Financial Stability Ratings

1
Financial Stability Ratings andFinancial
Reporting Issues Impacting Title Insurance

• Joseph L. Petrelli, ACAS, MAAA, FCA
• President, Demotech, Inc.

2
Corporate Milestones Title Insurance
1985 Founded by Joseph L. Petrelli and Sharon M. Romano to offer actuarial services.
MBA Research Project An Actuarial Perspective on Title Insurance
1986 First to issue Financial Stability Ratings (FSRs) for health maintenance organizations (HMOs).
1987 First to issue FSRs for public entity liability self-insured pools through the development of our Management Audit Process.
1989 First to have Property and Casualty insurance company rating process formally reviewed and accepted by Fannie Mae. An FSR of A or better eliminates the need for property insurance cut-through endorsements.
1990 First to have Property and Casualty insurance company rating process formally reviewed and accepted by Freddie Mac.
Began offering Property and Casualty insurance companies and Title underwriters loss cost analysis and rate, rule and form filing assistance.
Responded to the National Association of Insurance Commissioners (NAIC) requirements for Property and Casualty insurers to submit Statements of Actuarial Opinion related to loss and loss adjustment expense reserves concurrent with the 1990 Property and Casualty annual statement.
3
Corporate Milestones Title Insurance (cont.)
1992 First to analyze the financial position for each Title underwriter.
1993 First to have Property and Casualty insurance company rating process formally reviewed and accepted by HUD.
1994 Fannie Mae issued Title underwriting guidelines, naming Demotech as an approved Title underwriter rating service.
1995 First to promulgate Commercial Real Estate Recommendations (CRERs) to provide additional financial due diligence of Title underwriters involved in larger real estate transactions.
1996 Contacted by the Florida Office of Insurance Regulation (OIR) when the property insurance market encountered newly established insurers that did not meet traditional rating requirements. Working with the Florida OIR, Demotech developed evaluation procedures for the assignment of FSRs to newly formed Property and Casualty companies.
Coordinated the first seminar regarding the implementation of Statements of Actuarial Opinion for Title insurance companies on behalf of the Conference of Consulting Actuaries.
4
Corporate Milestones Title Insurance (cont.)
1999 Co-authored the Commerce Clearing House publication describing the evolution of the Canadian Title insurance industry.
2001 Completed the initial loss and loss adjustment expense review of the Iowa Finance Authority Title Guaranty Division.
2002 Revitalized the Ohio Title Insurance Rating Bureau (OTIRB).
2003 Assisted the North Carolina Title Insurance Rating Bureau with the development and filing of Closing Services insurance product.
Assisted the OTIRB with its first rate revision since 1980.
2004 Introduced Demotech Performance of Title Insurance Companies and Quarterly Updates.
Incorporated the Louisiana Title Statistical Services Organization and introduced a closing protection coverage in the State of Louisiana.
5
Corporate Milestones Title Insurance (cont.)
2005 HUD approved Demotechs rating process for professional liability insurance under Notice H04-15, Professional Liability Insurance for Section 232 and 223(f) Programs.
2006 Joseph L. Petrelli, ACAS, MAAA, FCA, authored What Weve Got Here Is a Failure to Communicate How Traditional Financial Reporting Contributes to Misunderstanding of Title Insurance Loss Activity. This discussion expounds upon the ramifications of Title underwriters required conformance with Property and Casualty financial reporting standards and how industry comparisons fail to recognize fundamental differences between Title and Property and Casualty coverage characteristics.
2007 Designated as the Official Research Partner of Insurance Journal, providing research, actuarial and statistical support and collaborating on special joint reports pertaining to insurance industry performance and financial results.
2010 Celebrating 25th anniversary on September 9, 2010.
6
Our Philosophy

• Our Philosophy is that Financial Stability
  Ratings (FSRs) should be based on a quantitative
  model and should be independent of size. Small,
  well-managed underwriters can be more financially
  stable than larger, highly leveraged competitors.
  Demotechs review reflects financial analysis
  and critical ratios while also considering
  operational indicators of success, such as
  business and marketing plans and operational
  efficiencies. Committed to this unique
  philosophy, Demotech serves the insurance
  industry by proactively satisfying the evolving
  uses and demands for ratings.

7
Why a Financial Stability Rating is Important

• Financial Stability Ratings are an assessment of
  an underwriters on-going financial stability.
  Based on a predominantly quantitative analysis, a
  Financial Stability Rating provides an impartial
  perspective on financial strength. Financial
  Stability Ratings streamline the administrative
  process by addressing concerns related to the
  financial stability of an underwriter while
  simultaneously enhancing the image of well-rated
  underwriters.
• Since their introduction in 1992, Financial
  Stability Ratings have been an integral part of
  the Title insurance industry. We review and rate
  more Title underwriters than any other service.

