The following is an excerpt from the 2013 Title Insurance Financial Report. The excerpt is a contribution from Demotech, written by Douglas Powell and Paul Osborne, senior financial analysts at Demotech, and it is also part of the company’s 2013 Edition of Demotech Performance of Title Insurance Companies.
Since 2006, the title insurance industry has experienced significant underwriter consolidation. At its peak in 2006, 96 underwriters reported statutory financial data. In 2012, the number of underwriters reporting decreased to 44.
A majority of the decrease in count resulted from larger groups assimilating acquisitions made from earlier years in an effort to improve operational efficiencies and eliminate redundancies. Other companies voluntarily ceased their underwriting operations due to the challenging economic conditions over the last few years. As market conditions improve, total count in underwriters may increase but should remain far below the market peak of 2006.
While it is important to acknowledge and recognize the importance of profitability, Demotech’s philosophy is that balance sheet strength and financial integrity are the ultimate determinants of the long-term financial stability required to honor legitimate claims. Accordingly, while operating profit remains an important element in evaluating the financial stability of an underwriter, the ability of an underwriter to remain financially stable under a variety of economic stress tests requires a focus on balance sheet integrity.
A major determinant of the financial stability of a title underwriter is an evaluation of critical financial stability ratios benchmarked against financial stability tests and the representative historical operating results of the insurer. Based upon a review of these key metrics and rating indicators, title underwriters collectively improved their overall financial stability in 2012. The underwriting and overall profitability of title underwriters has improved when comparing 2012 to the most recent reported years. Equally as important to note, title underwriters have continued to maintain a sufficient level of policyholders’ surplus and are adequately capitalized as a whole.
Premiums written
Title underwriters reported approximately $11.3 billion in direct premium written in 2012, representing a 21.6 percent increase over 2011 as well as a five-year high. According to statistics reported by the Mortgage Bankers Association of America, a majority of the premium growth experienced by title underwriters in 2012 was derived from refinance activity. While it can be argued that the refinance activity in recent years is based on historically low interest rates, it is important to note that the effect those interest rates would normally have in generating premium has been partially offset by high credit qualifications and loan-to-value ratio barriers.
In other words, there is no reason to be less optimistic about the macroeconomic drivers of premium growth in 2013. The title industry has reason to expect that the direct premium gains seen over the past few years are more than a brief respite and instead the start of sustained growth. Moreover, the rapid consolidation in the industry means that any new revenue is distributed among a smaller pool of companies, giving each a larger, potentially more profitable share. As the industry begins to string together quarters of positive growth, new investments in title underwriters may potentially emerge.
Underwriting results and overall profitability
Title underwriters have remained vigilant in achieving overall profitability. Over the last 10 years, title underwriters have aggregately reported a net income for nine of those years. Some of the factors that comprise overall profitability are premium, operating expenses, loss and loss adjustment expenses, investment income and income taxes paid.
The profitability of title underwriter operations has been encouraging throughout the year. For the year-end 2012, aggregate underwriting results on a year-to-year basis were positive for the title industry and over three-quarters of title underwriters reported a net underwriting gain. The title industry reported an aggregate operating gain of nearly $505 million at year-end 2012, ending a string of operating losses reported at the previous five year-ends.
As interest rates for many long-term and short-term investments are at or near historic lows, title underwriters have aggregately posted modest investment gains for the last five years. In 2012, title underwriters reported a 10-year low for net investment gain of $354 million, a decrease of 6 percent from the previous year.
Although title underwriters have aggregately reduced their operating expenses over the past several years, 2012 operating expenses incurred increased nearly 17 percent over the previous year. This may seem to be a significant increase but is largely a function of the increase in premium volume. For the last several years, title underwriters have aggregately reported operating expenses to net premium written over 100 percent at year-end. In 2012, operating expenses accounted for 97 percent of net premium written for title underwriters. Lower expenses to net premium written indicate operational profitability for title underwriters.
Although Demotech does not expect individual underwriters to report an underwriting gain at each year-end, a component of our review process is the evaluation of underwriting results. Any title underwriter recording an underwriting loss greater than 10 percent of prior-year surplus will be subject to a detailed review of current operating results.
As deferred tax assets must be used by title underwriters or expire, the amount of taxes paid increases in direct correlation with an increasing profit margin. Title underwriters aggregately paid taxes of nearly $129 million for 2012, an increase of 167 percent over 2011.
In 2012, title underwriters aggregately reported net income reminiscent of the pre-economic crisis years.The industry reported net income of nearly $722 million at year-end 2012, a 134 percent year-over-year improvement. This also marks the highest level of reported year-end net income for the title industry since 2007.
Assets, liabilities and policyholders’ surplus
While title underwriters increased direct premiums written and ended the streak of reporting net operating losses in 2012, they did so while continuing to increase policyholders’ surplus. Title underwriters, in aggregate, increased policyholders’ surplus over 30 percent from 2011 to $3.8 billion. Despite policyholders’ surplus improving in 2012, it remains below the historic high reported in 2006. Regardless, this in no way indicates the industry is under-capitalized, as title underwriters reported a net premium written to policyholders’ surplus ratio of 2.94 for year-end 2012. A net premium written to policyholders’ surplus ratio greater than 3:1 would also subject a company to greater scrutiny.
Title underwriters also strengthened their position in terms of short-term net admitted assets and total net admitted assets in 2012 over the previous year. For 2012, title underwriters aggregately increased short-term assets 7.8 percent and total assets 7.5 percent over the previous year while decreasing total liabilities 4.8 percent. This in turn improved aggregate leverage and liquidity ratios reported by title underwriters.
The title industry reported a leverage ratio (total liabilities to policyholders’ surplus) of 1.39 for 2012. Demotech prefers underwriters report leverage of less than 3:1 and a ratio greater than that will subject an underwriter to additional review and analysis.
The title industry reported a liquidity ratio (total liabilities to liquid assets) of 0.65. A value less than one is considered favorable because it indicates that the title underwriter has more than a dollar of liquid assets for each dollar of total liabilities.
Loss reserve development
Demotech views adverse loss reserve development as an impediment to the acceptance of the reported value of current and future surplus. From our perspective, any amount of adverse loss reserve development on a consistent basis is unacceptable, as it may be indicative of management’s inability or unwillingness to properly estimate ultimate incurred losses.
The title industry reported one year loss development to policyholders’ surplus of 9.1 percent and two year loss development to policyholders’ surplus of 8.5 percent at year-end 2012. Both of these percentages, while indicating unfavorable loss development for 2012 for title underwriters aggregately, do not appear to be part of a continuing trend.
For the rest of the feature and Demotech’s conclusion, as well as a contribution from Fitch Ratings and the rest of the 2012 title industry financial data, click here to download a PDF of the 2013 Title Insurance Financial Report.