One of the more bizarre aspects of the title insurance industry is the so-called monoline restriction. Essentially, what this means is that an insurer which sells title policies must only sell title policies; a company is ineligible by law to sell title insurance if it sells any other type of insurance. These laws are not uniform throughout the country and can vary by state, but in practice, just about all states have a law which is more or less identical to what I’ve described (Iowa being one notable exception, about which I’ll probably have to write a separate post later). You may wonder, as I certainly did when I first learned of it, how on earth these laws came to be? It’s a little complicated…
It all started in the great depression. Back then, companies would issue title policies along with mortgage insurance (policies which protect the lender against loss in the case of default by the borrower, with the cost of the policy being paid by the borrower.) When the depression hit and brought a huge housing bust along with it, many of these insurers went belly-up due to the large number of mortgage insurance claims that occurred as housing prices declined. The result was that title policyholders were left holding the bag, since the title insurance premium is paid up-front in exchange for indefinite protection against title defects. Due to no fault of their own, and in fact due to factors entirely outside of the realm of title insurance and title defects, their policies were rendered worthless after the insurance companies became insolvent. This situation struck many as unfair, and the monoline restrictions eventually followed, ostensibly as a way to protect title policyholders from the “contagion” of other insurance lines bankrupting the insurers underwriting the policies.
The underlying problem that this rule is at least attempting to address is the wide variation in volatility of the claims rates in different insurance lines. To understand this, the key conceptual distinction one needs to make is to think of whether claims for a particular type of insurance tend to occur in large bunches, or whether they’re stable over time. Well-known examples of “safe” insurance lines include fire and auto: one person’s house fire or car accident doesn’t really have any effect on the chance that anyone else will have a house fire or car accident. Probability works its magic, and the claims rate turns out to be pretty stable and predictable for these types of insurance. But, for the so-called “catastrophe” lines, it’s quite the opposite: If my house suffers flood or hurricane damage, it’s quite likely that many thousands of others will too, at more or less exactly the same time. These catastrophe lines are much more difficult to insure economically: For an insurer to be able to cover the losses from, say, a huge hurricane (such as Hurricane Andrew in ’92), the company must have gigantic cash reserves set aside, and the cost of keeping that much money sitting in very low-yield investments results in very high premiums. And of course, if the insurer does not maintain high cash reserves, there’s the perpetual risk that a major disaster could bankrupt the entire company.
Coming back to the monoline restriction then, title insurance is a safe line: Claims are very rare to begin with, but more importantly, are remarkably stable over time. Mortgage insurance, on the other hand, is wildly volatile. Mortgage defaults are very dependent on unemployment rates and declines in house prices, both of which are cyclical and affect millions of people at the same time. This chart that I stole from Dwight Jaffee’s paper Monoline Restrictions, with Applications to Mortgage Insurance and Title Insurance illustrates the idea pretty clearly:
(Also, notice how the claims loss rate for title insurance is unbelievably tiny compared to all the other lines? I’ll come back to that in some other post.)
Does the monoline restriction make any sense? As it is written in most states’ laws, definitely not. For a typical example, here’s the California law:
“An insurer which anywhere in the United States transacts any class of insurance other than title insurance is not eligible for the issuance of a certificate of authority to transact title insurance in this State nor for the renewal thereof.”
Wait a minute, though: the justification for the monoline restriction was to protect title policyholders from the “catastrophe” lines. I’ve read just about everything I can get my hands on about the monoline restrictions, and I’ve never seen any attempt at a justification for separating title insurance from the other “safe” lines. At the very least, then, the monoline restrictions are too broad and can be quite safely loosened to allow companies to underwrite both title and, say, fire policies.
To get to the heart of the matter, though, does it make sense to at least separate title from the catastrophe lines? To me, not particularly. I certainly acknowledge that the vast majority of homeowners aren’t well-informed enough about the product to make informed decisions on a title policy based on the insolvency risk of the insurer, and the monoline restriction is one way to limit the risk to a customer of having a title policy rendered worthless by insurer insolvency. But as Mr. Jaffee points out in his paper (one of the few analyses of monoline restrictions in the literature,) it’s not the only way.
I won’t be as detailed as Mr. Jaffee, but really, the way to control the insolvency risk of any insurer, whether it be monoline or multiline, is through the reserve requirements. By adjusting the required reserves that a company has to maintain depending on the mix of the types of policies it underwrites, the government can essentially legislate the insolvency risk to be whatever level it deems acceptable. A customer with a title policy from a multiline insurer need not be inherently at greater risk that someone with a policy from a monoline company; it’s only a multiline firm with insufficient reserves to reduce its insolvency risk to the same level of the competing monoline that passes along that risk to the consumer. It may turn out in practice that, in order to underwrite both mortgage insurance and title insurance, a company would need such high reserves that it would never be able to compete with monoline title insurers on price, and the market would naturally choose monoline insurers anyway. But I would say that’s for the actuaries and the markets to figure out, and there’s no need to dictate that outcome as a matter of policy. (For what it’s worth, Mr. Jaffee’s paper notes that such systems have been tried, but the resulting insolvency rates have been higher than estimated. To me, that’s an actuarial error that can be fixed, and not a legislative error, but Mr. Jaffee supports the continuation of monoline restrictions as the best current solution.)
Ultimately, the monoline restrictions seem a bit shady to me, but they’re not the real issue that prevents actual competition within the industry. After all, it’s theoretically possible for any insurer wishing to offer title policies to create a monoline subsidiary company to do so. The title insurance industry is indeed more concentrated among a few large companies than other types of insurance, suggesting that competition has been artificially reduced. But the real reason that prices are so high is… well, the fact that in many states, the prices for title insurance are set by law. It’s typically illegal for a title insurer to charge less than the state-mandated rate. Sound sketchy? It most certainly is, but this subject will have to wait for a future post.