SAN FRANCISCO — California regulators have yet to prove a lack of competition in the title insurance industry that would give the state the legal authority to move forward with a plan to roll back and cap rates, industry advocates said Wednesday at a public hearing on proposed new regulations.
Insurance Commissioner John Garamendi wants to roll rates back to where they were six years ago, before a run-up in housing prices. The rollback would cut title insurance rates by an average of 23 percent, and slash fees for escrow services provided by title companies by 27 percent, saving consumers $1 billion a year, Garamendi says.
The rollback, which would be implemented in March, is envisioned as an interim measure while regulators set a cap on title insurance rates using a complex formula intended to limit excessive profits by tying rates to insurers’ actual costs. Beginning in 2008, title insurance companies would be required to submit detailed information on their costs, and profits would be limited to a percentage of the industry average.
The 1973 law Garamendi says gives him the authority for a rate cap requires him to determine that there’s a lack of competition in the state’s $4.5 billion-a-year title insurance industry, and that rates are excessive. The Department of Insurance maintains that its own investigations and a recent study by Texas-based economist Birny Birnbaum showed that title insurance companies don’t compete for customers by offering them the best price. Instead, they market their products to real estate companies that refer business to them, providing them with illegal rebates and kickbacks as rewards, Garamendi says.
Those are charges that offend many who work in the industry, and Wednesday’s hearing was the first opportunity for some to air their grievances in a public forum.
Before the hearing, about 50 escrow agents from around the state held a press conference on the sidewalk in front of the high-rise building in San Francisco’s financial district where they took place. Some wore blue t-shirts bearing the slogan, “Shame on you John Garamendi.”
Speaking from a portable dais through a public address system to a handful of reporters and curious bystanders, the escrow agents complained that there is plenty of competition in the industry, and that the proposed regulations would result in layoffs and reduced services for consumers.
Fran Butler, president-elect of the California Escrow Association, said the 600 independent escrow companies in the state are “fiercely competitive.”
“It is absurd for Garamendi to think that without this ridiculous proposed regulation competition would not exist in the escrow industry,” Butler said.
P.J. Garcia, president of Beach Pacific Escrow in Huntington Beach and the chairwoman of the Escrow Institute of California, said she has 35 competitors within five miles of her office. Later, when the hearing commenced in a packed room 22 stories up, Garcia said she was disappointed that Garamendi himself was not in attendance.
“He beats up on us in the newspaper, but doesn’t have the courage to come here today and face us in person,” Garcia told a panel of three Department of Insurance staff members.
At the hearing, expert witnesses hired by title and escrow companies took turns attacking the proposed regulations. The state has not proved a lack of competition in the title industry, and therefore lacks the legal authority to impose a rate cap, they said. Industry advocates also maintained that regulating rates would reduce competition and harm consumers.
Fidelity National Title Group — which the Department of Insurance maintains is one of three companies that control 75 percent of California’s title insurance market — presented four expert witnesses, who attacked the proposal to cap rates as costly, impractical and contrary to the state’s goal of increasing competition.
The state’s plan to collect detailed information on title insurers’ costs is too complex and will cost millions to comply with, said Michael J. Miller, a consulting actuary for EPIC Consulting LLC.
Miller said the Department of Insurance proposes collecting information at an “unprecedented” level of detail, down to the type of messenger services companies use. Many companies don’t collecting such data now, and it’s unclear if the state is even equipped to crunch the numbers it gets back on an annual basis, he said.
“As the level of details increase in a statistical plan like this one, the problems of ending up of ending up with a useable database increases exponentially … I think this one will fall of its own weight,” Miller said.
“You’re not going to gather it once and then you’re done,” Miller added later. “You have to maintain it with reasonable accuracy year after year. The more you’re asking for, the closer it gets to being impossible.”
The Department of Insurance says it wants detailed cost data so it can accurately determine where to cap title insurance rates so that insurers can earn a predetermined profit margin.
But costs may vary because companies serve varied markets and employ different business models, Miller said. Capping rates based on average costs for the industry as a whole could force some businesses with higher-than-average costs out of the market, leaving others with lower costs to earn larger returns than regulators had intended.
“You’re going to have situations where an insurer who has lower than average costs is going to be permitted to charge higher rates than their own expected costs would justify,” Miller said.
As the rate cap is adjusted each year, Miller warned regulators could set in motion a cycle in which rates are driven down as the companies with higher costs exit the market, reducing competition.
“Ultimately, it will lead to just a single insurer or just a couple of insurers that have the same cost structures,” Miller said.
The proposed regulations create a “Catch-22” situation, in that they are intended to reinvigorate competition in the marketplace, but there is no provision to “sunset,” or get rid of them, if they do, Miller said.
Because it will take a long time to collect and analyze information, the state-imposed cap will always lag about two years behind marketplace realities, hindering the industry’s ability to adapt prices to changing conditions, Miller said. If rates are regulated, they will not only be cyclical, but out of synch, he said.
