A bizarre bazaar: mortgage holders demand that the problems with the home title be taken care of by a title insurance company. But the mortgage companies do not pay for, nor have any real incentive to contain the cost of insurance

Risk & Insurance, June, 2004 by Peter Rousmaniere

When did you last buy or sell a home? Do you recall that line item which demanded that you pay between $500 and $1,000 for home title insurance? You could find it toward the bottom of the closing document. It may have been listed there with the other incidental charges.

If that's what you see, you paid way, way too much--as I did.

My wife and I bought a house in Little Rock, Arkansas, in 1999 and sold it in 2003. In line with real estate practices there, we paid at each closing about half the cost of a title insurance policy, with the opposite party paying the balance.

The premium was set at a percentage of the sale price. Our own round trip, combining our purchase and sale, was about $1,000. The mortgage holder, listed as one of the insureds, didn't pay a cent.

Each year people like us pay $12 billion for home title insurance to a small club of insurers. And a club it is indeed--seven firms control 90 percent of the nationwide market.

This market serves a legitimate function to reduce risk in the home mortgage industry. The mortgage holder--along the daisy chain of a secondary mortgage market--demands that title problems be taken care of by a title insurance company.

But the mortgage companies do not pay for nor have any real incentive to contain the cost of insurance.

About 5 percent out of every premium dollar paid by homeowners on a title policy goes to pay losses. Say, for the sake of argument, that another 35 percent paid by the homebuyer/seller for the title policy goes to pay the insurer's overhead, commissions and profits.

Where goes the remaining 60 percent--about $7 billion a year--end up? In a dense local bazaar of data collectors, lawyers and referral sources.

People called title searchers or abstractors do the grunt work of inspecting public and private sources for evidence of title problems or claims upon the property. The fundamental risk is an unknown or underappreciated flaw in a property purchaser's legal capacity to enjoy rights of ownership. Watch how the hazards stack up.

First, a lender to a prior owner may place a lien on a property, but fail to submit the data properly into local public records. Or a public employee may fail to enter that submission correctly into the record. Or the title searcher may overlook or misinterpret an entry, or fail to check elsewhere. The majority of claims come from errors in the search. For this reason home title insurance is, in effect, an errors and omissions policy with a maximum payout equal to the purchase price of a property.

Unique among states, Iowa issues title insurance through a public agency acting as an insurer. The Iowa bar association endorses this approach and has defended it. The Iowa Finance Authority has experienced an incredibly small number of claims. It is dedicated to keeping down the costs. A $100 policy in Iowa would cost $500 in Arkansas and $300 in Massachusetts, where we resettled. Every few years, the Authority transfers profits into affordable housing programs.

For this type of insurance, maybe government is the best insurer. The Iowa Finance Authority is clearly committed to making title insurance as cheap as possible. High volume within one state allows it to spread fixed costs among many transactions. It has greater moral authority to induce Internet-age efficiency of record keeping among custodians of public information. Local governments have many reasons to make sure land records accurately match tax, land use and court databases.

Private insurers, on the other hand, have brief attention spans for premium payers, you and me. We have practically no leverage to induce lower premiums. The one party with real leverage, the mortgage company, is a free rider.

Jack Guttenberg, an advocate of mortgage reform and a former Wharton Business School professor, describes this market structure as perverse competition. More competition may drive up, not down, the cost to the premium payer. The problem arises out of the role of the intermediary. Beware, beware the man in the middle, when he learns to make much from a little.

Intermediary A, the mortgage broker or title search company, controls the selection of the insurance policy by customer C, the home and mortgage buyer, sold by vendor B, the mortgage insurer.

The customer pays the freight, but the insurers correctly finger the intermediary as their real customer. The insurers compete not by lowering premiums but by bidding up financial rewards to the intermediary.

Federal law from the 1970s prohibits mortgage insurers and intermediaries from splitting fees. But it does not prevent parties from winking.

That means the law does not prohibit the insurer from paying for outdated ways to prepare the local data. Nor does it prevent the local title search company from tacking additional charges, such as mailing costs to homebuyers for title searches, that you'd reasonably expect the insurer would take care of.

If Marriott Corp. operated this way, it would be cutting deals with credit card companies, and we'd see heating and elevator usage charges on our checkout statements. The buyer or seller, trapped by time pressures, pays--usually without protest or comprehension of these miscellaneous charges and the insurance premium.