June 6, 2006, Reviewed December 13, 2007
Competition for clients by title agencies is directed not at borrowers
but at the Realtors, lenders and builders who have referral power. Most
referrers use their power to benefit themselves rather than their
clients. Competition directed at referrers who expect to be compensated
tends to drive up prices. If lenders were obliged to purchase insurance
that protected them, competition by title insurers for their business
would force prices down.
Structure of the Title Insurance Industry
"The title insurance industry has been much in the news recently for a
variety of alleged abuses of consumers. Is there something fundamentally
wrong with this industry?"
I think there is, but the abuses reported by the media aren’t the
problem. The abuses are the consequences of a dysfunctional market.
Competition by sellers of title insurance does not benefit consumers the
way it is supposed to. When title companies compete, you lose.
The title insurance industry is structured much like the
wholesale/broker segment of the mortgage market. Mortgage brokers find
the customers, and do most of the work involved in originating loans.
When the work is done, the loan is funded by a wholesale lender, at a
price that lender had posted with the broker earlier.
Title agencies are the counterpart of the mortgage broker. They operate
locally or state-wide, and there are many thousands of them. They find
the customers and do all the work involved in creating title policies,
including searching title records. When their work is done, the policy
is issued by the agent on behalf of one of the title insurance
companies.
About two-thirds of all title policies are issued by independent agents,
which is about the same market share that mortgage brokers have. The
balance is accounted for by branches of insurers or by agencies wholly
owned by them.
But there are some important differences between the two markets. Where
there are hundreds of wholesale mortgage lenders, 5 title insurers
account for about 90% of the policies. While wholesale mortgage lenders
reset mortgage prices every day, furthermore, title premiums change only
occasionally. In most states, title insurance premiums must be posted
with the state in accordance with procedures established by state law.
Borrower Innocence and Competition
Few borrowers shop for title insurance, which is a minor part of a
larger transaction that commands their attention. In most cases, they
wouldn’t know where to shop even if they wanted to. The great majority,
therefore, accept the title agency recommended by their Realtor, builder
or lender, who often assure them that all agencies charge the same
price.
Competition for clients by title agencies is thus directed not at
borrowers but at the Realtors, lenders and builders who have referral
power. If the referrers are independent of the title companies and act
in the best interest of their clients, they will select agencies that
offer the best price and service. Sometimes this happens, but all too
often referrers use their power to benefit themselves rather than their
clients.
Competition directed at referrers who expect to be compensated tends to
drive up prices. It is sometimes referred to as "reverse" or "perverse"
competition. Compensation paid to referrers is called "referral fees" or
"kickbacks".
Kickbacks
Kickbacks in the title insurance market can be illegal, legal, or shams
which purport to be legal but aren’t.
Under the Real Estate Settlement Procedures Act (RESPA), a party who is
compensated for referring a customer to a title agency has received an
illegal kickback. Illegal kickbacks occur, because it is extremely
difficult to police all the ways that one party can provide something of
value to another. See
Questions
About Referral Fees.
A legal kickback is called an "affiliated business arrangement", or ABA.
The referring party (a Realtor, for example) and the title agency can
form a new title agency owned jointly. The Realtor can make referrals to
this new entity, and can profit in proportion to its ownership share.
ABAs are costly to create and operate.
A sham is an attempt to legalize kickbacks without incurring all the
costs of an ABA. It may have only the façade of an ABA, for example,
with the work actually done by another agency. Reinsurance schemes where
the referrer receives a portion of the title insurance premium in
exchange for assuming some of the insurance risk, have also been deemed
shams by regulators.
Government and Kickbacks
At this time, Government is doing nothing that would reduce the cost of
title insurance. The current policy of HUD (which administers RESPA),
and those state regulators who have gotten themselves involved, is to
eliminate shams. While the law should be enforced, requiring those with
referral power to incur heavy costs in order to legalize their kickbacks
will not drive down the price of title insurance.
The high price of title insurance, and the prevalence of kickbacks in
the industry, both stem from the fact that mortgage borrowers pay the
insurance premiums while others select the title agency. To reduce
prices, you have to change that.
Proposal For Lender-Paid Title Insurance
The way to reduce the cost of title insurance (and also mortgage
insurance and credit insurance) is to have the Federal Government
mandate a general policy that any insurance that protects only lenders
must be paid for by lenders. On any real estate transaction that
involves a mortgage, lenders should pay the policy premium on the lender
policy, plus related title costs.
If lenders had to pay for title insurance, prices would drop. Instead of
millions of buyers a year taking one policy each, there would be
thousands, each one purchasing many policies. The buyers would be
knowledgeable rather than ignorant; they would be in the market
continuously rather than once or twice; they would shop alternative
sources rather than accept recommendations from interested parties; and
they would have the clout associated with their purchase volume.
Of course, borrowers would pay for the lender policy in the price of the
mortgage. The incremental price, however, would be a faction of what
they pay now.
Lender Insurance Versus Borrower Insurance: On mortgage refinance
transactions, lenders would pay for lender policies, and borrowers would
have the option to buy or not to buy title policies that protect them.