8
Our Approach The Financial Stability Analysis
Model

• A Financial Stability Rating is based on several
  financial variables. Demotech combines a review
  of critical balance sheet and income statement
  items with strategic ratios weighted by using
  regression and multivariate analysis. These
  proprietary calculations comprise our Financial
  Stability Analysis Model.
• Our Financial Stability Analysis Model was the
  first risk-based capital or dynamic financial
  analysis model universally applied to the
  insurance industry. Its components, as well as
  selected operational indicators, complete our
  review and are combined to produce our opinion,
  summarized as a Financial Stability Rating.

9
Financial Stability Rating Definitions
The following Financial Stability Ratings represent our opinion of financial stability regardless of general economic conditions or the phase of the underwriting cycle. The following Financial Stability Ratings represent our opinion of financial stability regardless of general economic conditions or the phase of the underwriting cycle.
In our opinion, underwriters earning an FSR of A'' (A Double Prime) have an Unsurpassed ability to maintain liquidity of invested assets, quality reinsurance, acceptable financial leverage and realistic pricing while simultaneously establishing loss and loss adjustment expense reserves at reasonable levels.
In our opinion, underwriters earning an FSR of A''(A Prime) have an Unsurpassed ability to maintain liquidity of invested assets, quality reinsurance, acceptable financial leverage and realistic pricing while simultaneously establishing loss and loss adjustment expense reserves at reasonable levels.
The distinction between an underwriter earning an FSR of A'' and one earning an FSR of A' may be related to the magnitude of policyholders surplus, market share, national presence or other objective factors. The distinction between an underwriter earning an FSR of A'' and one earning an FSR of A' may be related to the magnitude of policyholders surplus, market share, national presence or other objective factors.
10
Financial Stability Rating Definitions (cont.)
The following Financial Stability Ratings represent our opinion of financial stability regardless of general economic conditions or the phase of the underwriting cycle. The following Financial Stability Ratings represent our opinion of financial stability regardless of general economic conditions or the phase of the underwriting cycle.
In our opinion, underwriters earning an FSR of A have an Exceptional ability to maintain liquidity of invested assets, quality reinsurance, acceptable financial leverage and realistic pricing while simultaneously establishing loss and loss adjustment expense reserves at reasonable levels.
In our opinion, underwriters earning an FSR of S have an Substantial ability to maintain liquidity of invested assets, quality reinsurance, acceptable financial leverage and realistic pricing while simultaneously establishing loss and loss adjustment expense reserves at reasonable levels.
11
Financial Stability Rating Definitions (cont.)
The following Financial Stability Ratings represent our opinion of financial stability regardless of general economic conditions or the phase of the underwriting cycle. The following Financial Stability Ratings represent our opinion of financial stability regardless of general economic conditions or the phase of the underwriting cycle.
In our opinion, underwriters earning an FSR of M have an Moderate ability to maintain liquidity of invested assets, quality reinsurance, acceptable financial leverage and realistic pricing while simultaneously establishing loss and loss adjustment expense reserves at reasonable levels.
In our opinion, underwriters earning an FSR of L are Licensed by state regulatory authorities. In our opinion, their ability to withstand general economic downturns or deterioration in the underwriting cycle is limited.
12
Commercial Real Estate Recommendations

Highly Recommended In our opinion, Title underwriters receiving a Commercial Real Estate Recommendation of Highly Recommended for Commercial Real Estate Transactions have substantial financial resources as well as significant in-house capacity and expertise.
Strongly Recommended In our opinion, Title underwriters receiving a Commercial Real Estate Recommendation of Strongly Recommended for Commercial Real Estate Transactions have adequate financial resources of their own and significant in-house capacity and expertise, or they have access to the necessary resources because of their placement of reinsurance coverage.
Recommended In our opinion, Title underwriters receiving a Commercial Real Estate Recommendation of Recommended for Commercial Real Estate Transactions have sufficient financial resources of their own and sufficient in-house capacity and expertise, or they have access to the necessary resources because of their placement of reinsurance coverage.
13
Summary

• FSRs are based, in part, upon the quality and
  liquidity of the invested assets of a Title
  underwriter, the adequacy of its loss and loss
  adjustment expenses reserves, quality and
  quantity of its reinsurance, leverage as
  measured by total liabilities to surplus as
  regards policyholders, operating profit or loss,
  and, in some situations, its ability to access
  additional capital.

14
What Weve Got Here is a Failure to Communicate

• While Title insurance coverage looks backward
  from a certain date, PC insurance coverage looks
  forward, utilizing a finite future period, to
  evaluate liability. The timeframe of coverage
  and cost containment activities are a fundamental
  difference between Title and PC coverages.
• This distinction for Title underwriters has not
  been properly reflected in financial reporting
  requirements nor statistical reporting
  requirements.

