Economic Downturn Presents Challenges for Title, Mortgage Industry

Reserving for mortgage insurance and title insurance in an economic downturn and amid a stressed real estate market can present challenges for insurers and actuaries, attendees at the Casualty Loss Reserve Seminar were told.

Joseph Petrelli, ACAS, president, Demotech Inc, gave an overview of the title insurance and private mortgage insurance markets, explaining that each are distinct monoline markets. He noted that the peak year for the title insurance market was 2005, with $16.8 billion in direct written premiums countrywide that year, but through the first and second quarters of 2008 there had been a 15 to 20 percent decline in premiums, leading to massive lay-offs.

In comparison, the private mortgage insurance market grew by about 50 percent to $6.2 billion in direct written premiums in 2007, up from $4.1 billion in 2001.

Petrelli noted that interest rates are typically a key driver of the title insurance market. “It has been an interesting year in the real estate and stock market, but interest rates through June 2008 were 5.99 percent, which on a historical basis are still favorable. Most of the problems related to title insurance have been related to the real estate and the lending side of things as opposed to the interest rate environment,” he explained.

Paul Struzzieri, FCAS, principal and consulting actuary, Milliman Inc., observed that there are a range of issues unique to title insurance that present challenges for both insurers and actuaries.

Unlike property/casualty insurance policies, in title insurance the loss is typically incurred prior to the effective date. “When you issue a title policy you are saying that any past defects to the title have been cured,” Struzzieri said.

This presents a challenge in that there is no stated expiration date to title policies. “In theory you can get claims 60 years out as long as it relates to a condition that existed prior to the effective date,” he explained.

A critical piece of missing information that poses a challenge for actuaries is that title insurers do not know whether policies are still in force because the owner or the lender is under no obligation to notify the title insurer when they sell the home or the mortgage is refinanced.

Another challenge for actuaries is that title insurance loss development patterns are influenced by events in future reporting periods not anticipated when the policy was written. “Economic events in the future can change title insurance loss development patterns,” according to Struzzieri.

Turning to mortgage insurance, Michael Schmitz, FCAS, consulting actuary, Milliman Inc. observed that economic conditions over the next couple of years will be critical to the private mortgage insurance market.

Schmitz noted that the original private mortgage insurance industry failed during the Great Depression of the 1930s and was reborn in 1957 under strict regulatory rules. Mortgage insurance is now a monoline business that cannot endanger property/casualty insurers with its risk.

“The property value risk factor is the root of the catastrophic nature of mortgage insurance. It’s highly dependent on economic conditions as we are witnessing and living through now. Considerable losses have resulted from regional recessions,” he said.

Schmitz noted that future forecasts of home price values indicate decreases in nine out of 10 U.S. cities continuing into 2009. This will have major implications for reserving as rising mortgage delinquencies will result in a larger reserve base and frequencies and severities have risen sharply, he said.

Thomas Conway, ACAS, principal, Ernst & Young LLP, outlined key differences in underlying exposures facing financial institutions compared to private mortgage insurers.

Conway noted that while private mortgage insurers are responsible for at most 20 to 30 percent of the mortgage, the remainder falls back on financial institutions. He also noted that frequency and severity of defaults impact financial institutions and private mortgage insurers in various ways.

He observed that the frequency of default potentially impacts both financial institutions and private mortgage insurers equally. “In a sense the bank is almost like a primary insurer and the private mortgage insurer acts as the surplus share reinsurer. There is definitely a tie on frequency.”

However, when it comes to the severity of default, it is more constrained for the private mortgage insurer, especially in times of negative home price appreciation, Conway said.

According to Kyle Mrotek, FCAS, actuary, Milliman Inc., one unique aspect to mortgage insurance that’s different than most property/casualty insurance lines is that the insured is not the person paying the premium or the beneficiary of the policy.

“In this case the borrower pays the premium that actually gets in the hands of the insurer, but in the event of default the claims payments go from the insurer to the lender,” he said.

Reserving issues related to mortgage insurance are another unique aspect of the business. For example, Mrotek noted that private mortgage insurers are required to set aside 50 percent of earned premium each calendar year into contingency reserves. These must be held for 10 years unless losses in a calendar year exceed 35 percent of earned premiums, depending on the state.

“The purpose of the contingency reserve is to protect policyholders against loss during periods of extreme contraction,” he said.

The Casualty Loss Reserve Seminar is jointly sponsored by the Casualty Actuarial Society and American Academy of Actuaries.

Source: CAS