On home purchases in areas where home buyers purchase their own title
insurance, they would have the same option. In both cases, borrowers
would have to be persuaded that the incremental protection provided by
owners’ policies are worth the price. This is as it should be.
In some areas, by law or custom, home sellers are obliged to purchase
homeowner policies for the buyer. Lender policies are a "simultaneous
issue", often priced at a discount. Since home sellers, in selecting a
title agency, will continue to be influenced by Realtors, instituting a
lender-pay requirement on lender policies may not have much immediate
impact on title costs. Hopefully, over time, the evidence of price
declines elsewhere will generate pressures to eliminate the practice of
having home sellers purchase title policies for buyers.
State Regulation a Partial Barrier: A potential impediment to price
declines would be state regulation of title insurance premiums. Such
regulation is supposed to protect consumers, which it doesn’t. In some
states, it may provide the major title insurers with a convenient way to
collude on premiums.
In Texas, New Mexico and Florida, the state actually sets the premiums.
In some others, insurers are allowed to band together to propose premium
rates that the state will then approve for all of them. In a third
group, each company posts its own premium rates with the state; in some,
the state must approve ("File and Use"), in others no approval is needed
("Use and File"). In all cases, the information is public and available
to other insurers.
Resistance to declines in posted insurance premiums will be strong. The
title insurance industry is highly concentrated at the insurer level,
with the 5 largest companies writing about 90% of the policies. These
companies also have a demonstrated ability to influence state
legislatures.
Prices will drop nonetheless. Large lenders probably will negotiate
package deals with the major insurers, who will be obliged to reduce
their posted prices. Smaller lenders probably will negotiate deals with
local agencies, which have cost structures swollen by high marketing
expenses, including legal and illegal kickbacks. (On average, agencies
retain more than 70% of all title insurance premiums). Large lenders
could also deal with the agencies if the large insurers refuse to drop
their posted prices.
Vested Interests in Existing Arrangements
The prospects for legislation that would require lenders to pay for
their own title protection depend on the attitudes of the major groups
that would be affected by it. In April, 2006, the House Committee on
Financial Services, chaired by Representative Oxley, held hearings on
title insurance. The papers prepared for the hearings reveal the
attitudes of the various groups with an interest in title insurance.
ALTA and Other Trade Groups: The paper submitted by ALTA, the trade
association of title companies, includes some interesting background
materials such as a history of the industry. On the issue of what is
wrong with the industry today, its position is very clear. There is
nothing wrong with the industry except illegal kickbacks and sham ABAs,
and its main policy prescription is that HUD and the states should
redouble their enforcement efforts.
The position of ALTA is seconded by The National Association of
Realtors, which is the largest of the trade groups participating, and by
RESPRO, which is the smallest. RESPRO is a trade association of firms
that participate in ABAs. These groups would adamantly oppose my
proposals.
Mortgage lending groups did not participate in the hearings. However,
the likelihood that they would support a legal requirement that they pay
for their own title protection, is low.
A Voice in the Wilderness: The most interesting testimony at the hearing
came from Douglas R. Miller, CEO of one of the few title agencies
remaining in Minnesota that is not part of an ABA. His prices are well
below those charged by the affiliated companies, but:
"Service excellence and price are now meaningless in my market. Instead,
we have a system that rewards real estate professionals for manipulating
their clients into selecting the highest priced title companies. We are
stopped at the door at most real estate brokerage houses in town. They
have their own "affiliated" title company and don’t want to hear about
us… Consumers are carefully guarded from information about competing
title companies, and agents are chastised if they recommend a title
company other than their in-house company."
Minnesota may be an outlier in the extent to which ABAs have come to
dominate the market. It is the direction toward which other markets are
trending, however, with increasing support from HUD.
HUD, a Public Guardian? HUD is responsible for enforcing RESPA, which
means it has the unenviable task of shutting down sham kickback
arrangements. But it also has a broader if less well-defined mandate to
reduce settlement costs, a goal that is not furthered by the pursuit of
sham kickbacks. Most of Mr. Miller’s problems, after all, are caused by ABAs, which generate legal kickbacks.
In the paper submitted for the hearings, HUD referred to a 1980 study
that concluded that title insurance was not provided to consumers "at a
price which approximates the cost of efficiently providing these
services…" And it went on to say that nothing has changed since then.
But the major part of the paper is directed to its enforcement efforts
directed against sham kickbacks.
HUD simply ignores the lack of congruence between its enforcement
obligations, and the policy objective that that enforcement is supposed
to further – but doesn’t. At the conclusion of the paper, instead of
informing Congress that the current rules will never reduce settlement
costs, it asks for more power to enforce those rules.
Consumer Groups: The Consumer Federation of America, on behalf of itself
and five other consumer groups, documents the large gap between the
direct costs of producing a title policy, and the price paid for the
policy by the borrower. They support two potential remedies, one of
which is to require that lenders purchase their own title policies. The
second is to have the states guarantee title, as is done now in Iowa.
While the Iowa system has merit, it would have to be adopted by each
state, some of which would surely muck it up. Lender-pay could be
implemented by the Federal Government, and it would work.