DUBLIN, Ohio — It’s quarterly earnings time for the nation’s publicly traded companies, and if you see earnings reports from the nation’s top title insurance underwriters, you’re also likely to see the name Demotech.
The financial analysis firm was the first company to review the financial stability of the title insurance industry and publish independent financial strength opinions. Today, these ratings are used by underwriters to demonstrate the independent, third-party evaluation of their financial health to mortgage lenders, government-sponsored enterprises and umbrella insurance markets.
But Demotech, founded in 1985 by Columbus, Ohio-area professionals Joseph Petrelli and his wife, Sharon M. Romano Petrelli, is much more than that. The firm works with state regulators to collect critical financial information about title insurance companies, provides actuarial services to the title insurance industry, and examines key trends and issues impacting the industry’s profitability and legal and regulatory compliance.
Petrelli, who had been employed in the property and casualty (P&C) insurance industry since the late 1960s, launched Demotech to serve the financial analysis and actuarial service needs of regional and specialty insurers. Demotech was the first company to issue financial stability ratings for health management organizations and public entity liability self-insured pools.
Petrelli first began looking at the title insurance industry in the 1980s as he worked on a research project in pursuit of his master’s degree in business administration from Ohio State University.
“We had some research done by a marketing research firm to see if there was a need for title insurance underwriter ratings in 1987, and we found there was a lot of interest in having that,” he said.
Demotech continued its work with P&C insurers, but he began moving toward filling this unmet need in the title insurance industry. Following its success in the P&C industry, the company began offering P&C insurers and title insurance underwriters loss-cost analysis and rate, rule and form filing assistance.
In the early 1990s, Petrelli began gathering information from state insurance departments. At the time, there were 86 underwriters in the title insurance business. Two years later, Fannie Mae and Freddie Mac began requiring title insurance underwriters to obtain financial ratings — and Demotech seized the opportunity.
“We were ahead of that parade,” Petrelli said. “We already had two years and eight quarters under our belts.”
And from there, Demotech was off and running. In 1996, the NAIC, which coordinates the reporting of underwriters’ quarterly financial statements, began requiring underwriters to get an actuary opinion on loss reserves. Demotech coordinated the first seminar on title insurance underwriters and claims.
In 2000, Demotech developed a consumer guide to educate the general public about the basics of title insurance. The guide was published in both English and Spanish, thanks to the help of Spanish-language professors from Ohio State University.
Another highlight from Demotech’s history and a big area of focus for the firm involves the issue of defalcations, or what is commonly called escrow theft in the title insurance industry. In 2002, Demotech produced an independent research paper on this troubling trend, and it updated that research with another report in 2012.
“Even though financially, the title industry has never been in better shape, this is still a concern on everyone’s mind — whether or not they want to talk about it,” Petrelli said. “These go on every day, but it’s very difficult to get good data. I don’t think we are ever going to get the thieves out of the equation.”
With the Consumer Financial Protection Bureau bestowing upon lenders the ultimate compliance responsibility for everyone at the closing table, Petrelli said it’s possible that people will talk even less about defalcations to preserve their relationships with their lender partners.
Already, lenders are getting picky about their title and settlement service providers, and enacting new preapproval processes to weed out potential bad actors. Demotech plans to examine these issues in a future report on defalcations.
“I’m concerned that if there is more news about defalcations, lenders will be re-evaluating the title insurance underwriters they work with,” Petrelli said.
Today, Demotech offers ratings — with the proprietary label Financial Stability Rating (FSR) — for 55 title insurance underwriters.
Many factors go into an FSR: first, financials, including sufficiency of loss reserves to ensure companies are able to pay any claims; liquidity of assets to ensure that if claims must be paid, companies are well-positioned to do that; operating profitability and companies’ ability to make money over time; and net worth to determine whether companies have sufficient enough margins to cover loss reserves or other contingencies.
Next, Demotech examines operational factors, including balance sheets, financial statements, the procedures that underwriters use to appoint agents, any incidents of escrow theft and related mitigation procedures, and the amount of reinsurance that companies have to make sure that property values are within reasonable limits.
Demotech offers several different FSR categories. A’’ (double prime), or “Unsurpassed,” means that, regardless of economic downturn or a deterioration in the insurance cycle, 100 percent of insurers are expected to have a positive surplus for 18 months following the rating assignment.
An A’ (prime) rating means 99 percent of insurers will achieve that. A, or “Exceptional,” is given to 97 percent of companies with that survival expectation, and S, or “Substantial,” is for companies in the 95th percentile.
Below those FSRs are SA and SA’, which are still accepted by most lenders and Freddie Mac and Fannie Mae; M for “moderate” financial strength where survival rates drop to 90 percent or less; and L, which Petrelli says is “a tongue-in-cheek way of saying they are licensed.” Demotech does not rate companies with lesser scores than that, and supports only companies at the S level and above.
Currently, the nation’s largest title insurers — Fidelity National Financial, First American Title Insurance Co., Stewart Title Guaranty Co. and Old Republic National Title Insurance Co. — all have either an A’ or A” Demotech rating.
Having been in a position to assess the title insurance industry’s financial position for more than 20 years, and having seen many boom and bust periods in the industry, Petrelli said that due to the consolidations that have taken place in the seven years following the financial crisis of 2008, “things in the title industry have probably never been better.”
“Many of those consolidations were very healthy for the big companies that had numerous subsidiaries,” he said. “The title insurance industry was caught completely unaware by the recession or housing bubble bust in the late 2000s because at the time, it was coming off its best years ever.”
Although interest rates are falling, title insurance premium activity has been largely focused on refinance transactions, “so dollar volumes have not been anywhere near the volume the industry saw nationwide in the peak years of 2005 to 2007,” Petrelli said.
“Companies are relatively slow to increase staffing or otherwise expand unless they are fairly comfortable that they will see immediate benefit,” he added. “This is something that has resonated with management, and they are much more acutely aware of how to manage and brand their companies. With the bulk of title insurance being underwritten by publicly traded companies, I think there is now more of a focus on getting fee revenue and money from nonvariable sources. For example, First American split its operations and analytics divisions.”
Some state regulators and lawmakers are still concerned about pervasive industry problems like illegal kickbacks to lenders, Realtors and other partners, and lowering the costs of premium rates. At the same time, misconceptions about the title insurance industry persist among government officials, other industries and the general public, Petrelli said.
“There seems to be a need to educate people as to why the loss ratio is so low,” he said. “Loss ratios are low because the company has expended an inordinate amount of money and resources to perfect the title as best it can. There still needs to be some clarification of what it is title professionals are doing to protect people.
“Also, there are still a fair number of people who don’t understand that this is a single, one-time premium policy that protects you for the duration of your homeownership. If people knew it was one-and-done, they would have a whole new perspective on that.”
Having nearly three decades of industry experience in his rearview mirror, Petrelli concedes that title insurance is “not exactly a conversation starter at a cocktail party,” but he adds, “people who do it for a living are so passionate about it.”
“They love it when they can fix something, or when they help someone who is buying their first home,” he said. “A lot of people in the industry are old enough to look at it from the perspective of it may not be their own son or daughter whose house they are protecting, but it’s someone’s son or daughter.”
Demotech also publishes an annual report that presents a composite financial view of underwriters providing title insurance coverage, including detailed statutory financial information, market share summaries, comparative ratios and analysis for title insurance underwriters representing more than 99 percent of the industry.
The 2015 “Demotech Performance of Title Insurance” will be published shortly.