“You’re going to find situations where … you’re implementing rates for 2010 that are maybe going up when they should be going down, because there have been changes in the real estate market, or cases when rates are going down when they really should be going up,” Miller said.
Another expert witness on Fidelity’s payroll, economist David Appel of the consulting firm Milliman Inc., said the formula the Department of Insurance proposes won’t give title insurers enough of a return on investment. The 8.75 percent return provided for in the formula is less than that allowed for other property and casualty insurers, and will make it impossible for title insurers to attract investment capital, Appel said.
California’s regulated water and power utilities are allowed a 10 percent to 11 percent rate of return on investment, when far less risk is involved, Appel said. The title insurance industry should be allowed to earn returns in the range of 12 percent to 13 percent, the “cost of capital” in other comparable industries, the economist said.
The purpose of the hearing was to gather public comments on the proposed regulations, and the panel of three Department of Insurance staff members conducting the hearing mostly posed questions rather than directly challenging the insurance industry’s points.
Deputy Commissioner Gary Cohen, however, grew frustrated with economist Gregory Vistnes, one of the consultants hired by Fidelity to testify. When Vistnes claimed that economists and regulators have come to view rate regulation as a “second-best solution” typically imposed only in markets where there can only be one provider — a so-called “natural monopoly” — Cohen chided him.
“You’re here to espouse an ideology, a pro-market ideology that is anti any regulation whatsoever,” Cohen said. Deregulation of the state’s energy markets, he said, “had a devastating impact in this state, costing Californians hundreds of millions.”
Vistnes and Cohen sparred throughout his testimony, with the economist making light of the state’s reliance on two studies of the title insurance industry, one which was conducted by the U.S. Department of Justice nearly 30 years ago, and the other by the Department of Housing and Urban Development 26 years ago.
“I don’t believe in 1977 the Department of Justice was looking at the facts I see in 2006,” Vistnes said. Economics is a science that has advanced in the last 25 to 30 years, he said.
Vistnes and other industry expert witnesses challenged the validity of Birnbaum’s more recent study, which the Department of Insurance cites as evidence of a lack of competition.
Several industry analysts have found the study “fundamentally flawed,” Vistnes said, because it doesn’t acknowledge ongoing price competition in the industry or assess competitiveness using relevant benchmarks.
If the state’s goal is to increase competition in the title industry, it could support efforts to educate consumers about their choices, Vistnes said, and step up enforcement against companies that violate the law by offering illegal rebates.
“You should be asking what is still fundamentally wrong with this industry … rather than throwing out competition, (ask how) can you make competition better,” Vistnes said.
“Those things should happen and to some extent they are happening,” Cohen said. “The problem is we have a law that says the insurance commissioner shall not permit insurers to charge excessive rates if there is no competition. We may disagree on that, (but) if we make that determination, then it’s not good enough for us to say we’re going to do all these other things. Because the law mandates us” to cap rates.
Birnbaum, who attended the hearing but did not testify, offered his views during a break in the proceedings.
“If competition is so active, why is it there has been no reduction in title insurance rates when property values are up? Why is there so much money available for illegal kickbacks?” he said.
Last year, the Department of Insurance reached a $37.8 million settlement with nine companies that allegedly paid $25.4 million in kickbacks to lenders, real estate brokers and builders. The companies — all owned or controlled by Fidelity, First American and Land America — settled without admitting wrongdoing.
Birnbaum’s study, available online, found title companies earned after-tax profits of 49 percent in 2003 and 32 percent in 2004, “excessive by any reasonable measure.”
The former chief economist for the Texas Department of Insurance, Birnbaum questions industry claims that competition could be increased by educating consumers and conducting more aggressive enforcement, rather than regulating rates.
“Vistnes proposed there are just some bad actors engaging in illegal rebates,” Birnbaum said. “The fact is, it’s endemic to the system, because of its market structure. (Title insurers) don’t market to consumers but to the people who refer business to them.”
Illegal kickbacks uncovered by HUD and state investigations are “just the tip of the iceberg,” of a problem that is not going away, he said.
“Basically, every time they investigate the industry, they find something,” Birnbaum said. “This is a structural problem, a market failure.”
Birnbaum dismissed industry claims that rate regulation will cost them millions without increasing competition.
In Texas and other states that regulate rates, “That’s always the response — that it will cost untold millions, and (the data) won’t be meaningful,” Birnbaum said. “The fact of the matter is, (the proposed regulations) don’t ask for anything the companies don’t collect already, or shouldn’t collect. Companies track their expenses in great detail when they want to.”
Now that the industry has had an opportunity to comment on the proposed regulations, Garamendi will decide whether to amend them. Any changes would be subject to a 15-day public comment period.
Although the rate rollback is scheduled to take effect in March, the California Land Title Association and Escrow Institute of California have said they are considering lawsuits to block implementation.