The growth of the title insurer rating business has left the title insurance industry awash in alphabet soup, because each of the rating companies has its own rating system. This article will provide some guidance in comparing ratings produced by different raters, how they approach the rating process, and what is included in the rating systems. It will also summarize the current ratings for the major title insurance underwriters.
How Far We’ve ComeIn the six years since I last reviewed the subject of financial ratings of title insurers with Title News readers (March/April 1994), ratings have gone from being a novel curiosity to being a staple of title insurer analysis. The title insurer rating business has grown apace. In 1994, three companies provided title insurer ratings. Today, six companies provide title ratings, including all the major rating organizations. Financial ratings of title insurers are followed closely by a wide variety of users of the title insurance product. In addition to Fannie Mae, whose requirements initiated the ratings process, other issuers of mortgage-backed securities also look to title insurer ratings. Originating lenders consider ratings when selecting insurers to work with, knowing that title problems for secondary lenders often come home to roost with the originator. Purchasers of commercial properties keep tabs on ratings when selecting title insurers. Even small consumers are becoming aware of ratings, as direct advertising plays a larger role in the overall title insurer marketing mix. Financial ratings are also considered by the industry itself. Companies, both inside and outside the title industry, which are considering making title insurer acquisitions consider both the current rating of an acquisition target and the likely impact of the acquisition on their own rating. Title insurance agents review financial ratings in selecting underwriters for whom to write. The financial ratings considered in this article are claims paying ability ratings. These ratings measure the likelihood that an insurer will be able to honor its financial obligations to policyholders, and so examine the financial condition of the company as a whole. They differ from traditional securities ratings, which measure the likelihood that an issuer will be able to honor its financial obligations on a particular security instrument. Nevertheless, these ratings are watched closely by the investment community, and changes in its ratings can have a material impact on a title insurer’s ability to raise both debt and equity capital.
Rating MethodologiesAt the outset, it is important to point out that each rating organization has its own unique methodology, incorporating somewhat different quantitative models, relying on somewhat different underlying data, and using somewhat different mixes of numerical calculations and informed judgement. Accordingly, each organization’s rating provides somewhat different information to the user. Table 1 gives an overall comparison of the rating methodologies of all the active rating companies. Listed below are brief descriptions of each title insurance rating organization. More complete descriptions are available on the company Web sites listed at the end of each section. A. M. Best Company. Best, of Oldwick, New Jersey, began producing insurance company ratings in 1899, and Best’s publications have been standard references for a century for all lines of insurance, including life, health, and property/casualty. However, it has only recently entered the title insurance rating business. Best’s carries out ratings on a fee-for-service basis (i.e., the rated company pays). Best produces two sets of ratings: Best’s Ratings, and Financial Performance Ratings (FPR’s). FPR’s are given only to very small or new companies. Best’s uses essentially the same methodology for rating all lines of property/casualty insurance, including title insurance. Its core quantitative model is a proprietary Capital Adequacy Relativity Model. Best evaluates capital adequacy for consolidated company groups and for individual insurers. In addition, Best takes explicit account of qualitative factors, including management quality, competitive posture, and a rated company’s future plans. (For further information go to www.ambest.com.) Demotech. Demotech, Inc., of Columbus, Ohio, is an actuarial consulting firm with experience both in general property/casualty insurance and in mortgage insurance. Demotech was the first company to release title insurer ratings to the public in 1992. It rates approximately one hundred title insurers on a fee-for-service basis. Its ratings and other financial data are made available annually to subscribers, in a book titled "First Rate/Title - Financial Stability Ratings." The ratings are monitored quarterly and updates are available on Demotech’s website. Demotech calls its ratings Financial Stability Ratings?, and uses a rating approach that is primarily dependent on quantitative analyses of the historic financial statistics of the rated underwriter, generally on a stand-alone basis. The ratings are developed through the use of a proprietary quantitative Financial Stability Analysis Model?, and a qualitative analysis of the company’s corporate affiliations, geographical diversity, and management. The financial data used in the model is based upon statutory accounting data, independent audits, and other financial information submitted by company management. In addition to Claims Paying Ability (CPA) ratings, Demotech also includes commercial real estate recommendations in its book. These recommendations consider the company’s commercial real estate expertise, access to reinsurance, and other forms of underwriting capacity, and financial strength. (For further information go to: www.demotech.com.) Duff & Phelps. Duff & Phelps Credit Rating Company of started out as a rating agency for fixed income securities, but has moved aggressively into the insurer rating business. It currently has claims paying ability ratings issued for some 600 insurance companies in life and health insurance, property/casualty, title insurance, and mortgage insurance. It performs ratings on a fee-for-service basis. Duff & Phelps designates its ratings as CPA ratings. Its primary quantitative model for title insurance rating is its Risk Adjusted Capital (RAC) model. The model is analogous to the risk-adjusted capital models adopted by the NAIC for the property/casualty industry. The details of the model are not proprietary, and all its parameters are described at length in a Duff & Phelps publication. In addition to using the RAC model, Duff & Phelps also takes explicit quantitative account of the amount of financial leverage used by a title insurance holding company in assessing insurer capital adequacy, and publishes its leverage criteria as well. Duff & Phelps indicates that it augments its quantitative models by qualitative or judgmental considerations. In particular, competitive positioning, management experience, and risk exposure are assessed as a major part of the rating process. (For further information go to: www.dcrco.com.) LACE Financial. LACE Financial Corporation, of Frederick, Maryland, provides ratings of all title insurers. LACE is an acronym for Liquidity, Asset quality, Capital adequacy, and Earnings. The LACE organization is primarily a financial institutions rating organization. LACE is the only organization that rates all title insurers without charge. It sells its ratings to subscribers in a book titled "LACE Ratings - Title Insurance Companies." LACE rates title insurers semi-annually using December and June data. The LACE service also designates its ratings as CPA ratings. LACE relies both on published statutory financial statements and on background information supplied by the companies regarding their scope and area of operations, type of policies issued, self-imposed policy limits, and any existing internal or external reinsurance agreements. The companies are divided into four peer groups based on asset size, and averages for each peer group are presented in addition to overall averages. While the LACE publication presents extensive statistical tables on each title insurer, the organization indicates that its final ratings incorporate substantial qualitative analysis of management and market factors. LACE indicates that its ratings are based exclusively on historic performance and current status, and do not depend on projections or expectations of future performance. In addition to overall CPA ratings, LACE also publishes a separate commercial capacity ratings service which indicates LACE’s assessment of the largest liability that the company can safely insure. Moody’s. Moody’s Investors Service of New York, founded in 1909, is a bond rating agency which has diversified into insurance company rating. While it provides ratings primarily on a fee-for-service basis, it also publishes unsolicited ratings when it believes that there is sufficient general interest in a particular company. Moody’s calls its ratings Financial Strength Ratings (FSR’s). It uses essentially the same methodology for rating all lines of property/casualty insurance, including title insurance. It does not use a single master quantitative model, although it carries out many quantitative analyses in areas including reserve adequacy, liability and asset maturities, and investment portfolio diversification. It augments its quantitative analyses with considerations of management ability, strategic focus, reinsurance posture, holding company leverage, and other general issues. (For further information go to: www.moodys.com.) S&P. S& P also calls its ratings Financial Strength Ratings. The S&P approach places substantial weight both on management’s strategic intentions and on the resources available from corporate parents. In contrast to the other rating companies, S&P places primary reliance on GAAP figures rather than on statutory figures as reported on the Annual Statement (Form 9). (For further information go to: www.standardpoor.com.)
Rating CategoriesAlthough they do not use precisely the same words to describe their rating categories, four of the rating companies divide their ratings into two basic groups. These four raters believe that companies in the first rating group (called "secure" by Best, LACE, and S&P, and called "strong" by Moody’s) will not have any difficulty meeting their policyholder obligations under any likely circumstances. In contrast, the raters believe that companies in the second group (called "vulnerable" by Best, LACE, and S&P, and called "weak" by Moody’s) may experience difficulties making claims payments if economic conditions or loss experience deteriorate. Demotech and Duff & Phelps give qualitative descriptions for each of their rating categories, but do not formally define subgroups. The ratings are generally some combination of letters, numbers, and + or ? signs, and have ancillary descriptions using qualitative adjectives like "excellent" or "good" or "adequate." Except for the Demotech ratings, the earlier a letter is in the alphabet, the better, i.e. A is better than D. Given a letter rank, the more letters there are, the better, ie. AA is better than A. And given the letter rank, the lower the number, the better, ie. A1 is better than A2. Also, + is better than -. Demotech uses a different ranking order. Table 2 sets forth the rating categories used by all six rating organizations.
Comparative RatingsThe six largest title insurer groups provide about 90 percent of all title insurance coverage in the United States. In order to afford some insight into the differences among the different rating services, Table 3 presents the ratings for these groups published by the title insurance rating organizations. (Because Demotech, LACE, and Moody’s only publish ratings for the individual companies rather than the groups as a whole, we have presented the ratings for the two primary underwriter members of the groups where their ratings differ.) Not surprisingly, there are small differences in the absolute and relative rankings the various raters give to the major title underwriters. But the most important aspect of Table 3 is that all the raters consider all the major title insurers to provide solid financial protection to their policyholders.
Where will ratings go in the future?Undoubtedly to more specificity. We have already seen the introduction of commercial capacity ratings by two raters. We can be sure that as the economy moves further into the "Information Age," and consumers and businesses demand even more detailed information, the rating industry will meet these new needs through the introduction of new rating standards. And we can be just as sure that the title industry will rise to the challenge. I would like to thank Gary Ketcham of A. M. Best; Joe Petrelli of Demotech; Jim Auden and Keith Buckley of Duff & Phelps; Barry Putnam of LACE; Alan Murray of Moody’s; and Fred Loelloff of Standard & Poor’s for their generous assistance in providing source material for this article. The views presented here are solely mine, and the responsibility for any errors or omissions is, of course, entirely my own. (The charts are available with the actual magazine.)