

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Reserve TestingReserve Testing

a)a) Compare Schedule P Reserve against Compare Schedule P Reserve against Known Claims Reserve + SPRKnown Claims Reserve + SPR

b)b) Schedule P includes Known Claims, Schedule P includes Known Claims, so really testing SPR vs. IBNR so really testing SPR vs. IBNR

c)c) If SPR > IBNR, book SPRIf SPR > IBNR, book SPR

d)d) If IBNR > SPR, book SPR + If IBNR > SPR, book SPR + Supplemental ReserveSupplemental Reserve

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Industry ReservesIndustry Reserves@ 12/31/03@ 12/31/03

Known ClaimsKnown Claims == $556M$556M

SPR SPR == 3,258M3,258M

TotalTotal == $3,814M$3,814M

Schedule PSchedule P == $2,741M$2,741M

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III) Actuarial ChallengesIII) Actuarial Challenges

a)a) Title insurers do not know the number of Title insurers do not know the number of policies in-force!policies in-force!

b)b) Correlation between calendar year loss Correlation between calendar year loss emergence and mortgage ratesemergence and mortgage rates

c)c) Refi policies have lower loss ratios than Refi policies have lower loss ratios than original title policiesoriginal title policies

d)d) Commercial vs. residential policies Commercial vs. residential policies

e)e) New productsNew products

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Actuarial Methods – Loss Actuarial Methods – Loss DevelopmentDevelopment

a)a) Paid and incurred loss development Paid and incurred loss development triangles from Schedule Ptriangles from Schedule P

b)b) Industry composite data available Industry composite data available

c)c) Historical patterns can be distortedHistorical patterns can be distorted

i.i. Drop in interest rates leads to refi’sDrop in interest rates leads to refi’s

ii.ii. When lender policy is refinanced, original When lender policy is refinanced, original policy is extinguished.policy is extinguished.

d)d) Try to adjust patternTry to adjust pattern

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Actuarial Methods – Actuarial Methods – Expected Loss RatioExpected Loss Ratio

a)a) Expected Loss Ratio for refinance Expected Loss Ratio for refinance policy is lower than original policypolicy is lower than original policy

b)b) Policy Year with high refinance % Policy Year with high refinance % expected to have lower loss ratioexpected to have lower loss ratio

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0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

Policy Year

Title

Los

s R

atio

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

Ref

i %

Ultimate Loss Ratio Refi Percentage

Refi Percentage vs. Refi Percentage vs. Title Loss RatioTitle Loss Ratio

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Actuarial Methods – Actuarial Methods – Expected Loss RatioExpected Loss Ratio

a)a) Econometric modeling of Econometric modeling of Expected Loss Ratio – Expected Loss Ratio – variables could include:variables could include:i.i. Mortgage ratesMortgage rates

ii.ii. Refinance percentageRefinance percentage

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2.0%3.0%4.0%5.0%6.0%7.0%8.0%9.0%

10.0%11.0%

Policy Year

Lo

ss R

atio

Actual Loss Ratio Modeled Loss Ratio

Modeled Loss Ratio vs. Modeled Loss Ratio vs. Actual Loss RatioActual Loss Ratio

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Actuarial Methods – Cape Cod Actuarial Methods – Cape Cod or Bornhuetter-Fergusonor Bornhuetter-Ferguson

a)a) Combines Expected Loss Combines Expected Loss Ratio and Development Ratio and Development Methods.Methods.

b)b) To calculate Expected Losses, To calculate Expected Losses, can use:can use:

i.i. PremiumPremium

ii.ii. Amount of InsuranceAmount of Insurance

iii.iii. Counts & AveragesCounts & Averages