Will the industry's boom turn into a bust in a housing downturn?
Note to Readers: This article provides an overview of the title insurance industry. It is the first article in a two-part series. The second article covers one of the companies in the title insurance industry in more detail and will be published later this week. Rational Reflections publishes a minimum of twelve business profiles per year for premium subscribers.
Property and casualty insurance provides protection against future events. When we buy homeowners insurance, we exchange a relatively small amount of money every year for protection against future property damage and liabilities. Automobile insurance can reimburse us for loss of a vehicle, medical expenses, and liabilities related to a future accident or theft. Most insurance policies will not cover events that took place before a policy was issued. For example, it is not possible to purchase home coverage to pay for damage caused by a hurricane that took place last week.
In contrast to most other forms of insurance, title insurance protects policyholders against past events in exchange for a one-time premium payment. When we purchase real property, it is necessary to ensure that the seller has clear title in the form of a valid and unencumbered deed. A seller who lacks clear title might not be the true owner, or there could be undisclosed liens that impair the seller’s ownership interest.1
Title insurers are responsible for performing an examination of property records to ensure that the seller has proper standing to convey ownership to the buyer. In the event that the title proves to be defective at a later date, the title insurer is responsible for covering losses up to the limit of the policy. For mortgaged properties, the buyer is almost always required by the lender to purchase a title insurance policy that protects the lender up to the mortgage amount. The buyer may optionally purchase a separate owner’s title policy to protect the investment.
In theory, rigorous title examinations should make it possible for title insurers to minimize losses. However, in practice, property records in many parts of the country are not fully digitized and are prone to errors. This is especially true in regions where homes tend to be older and have changed ownership multiple times over many decades. It is far more likely for a single family home dating back a hundred years to have title issues than a condominium in a recently constructed tower.2
For home buyers, title insurance is one of many one-time costs associated with the purchase. The premium for title insurance depends on the price of the property. In 2021, the average premium earned per title insurance policy was slightly over $1,000.3 The low cost of title insurance relative to the cost of the property means that there is an asymmetric trade-off and most buyers do not question the premium.4
Title insurers have major incentives to conduct a thorough title search before issuing a policy and most defects are caught at this stage. If caught prior to the close of the transaction, the seller is responsible for correcting title defects. Only title defects that escape notice prior to the sale can eventually become the responsibility of the insurer.
The economics of the title insurance industry differ significantly from the property/casualty industry. Since the premium is a one-time event that occurs when property changes hands, title insurers do not have the kind of recurring revenue stream that property/casualty insurers have with annual renewals. This makes the industry’s fortunes closely correlated to purchase and refinance activity in the housing market. Losses are relatively rare, but when they occur, the damage can be significant. Title insurers typically have a far lower loss ratio compared to property/casualty insurers, but this is offset by a much higher expense ratio.5
This article provides a high level overview of the title insurance industry with particular focus on the unique economics compared to property/casualty insurance. The industry has been booming over the past few years due to a very strong housing market which naturally led to strong premium growth. Claims are also lower in an environment in which home prices are steadily rising. A slowdown in the housing market due to higher interest rates will likely reduce home purchases and cause refinancing activity to plummet which could cause challenges for title insurers.