Rising mortgage rates, lower homebuyer demand and fewer homeowners choosing to sell their homes caused the housing market to slow during the second half of 2022. In the title insurance industry this resulted in a drop in capital adequacy, according to a report released Friday by Fitch Ratings.
In 2022, the title industry’s aggregated risk-adjusted capital (RAC) ratio, which is a measure of resiliency of a financial institution’s balance sheet to endure an economic risk or recession, fell to 168%, compared to 182% in 2021. However, the 168% figure is consistent with Fitch’s guidelines for an “A” category rating.
According to Fitch, this shows that the headwinds faced in the second half of 2022 led to revenue and earnings weaknesses and it also adversely impacted capital levels at some underwriters.
Fitch attributed the decline in industry-wide aggregate RAC score to a drop of roughly 17% in adjusted policyholders’ surplus (APS), which was offset slightly by a decline in target policyholders’ surplus (TPS) due to a lower expense leverage and large loss charge.
In addition, Fitch estimates that the level of redundant statutory loss reserves fell 14% year over year, also contributing to the lower RAC ratio, and that 81% of reported statutory reserves ($5.1 billion) were used in the 2022 RAC ratio and just over 100% of Schedule P reserves ($4.1 billion). Fitch noted that based on Schedule P reporting, recent underwriting periods continue to generate low reported loss ratios compared to historical averages.
The industry base RAC score also fell, dropping 13 percentage points compared to the year prior to 136% at the end of 2022.
When broken down by company, of the Big Four, Fidelity National Financial had the lowest RAC ratio at the end of 2022, after it fell 13 percentage points year over year to 129%, with the largest driver of the decrease being an increase in the large loss and ceded reinsurance risk charge and an almost 32% decline in APS.
Old Republic had the second lowest RAC at 158%, six percentage points lower than a year ago. Fitch attributed this decrease to a 9% drop in surplus and an increase in large loss and ceded reinsurance charges, which was partially offset by a decrease in expense leverage and agency risk charges. First American ranked third, with a RAC ration of 186%, a slight increase compared to a year prior, keeping the firm in line with Fitch’s “A” rating guidelines. The slight increase was driven by an 18% drop in TPS, due to a drop in large loss and ceded reinsurance charges, despite a drop in surplus.
Stewart had the highest RAC at 221%, remaining essentially unchanged compared to a year ago, keeping the firm in line with Fitch’s “AA’ rating guidelines. Fitch attributes Stewart’s results to a slight decline in surplus and a slight improvement in estimated reserve redundancy, as well as a slight decline in TPS. Stewart’s base RAC of 191% is the highest in Fitch’s universe.
Looking ahead, Fitch believes that we will start to see the impact of some of the title firms’ expense reduction measures in the second quarter of 2023 and that the industry should expect net profits for full-year 2023 to be “on par or slightly better than 2022 despite the slowdown in originations and home price declines.”
“The declines in premium volume and reduced operating expenses, with flat to modestly higher capital levels, will promote modest capital adequacy improvement in 2023,” the report reads.
“Title insurers are actively pursuing expense reductions in response to macroeconomic pressure, which coupled with lower premium volumes, will promote modest improvement in capital adequacy in 2023,” Gerry Glombicki, Fitch’s senior director, said in a statement.
In addition, Fitch also expects industry capital levels to, at best, move slightly higher in 2023, benefiting from recent expense reduction measures. However, Fitch Ratings also states the further expense reductions may be necessary if market conditions worsen.
While the confluence of higher mortgage rates, lower home prices and limited existing home inventory continues to put a strain on the industry, the industry-wide decline in operating expenses coupled with flat capital levels is expected to cause an increase in the title RAC ratio by the end of 2023.