Reserving for Title Insurance 2004 Casualty Loss Reserve Seminar Paul J. Struzzieri, FCAS Milliman, Inc. September 14, 2004

MillimanPage 2 Outline I. Introduction to Title Insurance II. Financial Reporting Issues III. Actuarial Challenges & Methods

MillimanPage 3 I) Introduction to Title Insurance a) Types of Policies b) Coverage c) Unique Issues d) Markets e) Distribution f) Reinsurance

MillimanPage 4 Types of Title Insurance Policies a) Purchase Mortgages i. Lender Policy – based on $ amount of loan ii. Owners Policy – based on $ amount of purchase b) Refinance Mortgages i. Lender requires new policy ii. Owners keep original policy

MillimanPage 5 Purchase vs. Refi Mortgages

MillimanPage 6 Coverage a) Lender’s and owner’s interests are protected b) Cost to cure the defect; plus defense costs c) Common title problems: i. Defects, liens, easements – catch during search ii. Hidden hazards – undisclosed heirs, forged deeds iii. Unmarketability of title iv. Defalcations

MillimanPage 7 Coverage Example #1 Young couple buys home from widow (whose husband died without a will). Young couple buys home from widow (whose husband died without a will). Widow’s son shows up and claims a share of the home. Widow’s son shows up and claims a share of the home. Title insurance pays the missing heir the value of his share. Title insurance pays the missing heir the value of his share.

MillimanPage 8 Coverage Example #2 Just prior to closing, a prior lien is discovered. Just prior to closing, a prior lien is discovered. For example, a paid but unreleased mortgage. For example, a paid but unreleased mortgage. Purchaser can decide not to close based on this discovery. Purchaser can decide not to close based on this discovery. Title insurance policy will respond if unmarketable. Title insurance policy will respond if unmarketable.

MillimanPage 9 Issues Unique to Title Insurance a) Loss is “incurred” prior to policy issuance b) No policy expiration date  how to earn premium? c) Goal of title search & examination = loss elimination d) High expense ratios (90%+); low loss ratios (4-10%)

MillimanPage 10 U.S. Market Share 2003 DWP Share 1)Fidelity National Financial $4.9B32% 2)First American 3.3B21% 3)Land America 2.8B18% 4)Stewart Title 1.8B12% 5)Old Republic 1.0B 1.0B 6% 6% Subtotal13.8B89% All Others 1.7B11% Total15.5B100%

MillimanPage 11 International Markets a) Canada b) Australia c) Europe

MillimanPage 12 Distribution Channels a) Agency Business (86%) i. Independent Agents – including attorneys (59%) ii. Owned Agencies (27%) b) Direct (14%)

MillimanPage 13 Reinsurance a) Typically excess of loss b) Larger title insurers reinsure the others c) Assumed and ceded = offset each other

MillimanPage 14 II) Financial Reporting Issues a) Financial Reporting i. Form 9 ii. Statement of Actuarial Opinion b) Categories of Statutory Reserves c) Reserve Testing

MillimanPage 15 Financial Reporting a) Form 9 = Statutory Annual Statement b) Schedule P i. By Policy Year ii. By Report Year c) Statement of Actuarial Opinion – since 1996 Annual Statement d) Opine on Schedule P reserve, NOT booked reserve

MillimanPage 16 Categories of Booked Reserves a) Known Claims Reserve b) Statutory Premium Reserve (SPR) = “Unknown” Claims i. SPR Functions as Unearned Premium Reserve ii. Formula = Amount & Take-down Pattern c) Supplemental Reserve

MillimanPage 17 Reserve Testing a) Compare Schedule P Reserve against Known Claims Reserve + SPR b) Schedule P includes Known Claims, so really testing SPR vs. IBNR c) If SPR > IBNR, book SPR d) If IBNR > SPR, book SPR + Supplemental Reserve

MillimanPage 18 Industry 12/31/03 Known Claims=$556M Known Claims=$556M SPR =3,258M SPR =3,258M Total=$3,814M Schedule P=$2,741M Schedule P=$2,741M

MillimanPage 19 III) Actuarial Challenges a) Title insurers do not know the number of policies in-force! b) Correlation between calendar year loss emergence and mortgage rates c) Refi policies have lower loss ratios than original title policies d) Commercial vs. residential policies e) New products

MillimanPage 20 Actuarial Methods – Loss Development a) Paid and incurred loss development triangles from Schedule P b) Industry composite data available c) Historical patterns can be distorted i. Drop in interest rates leads to refi’s ii. When lender policy is refinanced, original policy is extinguished. d) Try to adjust pattern

MillimanPage 21 Actuarial Methods – Expected Loss Ratio a) Expected Loss Ratio for refinance policy is lower than original policy b) Policy Year with high refinance % expected to have lower loss ratio

MillimanPage 22 Refi Percentage vs. Title Loss Ratio

MillimanPage 23 Actuarial Methods – Expected Loss Ratio a) Econometric modeling of Expected Loss Ratio – variables could include: i. Mortgage rates ii. Refinance percentage

MillimanPage 24 Modeled Loss Ratio vs. Actual Loss Ratio

MillimanPage 25 Actuarial Methods – Cape Cod or Bornhuetter-Ferguson a) Combines Expected Loss Ratio and Development Methods. b) To calculate Expected Losses, can use: i. Premium ii. Amount of Insurance iii. Counts & Averages