It has been recently reported that many of the underwriters are re-evaluating many of their agency relationships and canceling agreements that are not in-line with profitability and claims expectations. This will likely mean a further shift toward more direct operations, but is that a good thing for the underwriters? In a down market, direct operations mean higher fixed costs that are more difficult to control when revenues decline. Fitch has described this as a "primary risk" factor and A.M. Best has also recognized the advantages of agency operations as a distribution channel.
Fitch recently reported that the title industry's risk-adjusted capital (RAC) ratios are the lowest in over a decade, since the RAC model was first introduced. First American and LandAmerica showed disproportionately large declines, according to Fitch, and those underwriters account for about half of the industry's revenue.
The fall in the RAC ratio reflects both a deterioration in capital and a reduced redundancy between statutory reserves and expected claims, Fitch said. Widespread expense reductions favorably influenced targeted policyholders’ surplus, but the effect was outweighed by lost surplus. While the industry ratio fell dramatically, Fitch notes that a few companies held relatively steady and consequently, disparities among individual title insurance companies deepened.
It is Fitch’s view that the primary risk facing most title insurers is the inability to quickly cut fixed costs in the face of retreating revenue.
Those fixed costs are largely attributable to direct operations. From the 2008 10-Q filings of each of the Big 5, we can see how much revenue each of them generates from direct operations and agency operations respectively.
First American
direct operations: 53.66%
agency operations: 46.34%
Stewart Title
direct operations: 48.59%
agency operations: 51.41%
LandAmerica
direct operations: 42.37%
agency operations: 57.63%
Fidelity Financial
direct operations: 41.85%
agency operations: 58.15%
Old Republic
direct operations: 37.80%
agency operations: 62.20%
A.M. Best also recognizes the benefits of agency operations in a troubled housing market. A.M. Best affirmed Old Republic's financial strength rating (FSR) of "A+", and issuer credit rating (ICR) of "aa-." Although the outlook was revised to "negative" from "stable" that is attributable to Old Republic's mortgage guarantee operations which are expected to suffer from the "ongoing downturn in the housing market and related mortgage finance markets."
However, the group’s title premium is nationally diversified, which somewhat limits volatility to regional fluctuations in real estate markets. Moreover, approximately two-thirds of the group’s premium is generated through independent agents. This enables the group to potentially better manage down cycles as fixed costs are generally lower for that distribution channel.
In a booming market it may be advantageous to grow direct operations, which may be why there were so many buy-outs of large agency operations over the past several years. However, when the market softens, like we have seen recently, the direct operations may become a liability.
When underwriters start making decisions to cancel agency agreements, and they are forced to close direct operations due to lack of business, it may make it more difficult for them to manage when the business grows again. These ups and downs are largely avoided by maintaining small direct operations and relying a large network of quality agents.
There is certainly a downside to direct operations, and Old Republic will likely be the least affected by the disruption caused by the mortgage crisis. It will be interesting to see how these numbers change on future 10-Q filings. I'd expect to see a greater separation between First American as they reduce their agency operations, and Old Republic, which has traditionally been more focused on growing through their network of independent agents.
Robert A. Franco
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