Flavors of Insurance, Part IX (Title)

The title insurance industry is small. How small is it? If you added together the market capitalizations of all title companies, it would be smaller than half the market capitalization of the largest life company. It would be less than 5% of the size of AIG.

Most people view title insurance as a necessary evil, or even a pseudo-tax, when they purchase or refinance a home. The main reason for that is that few people ever experience a fraudulent conveyance of a title to a property. Loss ratios are mid-single digits in percentages. There is no underwriting cycle in title insurance because claims are not a big enough part of the business.

Most of the economic challenge of running a title insurer comes from expense control. Distribution expenses are big; they range around half of premiums. Profit margins are typically a mid-single digit percentage of premiums as well. General and administrative expenses absorb the rest of the premiums.

Title insurers exist to protect purchasers of homes and their lenders from fraud in the conveyance of the title to the property. Title insurance is different, because it protects against events that have happened prior to the inception of the policy. Title insurance allows the gears of buying and selling homes to grind smoothly in the US. If our local governments did a better job of tracking property transactions, perhaps title insurers would not exist, as is true in most of Europe.

Because a large number of title policies are originated because of refinancing, and refinancing comes in waves, expense management is a priority for title insurers. Today, most title insurers employ temporary workforces that they grow substantially during refinancing waves. It is more costly to have temporary employees, but it makes responding to large changes in demand possible.

That interest rates have fallen so much has driven many of the title insurers to seek avenues of diversification, because opportunities to originate policies because of refinancing will likely not be as big in the next ten years as it was in the last ten. Most of the diversification is taking place in real estate related industries, thus leveraging off of existing competencies and relationships. Other efforts have been into other financial businesses including asset management, trust services, and credit verification services. The jury is still out on whether these diversification efforts will pay off; still to this point, no major company in the space has less than 75% of profits coming from lines of business other than title insurance.

For a business that sounds so marginal, why have the stocks done so well over the past ten years? A combination of three factors made it so: first, valuation levels were low back in 1994, as refinancing slowed down marked when rates began to rise. Second, there are barriers to entry; creating a new title insurer would involve creating or purchasing new databases of property records, which would be prohibitively costly. Third, falling interest rates since 1994 created three major refinancing waves that allowed for the issuance of many additional policies. Because interest rates are low now, and valuations considerably higher than where they were in 1994, we are less optimistic on high returns for the sub-industry for the immediate future. It is also possible that new title products, such as lien protection products, may eat into gross margins. That hasn’t happened so far, but it is another thing to watch.


Bringing it to the Present

The big four became the big three.  LandAmerica died, which was the company I thought was the most reckless (note my comments at RealMoney).  The two large companies, FAF and FNF went through transformations, selling off their arms that did everything except title, unlocking a lot of value in the process.

Lien protection products ended being a big zero.  Perhaps that could have been a way for the GSEs to justify their existence, but no.

And yet, title insurers took some real losses from the financial crisis.  Not surprising, given the open-ended nature of title claims, and the degree of potential for fraud when real estate is sagging dramatically.

Just as residential real estate will take a while to settle, so will it be the same for title insurers.