15
Typical Language in a Title Insurance Policy
States

• Subject to the exclusions from coverage, the
  exceptions from coverage contained in Schedule B
  and the conditions and stipulations, the Title
  insurance company, as of the Date of Policy shown
  in Schedule A, against loss or damage
• Coverage is Retrospective.

16
Typical Language in a PC Insurance Policy
States

• In Consideration of the Provisions and
  Stipulations herein, the Property and Casualty
  Insurance Company, for the term of this date at
  1201 a.m. to one year later at 1201 a.m. at the
  location of the property involved, does insure
• Coverage is Prospective.

17
Date of Policy
Date of Policy
P C is Prospective
Title is Retrospective
Incident must have occurred prior to policy date
to be considered covered
Incident must occur within policy period to be
considered covered
18
Loss and Loss Adjustment Expense Ratio

• Loss adjustment expenses include allocated loss
  adjustment expenses and unallocated loss
  adjustment expenses.
• Allocated loss adjustment expenses are those
  expenses, such as attorneys fees and other legal
  costs, that are incurred in connection with and
  assigned to specific claims.
• Unallocated loss adjustment expenses are all
  other claim adjustment expenses and include
  salaries, utilities and rent apportioned to
  support the claim adjustment function although
  not readily assignable to any specific claim.

19
Allocated Loss Adjustment Expense

• An expense directly allocated to a particular
  claim or incident.
• Addressing specific defects and everything in
  Schedule B?

20
Unallocated Loss Adjustment Expense

• An expense pertaining to handling claims that
  cannot be specifically attributable to a specific
  claim.
• Your entire preliminary investigation? Looking
  for situations that need to be cured!

21
Unallocated Loss Adjustment Activity

• Order Entry
• Verify property address
• Verify owner(s)
• Legal Description
• Run the Chain
• Run names and nicknames
• Determining encumbrances or possible
  encumbrances
• Back ground determining and indication of legal
  incompetence conservator, bankruptcy, etc.
• Impairments in chain of Title
• Determine adverse claims
• Interest which affects tenancy
• Property tax

22
Unallocated Loss Adjustment Activity

• Examination
• Legal Description
• Conveyances
• Execution
• Notarization
• Evidence of fraud, forgery, competence, etc.

23
Unallocated Loss Adjustment Activity

• Matters Affecting
• Covenants and restrictions
• Easements
• Rights of first refusal
• Judgment of lien
• Market requirement to cure
• Indemnities
• Review prior transaction
• Application of statute of limitations

24
Unallocated Loss Adjustment Activity

• Matters Affecting (cont.)
• Update for last minute items
• Fallout
• Review tax certificate
• Reconcile difference with tax discrepancies
• Check for outstanding tax sales
• Review survey for adverse matters
• Verify legal access
• Mineral reservations
• Geographic posting

25
Unallocated Loss Adjustment Activity

• File Work Up
• Verify sellers names on contract match vesting
• In a refinance, verify borrowers names match
  vesting
• Ensure all Title requirements are addressed on
  the settlement statement
• Comply with terms of real estate contract
• Comply with requirements in lenders closing
  instructions
• Verify borrowers names on loan document match
  contract

26
Unallocated Loss Adjustment Activity

• Closing
• Ensure all documents are executed properly
• Correctly notarize all appropriate documents
• Comply with lenders funding requirements
• Ensure no disbursements are made without all
  funds being received
• Post-closing
• Disburse all funds per HUD-1
• Return lenders package
• Record documents in correct order

27
Allocated Loss Adjustment Expenses

• Once you found a situation that needed to be
  resolved, no matter how simple or routine, the
  time and effort on that specific situation would
  be allocated loss adjustment expense.

28
WAC 284-24D-020 (Excerpts)Property and Casualty
Insurance Code

• Allocated loss adjustment expense or ALAE
  means expenses paid to defend and litigate a
  claim. These expenses may be internal or
  external, and include
• Attorneys fees paid to defend claims
• The cost of engaging experts
• Litigation management expenses
• Fees or salaries for private investigators,
  hearing representatives or fraud investigators
• Surveillance expenses and
• Court costs
• Stenographic expenses
• Fees associated with witnesses and summonses and
• The costs to obtain copies of documents.

29
Example of Inequity PC vs. Title

• Missed lien by a Title professional.
• Truck driver in an accident.

30
Incidents Per Policy
State Policies in Sample Incidents Discovered and Resolved
Colorado 83 888
Florida 43 248
Louisiana 114 585
North Carolina 270 3,323
All Samples 510 5,044
31
Conclusion

• Given the retrospective nature of a Title
  insurance policy, appreciable loss adjustment
  expense unallocated and allocated is expended
  prior to policy issuance. This effort resolves
  claims that would otherwise occur.
• Unfortunately, current financial reporting
  requirements are based upon the prospective
  nature of PC policies, thereby overstating the
  Title expense ratio and understating the Title
  loss adjustment expense ratio.